Many personal finance articles focus on how to become an expert stock-picker and the virtues of picking stocks. They’ll typically cherry-pick a successful stock like Apple (it used to be Microsoft a decade ago) and how much you would have made if you bought it decades ago. Well, the reality is that for most typical Americans (retail investors), picking their own stocks has been a losing game. Here’s why:
- Even Highly Paid Experts Can’t Beat the Market – According to CNN, 86 percent of professional mutual fund managers could not even beat the benchmark they were tracking. For instance, if it’s a large cap stock fund, they could not beat the S&P500. Since there are low cost index funds and ETFs that mimic the S&P500 perfectly, it’s a better investment than most fund managers who can’t even match. This begs the question that if a professional money manager with an entire team of analysts and researchers can’t beat an index, why should a routine retail investor think they can? Based on statistics, they don’t. But many people think they’re smarter than the market or have a lucky streak. Unfortunately, over time, any luck or good prior investment moves are typically offset by the law of averages.
- Fees Put a Dent in Total Returns – Aside from the fact that most retail investors would not be indexes, you also lose a lot of money to trading fees (and taxes). See, each trade has a cost with the purchase and sale. And then, it also triggers a capital gain or loss, which is a taxable event. By just leaving money sitting in say, an index ETF with an expense ratio of 0.10 percent or lower, it’s a virtual perfect match to the index without worrying about trading fees and taxes. Over a decade long period of time, which is the horizon most adults try to trade their own stocks, there can easily be a difference of several thousand dollars as opposed to a simple passive investing approach.
- It’s Not a Level Playing Field – Even though the professional money managers don’t tend to beat the market over long periods of time, the scary thing is, they are actually better at stock-picking and have an edge over retail investors. This just shows how far in the hole a routine retail investor is in the beginning. Professional traders have much faster execution, much lower pricing on their trades, and these days, there are even thousands of computer algorithms that conduct trades within a split second with no human intervention. How can you compete with that?
I used to routinely trade my own stocks, thinking I had the next great idea. Sometimes my investments did quite well, but often times those wins were offset by losses. People tend to relish their wins and focus on them, but over the long term, in the grand scheme of things, most people would purely be better off in low-cost mutual funds or ETFs.
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