That is the question I asked a couple of weeks ago in a post where I explained that for certain kinds of portfolios, the costs of individual stocks can be equal to or less than funds or ETFs.? A reader asked if I wouldn't mind addressing a more complicated concern about individual stocks: the widely discussed fact that most investors substantially lag the market.
I will warn you up front that this whole post is probably going to sound evasive.? Like a lot of financial questions, I don't like how it is framed.? The purpose of this post is to show the complexity of the question and the backdrop behind it.? If reading this article puts a lot of uncertainty in your mind, then I've done my job.? My argument is not that individuals can or can't beat the market, because frankly I don't know and I tend to think a "yes" or "no" is not a helpful answer.
My Personal Biases
I have been a student of the markets for more than 25 years, and I respect the price discovery mechanism in markets immensely.? Thus, I am not the kind of person who thinks "investing is easy".? You have no idea how much I cringe when I read articles purporting to tell people it's simple and straightforward.? I also believe most lists of "5 Stocks To Own Now" are misguided (at best).? Worst of all,?I'm especially irritated when I read articles where people brag about how they started investing a year?ago, how they bought a half dozen stocks that have outperformed the indexes, and how this proves that they're amazingly smart and investing is really easy.
And yet...
I confess that I buy individual stocks myself.? So do I think I'm smarter than the market?? No.? Am I just emotional and can't practice what I preach?? No.? Am I just delusional?? I hope not.? Let me try to explain...
How People Underperform The Market Indexes
Although there are a thousand reasons why people mess up, the mechanics of what happens can all be generalized to just a few problems.? This is not rocket science.? If someone underperforms the indexes, one of the following issues occurred:
- Bad Timing.? This is the major reason.? Index returns assume continuous holding of your investment.? In contrast, a lot of people jump in and out of the market, and most of those people time the market very badly.? Note that this mistake is not limited to individual stocks.? Many people jump in and out of index funds or other vehicles as well, usually reducing their returns substantially.
- Bad Selection.? You would think that stock picking would be easier than market timing, but evidently it's not quite so easy either.? Actively managed funds have every incentive to beat the markets, have the resources to perform extensive research, and (usually) have a mandate to avoid market timing.? Yet almost none of these funds perform better than the indexes over long periods of time.
- Bad Diversification.? While I agree that in some ways this is just a variant of bad selection,?I believe it's a slightly different scenario.?If someone picks 100 stocks and they return far less than the market averages, then I think it's fair to say that person is just not good at picking stocks.? But if someone only picks one stock, how do we really know if they are skilled or not?? We have almost no sample size.? In my mind, the person who picks only one stock has only gambled, and has not really tried to pick stocks.? If someone thinks they are really so skilled at picking good stocks, then why can't they pick 25 good stocks instead of one or two?
- Bad Allocation.? Yes, this is also bad selection in a way because it's the selection of different asset classes.? In the case of asset allocation, however, we generally do not assume that one should even be attempting to find and pursue the combination of assets that has the highest return.? Individuals may pursue different asset allocations based upon their age, risk tolerance, tax circumstances, and other factors.? Hence, we often don't know what the baseline should be.? If an investor outperforms the S&P 500 because he purchased small caps when they were in vogue, is this a sign of superior investing, or would we see underperformance if compared to the S&P 600?? Individual investors often do not state their asset allocation objectives, making performance comparisons difficult.? Yet many investors do intuitively gravitate towards allocation strategies with which they feel comfortable.
How People Outperform the Indexes
So in order to outperform the indexes, someone needs to reverse the items above.? We need superior timing, selection, diversification, allocation, or some combination thereof.? I agree most people will probably not find a suitable combination.? However, I would also guess that if someone was serious enough to understand the basic ideas above, they might very well get a lot closer.
Clearly people do outperform the indexes.? The question is not only how long it can be sustained, but more fundamentally, whether the outperformance is simply luck.? With enough investors on the planet, surely some people were just lucky.? In some cases, this may be obvious.? For example, if someone just happens to invest 100% in stocks during a bull market, and then?puts all the money into bonds at the top of the stock market at retirement, this would generally be considered luck.? But what about the person who does well researching and selecting stocks?? He, too, may just be lucky...or he may have skill.? I don't think we can really know.? Statistically, the number of years it would take to?prove someone is skilled (instead of lucky) is simply too much for one lifetime.
Why I Buy Stocks
So here are my personal reasons for buying individual stocks.? They will probably surprise.
- I enjoy constructing portfolios from scratch.? It is fun for me.? Hence, if I only duplicate the return of the indexes, I don't feel like I wasted all that effort.? Now if I thought I would substantially underperform, that would be quite an expensive hobby, wouldn't it?? But I am fine with achieving the market returns after all my work.? I am not swinging for the fences.
- What I'm really looking for is lower risk.? I'm not attempting to achieve higher returns at market risks, but market returns at lower risks.? This is not a typical objective for small investors, and it is not well served.? For example, the DVY ETF is interesting, but why should I pay 40 basis points in annual fees and allow them to put 1/3 of the portfolio in the utilities sector?
- Hand selected portfolios bring greater clarity and confidence.? If I could buy funds where the 10 top holdings always included names I could believe in, I probably would stop buying stocks myself.? But invariably, I see things I don't want.? This makes it harder to avoid the timing and other issues mentioned above.? If you truly believe in your own diversification and selection, perhaps you will avoid subpar timing and allocation.? On the other hand, investors are notoriously overconfident, aren't we?? At any rate, these are my reasons.? I'm well aware that the jury is still out.
Source: http://www.saveinvestgive.com/2012/09/my-reasons-for-individual-stocks.html
nerlens noel don t trust the b in apartment 23 world financial center shabazz muhammad angela corey zimmerman charged bonobos
No comments:
Post a Comment