Stock picking is sexy. Unfortunately, however, it doesn’t work.
Instead, the easiest way to get rich through the stock market (and with the highest chance of success) is to invest in a diversified portfolio of Exchange Traded Funds (ETFs).
Stock picking is sexy, just like smoking was in the 1990s...
The art of stock picking... discovering the next hot tip before anyone else… making millions... and being interviewed on Bloomberg TV. These are the dreams of stock picking!
And as they loop around, incessantly, through a stock picker’s mind you can almost smell the cigarette smoke as they blow it out, coolly, but by themselves, standing by the fire escape of their building, now banned from smoking inside because the science eventually caught up with that incredibly alluring appeal...
Smoking and stock picking actually have a lot in common - Both have an incredibly alluring appeal, that is completely shattered by a full appreciation of the underlying facts. And so it’s not completely delusional to think that one day adverts for stockbrokers might also have to be plastered with facts and figures showing that ‘stock picking is bad for your wealth’ in a similar style to those ‘black-lung’ type pictures plastered across cigarette packs stating that ‘smoking is bad for your health’.
Eventually the science catches up
Each year SPIVA, which is a widely-referenced research piece published by the S&P Dow Jones Indices, analyses the performance of fund managers. Fund managers are the professionals at the very top of the investment food chain. They’re the people managing trillions of dollars and taking home huge salaries in compensation for their supposed expertise. They’re paid these huge salaries because they claim to be able to beat the market.
So how well do they actually perform? In SPIVA’s most recent report they found that 90% of all active fund managers failed to outperform the market across the long-run. Put another way, as a retail investor, if you bought an index tracker fund and literally did nothing else, you would outperform 90% of the ‘smartest guys on wall street’...
And unfortunately the story actually gets even worse for most retail investors. A joint study by the University of California and Peking University found that, over a 12-year period, only 5% of active retail inventors made any profit at all.
The simple fact is that stock picking just does not work. And this makes perfect sense because it assumes that you can accurately predict the future, and obviously that’s not possible...
The goal is not to beat the market, but instead to follow the market
Average long-term market returns have been about 7% p.a. across the last 50 years or so. For example, since 1950 the S&P 500 Index has grown at an average annual rate of 7.7%. Similarly, since 1987 Hong Kong’s Hang Seng Index has delivered an annual growth rate of 7.4%. That’s not bad by anyone’s standards!
Stock market indices have managed to deliver such high returns because they automatically include the stocks and shares that do experience rapid growth, the type of growth that stock pickers dream of. The benefit of buying a tracking fund that tracks the market, therefore, is that you can buy these stocks by default, without ever having to guess which ones they’ll be before they take off. The founder of Vanguard, Jack Bogle, famously said “Don’t look for the needle in the haystack. Just buy the haystack.”
And fortunately for retail investors, buying that haystack has now become exceptionally easy, through the use of Exchange Traded Funds (ETFs). ETFs were first created about 30 years ago, and each ETF is a fund that tracks a specific index. As such, they automatically buy all of the stocks included in that index for you, all in one go. ETFs are the most efficient way for you to buy and track a market, and you can buy them directly without the need for a financial advisor or their ridiculously high fees and commissions.