Step 3: Stock Pickers

Accept that stock pickers do not beat the market.

The primary factor determining the success of a stock picker is luck. In numerous studies, only about 5% of stock pickers beat their appropriate benchmark. Most stock pickers invest in stocks that have done well recently; however, those same stocks do poorly in subsequent periods. Stock price changes are random, closely following the news reported on their progress. It isn't possible to consistently pick stocks that will be top performers in the future.

Video clips on the failure of stock pickers.
One self-touted stock picker is Ken Fisher. You may want to read the Complaints Board before turning over your hard earned money to him.

3.1

Introduction

Stock pickers are exactly what their name implies - active investors who pick stocks or even mutual funds based on perceived mismatches between the current market prices and their supposed true values. This is a major problem. In this random and efficient market, there are no mismatches between the current market prices and their true value. Stock pickers listen to their feelings and instincts when choosing which stocks to pick. This Step reveals a study that determined the chances of an active manager beating the appropriate index are just one in thirty-six, the same long shot as throwing snake eyes at the craps table! In fact, less than three percent of managers even beat their proper benchmark. Unlike index investors, active investors who try to pick winning stocks are little more than gamblers who rely on raw emotion and their imagined ability to predict tomorrow's news. As Nobel Laureate Bill Sharpe asks, "why pay people to gamble with your money?" When investors pay high loads, commissions or fees to stock pickers, it may be more appropriate to refer to them as pocket pickers.

Quotes

William Bernstein

"it turns out for all practical purposes there is no such thing as stock picking skill. It's human nature to find patterns where there are none and to find skill where luck is a more likely explanation (particularly if you're the lucky [mutual fund] manager)." Mutual fund manager performance does not persist and the return of stock picking is zero." We are looking at the proverbial bunch of chimpanzees throwing darts at the stock page. Their "success" or "failure" is a purely random affair."

William Bernstein, The Intelligent Asset Allocator

Nobel Laureate, Merton Miller

"If there's 10,000 people looking at the stocks and trying to pick winners, one in 10,000 is going to score, by chance alone, a great coup, and that's all that's going on. It's a game, it's a chance operation, and people think they are doing something purposeful... but they're really not."

Merton Miller, Nobel Laureate and Professor of Economics, Univ. of Chicago, Transcript of the PBS Nova Special,"The Trillion Dollar Bet"

Richard M. Ennis

"Empirical evidence provides no support for the claim that active management of small-cap portfolios is more fruitful than it is for large-cap portfolios."

Richard M. Ennis, The Small-Cap-Alpha Myth

The Trillion Dollar Bet

"The economists arrived at a devastating conclusion: it seemed just as plausible to attribute the success of top traders to sheer luck, rather than skill."

Transcript of the PBS Nova Special, "The Trillion Dollar Bet"

Zvi Bodie

"Not surprisingly, the efficient market hypothesis does not exactly arouse enthusiasm in the community of professional portfolio managers. It implies that a great deal of the activity of portfolio managers - the search for undervalued securities - is at best wasted effort, and quite probably harmful to clients because it costs money and leads to imperfectly diversified portfolios."

Zvi Bodie, Alex Kane, Alan J. Marcus, Investments, p. 355

Eugene Fama, Jr.

"After taking risk into account, do more managers than you'd see by chance outperform with persistence? Virtually every economist who studied this question answers with a resounding "no." Mike Jensen in the Sixties and Mark Carhart in the Nineties both conducted exhaustive studies of professional investors. They each conclude that in general a manager's fee, and not his skill, plays the biggest role in performance." [the higher the fee, the lower the performance]

Eugene Fama, Jr.

Anonymous Stock Broker

"I have been a stockbroker for 5 years and have made people money, but I always lose it in the end. I have taken huge risks with my clients. I have lost millions, but I am tired of looking for new clients."

Anonymous Stock Broker Sept., 2001

Michael Jensen

"Very little evidence [was found] that any individual [mutual] fund was able to do significantly better than that which we expected from mere random chance."

Michael Jensen, "The Performance of [115 US Equity] Mutual Funds in the Period 1945-1964", Journal of Finance, May 1968

Burton Malkiel

"It's like giving up a belief in Santa Claus. Even though you know Santa Claus doesn't exist, you kind of cling to that belief. I'm not saying that this is a scam. They generally believe they can do it. The evidence is, however, that they can't."

Professor Burton Malkiel: - ABC News Program: 20/20, November, 1992

Mark Hebner

"The only way to "beat an index" is to invest in something other than the index. Why would you, when the only source of long-term risk and return data IS the index? Since you can't beat the index, be the index."

Mark Hebner, Founder, Index Funds Advisors, Inc.

Economics

"The implication [of the Efficient Market Hypothesis] for the investor is that it is almost impossible to "beat the market."

12th Grade Economics Text Book, Economics, (even our kids are learning this)

Patricia C. Dunn

"Investment managers sell for the price of a Picasso [what] routinely turns out to be paint-by-number sofa art."

Patricia C. Dunn, CEO, Barclays Global Advisors (World's largest money management firm, approx $1 trillion of assets under management, approx 80% indexed)

William Bernstein

"All such [market beating] strategies have two things in common: First, they won't work. And second, the reason they won't work is that the anonymous investors on the other side of the trade usually have more on the ball than you imagine."

William Bernstein, Money Magazine, Oct. 22, 2008

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Step 1: Active Investors

Definitions

Problems

Solutions

Step 2: Nobel Laureates

Definitions

Problems

Solutions