You're probably the best stock picker you know. I'm not just kissing up. Let's look at some of the alternatives.
managers, on the whole, produce lousy
returns. And they're getting worse. The average
actively managed mutual fund lagged the broad market by 1.7 percentage points a year during the two decades ended 1965 and by 2.7 percentage points during the two decades ended 2003, according to a 2005 Journal of Finance study.
mutual fund manager might seem different. You might have been convinced to buy shares of the fund only after reading that it had soundly beaten the market over the past one, three and five years. But I've got news for you, and you're not going to like it.
Imagine you call 800 people. You tell half of them the stock market will rise tomorrow, and half that it will fall. Come tomorrow, you'll have given great advice to 400 people. You call them and repeat the process. You keep going until you've been right four times in a row with 50 people. Then you offer these amazed folks and the next day's forecast for a fee. Sounds shady, I know. But the mutual fund industry was all but founded on that practice.
Fund companies "incubate" far more funds than they need, placing different investments in each. Some win, some lose. Winners get marketed. Losers are quietly closed.
We can hardly blame fund managers for their poor performance. They face obstacles that you and I don't have to deal with.
Diversification requirements force them to buy 100 or more stocks they're only ho-hum on, whereas we can buy just the eight or 10 we love. Fund managers have to pretty-up their
portfolios with popular stocks each
shareholder reports go out, whereas we can hold ugly stocks when doing so seems wise. And of course, fund managers have to make up for those big
Forget Wall Street
analysts, too. According to an exhaustive 2004 study of more than 50,000 recommendations made over 13 years, the predictive ability of a "buy" recommendation is statistically insignificant. Often, these recommendations are based on guesswork disguised as math, called discounted cash flow analysis. If you know what a company's
margins will look like over the next 10 years, and you can somehow quantify exactly how
risky that company is and will become, you can calculate to the penny how much it's
worth today. But you can't know any of that stuff without guessing. (And are the analysts who project 2017
revenues the same ones who can't get this quarter's
earnings forecasts right?)
Brokers and advisors:
Stockbrokers are rarely worth the money. The ones who are still permitted by
their firms to recommend individual stocks are usually restricted to ones that analysts at those firms have saddled with "buy" recommendations -- no thanks. Many investment brokers aren't allowed to recommend stocks at all. They are usually called something like "financial advisors." They stress a consultative approach and plenty of long-term planning, but nearly always suggest high-fee mutual funds. Invest $100,000 with these advisors, and you might pay as much as $5,000 up front, or $1,500 annually. Ouch.
Other stock pickers.
What about pundits like, well, me? Some are better at talking or writing about today's popular stocks than selecting tomorrow's winners. Some pundits really know their stuff, but are then called on to produce dozens of stock picks a week, which dilutes their ability. And as for stock tips from friends, coworkers and relatives, they can usually be traced back to pundits, analysts and brokers.
You should pick your own stocks. The best way to do that involves a process called
screening. Tomorrow's great stocks are leaving clues today. Decades of research have shown which clues work the best. One company's clue might be that its managers are buying shares in a particularly promising pattern. Another company might have recently spent plenty on research, suggesting that its profits are poised to balloon. You can search the entire market in seconds for a handful of companies producing these clues and many others. My job as a columnist at SmartMoney is to write about the most reliable and profitable stock screen strategies I can find. I don't create the strategies. I steal them from people who are much smarter than me, but who aren't nearly as willing to yammer on about their work in columns and on television. I've collected the best stock screen strategies I've found (stolen) into a new book called
Your Next Great Stock
Check out TheStreet.com Ratings Screener.
Of course, if stock screening truly isn't for you, there are always
index funds, right? Sure, but these are essentially stock screens that look for a single and not especially desirable clue. Most indices are based on company size. The most popular one, the
, selects America's 500 largest companies, more or less. To me, that seems like a retirement home for companies that have produced enormous
growth in the past. You won't get hurt in an S&P 500 fund, but I think you can easily beat one by a few percentage points a year by finding your own stocks if you're looking for the right clues. And a few percentage points a year for a young investor can mean an extra decade spent doing anything but schlepping to work.
I should point out that index funds are popular among people who believe that it's not possible to beat the stock market, and that Nobel Prizes have been awarded over the past half century to mathematicians who claimed just that. In the book, I argue that their theories were based on a misapplication of math and a mischaracterization of
risk, and that they have since been debunked. But then, I also spelled
Warren Buffett with only one "t" in a couple of parts, so you'll have to decide for yourself whom to believe.