Speaker 1: Because I'm a bigger, I'm a grinn. I'm Barry Ridholtz,
Speaker 1: And on today's edition of At the Money, we're going
Speaker 1: to discuss whether or not you should try your hands
Speaker 1: at stock picking. It's fun, it gives you stuff to
Speaker 1: talk about at parties, but is it profitable To help
Speaker 1: us unpack all of this and what it means for
Speaker 1: your portfolio, let's bring in Larry Swedrow, head of financial
Speaker 1: and economic research at Buckingham Strategic Wealth. The firm manages
Speaker 1: or advises on over seventy billion dollars in client assets,
Speaker 1: and Swedrow has written or co written twenty books on investing. So, Larry,
Speaker 1: I know you're not a big fan of stockpicking. What's
Speaker 1: the problem with throwing a couple of great stocks into
Speaker 1: your portfolio?
Speaker 2: If it's done for an entertainment account in the same
Speaker 2: way that we know expect to get rich going to
Speaker 2: Las Vegas. No one would invest their eye in the
Speaker 2: casinos of Las Vegas or go to the racetrack with it.
Speaker 3: So that's okay if you're prepared to lose.
Speaker 2: The evidence is very clear that stock pickers on average
Speaker 2: lose because of their trading costs, not because they're generally dumb,
Speaker 2: although I will add this, Barry, the typical retail investor
Speaker 2: is actually dumb or naive, and they get exploited by
Speaker 2: institutional investors. And it's a lot to do with biases.
Speaker 2: On the behavioral side, they like to buy what are
Speaker 2: called lottery like stocks, things that the vast majority of
Speaker 2: the time do poorly, but occasionally you find the next Google.
Speaker 2: So stocks they like to buy include things like stocks
Speaker 2: and bankruptcy penny stocks, small cap growth stocks with high
Speaker 2: investment and low profitability. Those stocks have underperformed treasury bills,
Speaker 2: but they're the favorites of the retail investors, and the
Speaker 2: institutions avoid them.
Speaker 3: Giving them somewhat of an advantage.
Speaker 1: I know you wrote a book about what a great
Speaker 1: investor Warren Buffett is and how we can invest like him.
Speaker 1: Peter Lynch was a great staff picker, Karl Icon, Bill Ackman,
Speaker 1: all these different fidelity fund managers have been great stoff pickers.
Speaker 1: How hard can it be? Why can't we just go
Speaker 1: out and pick a few great stocks and that's our portfolio, right?
Speaker 2: Okay, So let's start with the premise that markets are
Speaker 2: not perfectly efficient.
Speaker 3: There are a few people.
Speaker 2: Who I've managed to outperform for whatever reason. And I
Speaker 2: would agree with you that Peter Lynch certainly was a
Speaker 2: great stockpicker. Maybe Bill Ackman, you could add, I would
Speaker 2: disagree with Warren Buffett being a great stockpicker, taking nothing
Speaker 2: away from what Buffett did, but the research show that
Speaker 2: Buffett generated massive out returns not because of individual stock
Speaker 2: picking skills, but because he identified certain traits or characteristics
Speaker 2: of stocks that if you just bought an index of
Speaker 2: those stocks, you would have done virtually as well as
Speaker 2: Buffett did.
Speaker 3: In the stock picking.
Speaker 2: He has been telling people for decades to buy companies
Speaker 2: that are cheap, profitable, high quality, low volatility of earnings, etc.
Speaker 2: And the academics through reverse engineering, though it took him
Speaker 2: fifty years to figure it out, now have identified these characteristics.
Speaker 2: And all of the mutual funds I use run by
Speaker 2: companies like Dimensional Bridgeway AQR, they all use the same strategies.
Speaker 2: And Buffett's bird share has not outperformed in the last
Speaker 2: couple of decades because the market is caught up to
Speaker 2: him and elimit those anomalies. If you will, you can
Speaker 2: do the same thing. So it takes nothing away from Buffett.
Speaker 2: He gets all the credit for figuring it out fifty
Speaker 2: years before everybody else. But it wasn't stock picking, and
Speaker 2: it certainly wasn't market timing.
Speaker 1: So I know the indexes will give me eight ten
Speaker 1: percent a year annually, and those are great returns. But
Speaker 1: Netflix is up like one thousand percent over the past
Speaker 1: couple of years, and then Video is up three thousand
Speaker 1: percent over the past couple of years. Wouldn't that goose
Speaker 1: my returns if I can own companies like that?
Speaker 2: Yeah, certainly true, Barry, but we got a couple of
Speaker 2: problems with Edit. And but by the way, those kind
Speaker 2: of returns are the ones that encourage people to try
Speaker 2: to hit those home runs.
Speaker 3: The data shows this.
Speaker 2: Out of the thousands of stocks that are out there
Speaker 2: over the you know now of one hundred years virtually
Speaker 2: of data in the US, only four percent of stocks
Speaker 2: four percent have provided one hundred percent of the risk
Speaker 2: premium over at T bills. What are the odds you're
Speaker 2: going to be able to find those stocks? Problem number
Speaker 2: two is people cite the in videos, but they also
Speaker 2: forget that last year, a good example, while the SMP
Speaker 2: was up twenty six and a half percent, ten stocks
Speaker 2: underperformed by at least like sixty percent. At least sixty percent,
Speaker 2: they're down at least thirty two. So everyone likes to
Speaker 2: point out the winners, but you also then have a
Speaker 2: good shot at getting the losers. In fact, the odds
Speaker 2: are you're going to pick the losers.
Speaker 3: Here's why.
Speaker 2: Because only four percent of all the stocks account for
Speaker 2: all the outperformance. That means the average stocks underperforms the average.
Speaker 2: So the odds are you're going to pick the underperformers,
Speaker 2: not the outperformers.
Speaker 3: That's simple math.
Speaker 2: So the more stocks you own, the better your odds
Speaker 2: of earning the average.
Speaker 1: So if I'm a stock picker and I have a
Speaker 1: full time job and I'm doing this, you know, on
Speaker 1: the side, what sort of performance should I expect?
Speaker 2: Should expect a performance that if you are familiar with
Speaker 2: asset classing asset class pricing models. So if you buy
Speaker 2: a large value stock, you're probably going to get the
Speaker 2: returns of a large value index, but with a lot
Speaker 2: more volatility because you own one stock instead of maybe
Speaker 2: two hundred, So you could have what's called tracking variants
Speaker 2: around that of five or even ten percent. But the
Speaker 2: more stocks you want, the closer you're going to get
Speaker 2: to that index, so why bother. You're better off just
Speaker 2: owning the index at very low costs. You don't have
Speaker 2: to spend any time doing it. Your life will probably
Speaker 2: be a lot better and you know, because you'll spend
Speaker 2: more time with your wife and your kids and enjoying
Speaker 2: a nice round of golf, for a walk in the park.
Speaker 3: Or do what I do playing with my grandkids.
Speaker 2: Get a lot more pleasure out of that than trying
Speaker 2: to pick stocks at time the market.
Speaker 1: What about emotional biases? How do they affect people who
Speaker 1: think they could go out and pick the winning stocks
Speaker 1: versus simply owning a broad index.
Speaker 2: Yeah, there's certainly that emotional biases are part of the
Speaker 2: reason people think they're going to outperform their Research shows,
Speaker 2: for example, that were human beings, and we tend to
Speaker 2: be over optimistic, over confident in our skills, so that
Speaker 2: ninety percent of the people think they're better than average,
Speaker 2: regardless of the endeavor, whether it's whether you're a better
Speaker 2: than average driver, a better than average lover, or a
Speaker 2: better than average stock picker, so you think.
Speaker 3: You're likely to outperform.
Speaker 2: In fact, studies have shown people were asked did you outperform,
Speaker 2: and by how much The people who thought they actually
Speaker 2: outperformed actually even lots money in the years not only
Speaker 2: did they not outperform, So selective memory creates a problem
Speaker 2: as well.
Speaker 1: Amazing. One of the things I've heard people talk about
Speaker 1: is setting up a small what I've heard described as
Speaker 1: cowboy account where they can throw caution to the winds.
Speaker 1: They take less than five percent of their liquid assets,
Speaker 1: and that's as much as they're willing to risk and
Speaker 1: allows them to scratch that itch of either stock picking
Speaker 1: or whatever it is. What are your thoughts on that
Speaker 1: sort of approach.
Speaker 2: Taking five percent of a portfolio is not likely to
Speaker 2: cause your great harm. And if you don't do a
Speaker 2: lot of trading, and you'd build a little bit of
Speaker 2: diversified you're probably going to get something like market returns
Speaker 2: in a few follow the research as presenting my books,
Speaker 2: you can avoid those lottery stocks, improving.
Speaker 3: Your odds, you know.
Speaker 2: But my question to you is if you need to
Speaker 2: get enjoyment out of stock picking to have a good life,
Speaker 2: I suggest you might want to get another life.
Speaker 3: Now.
Speaker 2: I say that with tongue in cheek, because people like
Speaker 2: to go to the racetrack and you know, go to
Speaker 2: the casinos. There's nothing wrong with that, but if that's
Speaker 2: what you really need to enjoy your life, you might
Speaker 2: want to think about where your values are.
Speaker 3: Again, I say that with tongue in cheek.
Speaker 1: So to wrap up. Investors who think they can become
Speaker 1: winning stock pickers face long odds. Most of the stocks
Speaker 1: that are out there will underperform the index and certainly
Speaker 1: not be a source of outperformance. The odds are that
Speaker 1: they're going to add risk and volatility while spending a
Speaker 1: lot of time and effort to pick stocks, and the
Speaker 1: key takeaway is they're going to underperform a broad index anyway.
Speaker 1: That's what they need to understand. If you want to
Speaker 1: set up a cowboy account with a tiny percentage in
Speaker 1: play with that, knock yourself out, have some fun, just
Speaker 1: recognize that's all it is, and your real money should
Speaker 1: be locked away in working over the long haul for you.
Speaker 1: I'm Barry Ridholts and this is Bloomberg's at the Money.
Speaker 3: Because I'm a I'm a grinner, I'm a lover, and
Speaker 3: I'm a sinner. I blame my music in this U