The Wall Street Journal recently discussed The Dying Business of Picking Stocks and how passive investing in index funds has become common. Despite this trend there are folks who make a lot of money on specific stocks. When is stock picking likely to be successful and when should you stick with an index fund?
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Pension funds, endowments, 401(k) retirement plans and retail investors are flooding into passive investment funds, which run on autopilot by tracking an index. Stock pickers, archetypes of 20th century Wall Street, are being pushed to the margins.
Over the three years ended Aug. 31, investors added nearly $1.3 trillion to passive mutual funds and their brethren-passive exchange-traded funds-while draining more than a quarter trillion from active funds, according to Morningstar Inc.
Advocates of passive funds have long cited their superior performance over time, lower fees and simplicity. Today, that credo has been effectively institutionalized, with government regulators, plaintiffs’ lawyers and performance data pushing investors away from active stock picking.
A decade ago 84% of funds were actively invested and today it is 66%. During the same decade U.S. stock mutual funds have not done well. As a group they have either closed their doors or have seriously underperformed index funds. Hedge funds as a group have not beaten the market since 2008. Why should an investor pay for “expertise” that results in lost money instead of gains? And if the experts cannot make money by picking stocks how can you? Here are a few thoughts on when stock picking is likely to be successful.
What Do You Know and How Can You Be Sure?
There have been investors over the years who have seen the future and profitably invested in it. If you had a clue about how personal computers would change the world you could have bought Microsoft in the 80’s when it went public. Biographies of baseball legend Ty Cobb typically mention that in the World War I Era and 1920’s that he invested in AT&T, Coca Cola and other stocks that proceeded on to exceptional growth. If your forte is bio tech you may have insights that will lead to you invest in the small company that will produce the next cancer cure. And if you are a follower of investing greats like Warren Buffett you will have learned how to seek out measures of intrinsic stock value so that you can routinely buy winners and avoid losers. The best advice for being successful at picking your own stocks is to stick with what you know, learn how to appraise value and keep an eye on your portfolio so that you get rid of stocks that no longer meet your criteria for winners.
Who Can You Trust to Invest Your Money?
People who loved the apparent returns that scammer Bernie Madoff gave them were sickened when it turned out that he ran a pyramid scheme which lost investors about $65 billion! Bernie is seven years into a 150 year prison sentence for this massive fraud. If someone else is handling your money you need to pay attention and if it seems too good to be true maybe you want to get out before everything collapses. This, on a lesser level of loss, it what has happened with many mutual funds and hedge funds. Many of these folks are paid well to handle your money but they end up losing money or making gains that trail the index funds. If you are a totally passive investor already the better choice is to use an index fund and avoid excessive fees for high volume trading that is eating away at your capital.