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Picking Individual Stocks

 

According to John Bogle it is a mathematical certainty that over a lifetime you cannot beat the indexes with active management. He's speaking about paying Wall Street experts to pick stocks for you within a mutual fund. So what about doing your own stock picking? This would at least eliminate the high cost of your broker's sales commission and the fees that go towards managing the fund, all of which are factored in as either a front-end load fee (of perhaps 5 1/4%) and/or ongoing high fees (of perhaps 1% per year).

 

But as a casual investor are you really an expert? Let's be honest. No. Will your expertise tip the scales in your favor? The efficient market hypothesis says that even the experts have no edge. It should be like trying to pick either heads or tails on a coin flip. The main thing you are doing is just piling on extra trading costs from getting in and out of stock investments.

 

Market Timing Risk

 

And if you are trying to time the market, then this adds risk of missing out on gains. Some of the biggeset market swings have occurred in one day or just a few days. Selling a stock could work to your advantage or it could back fire. Also consider that timing the market requires not just an exit point but a reentry point. Because the stock market generally goes up, the odds are working against you. Once again the efficient market hypothesis says that buy and hold is the best strategy.

 

But there's more. By picking individual stocks rather than investing in index funds (like VOO and AGG) then you are taking on more risk.

 

Surprisingly High Risk of Picking the Wrong Stocks


In an article called “Swear Off Individual Stocks For Better Returns" Forbes magazine reported about a study by Longboard Asset Management. They looked at the returns of 3,000 stocks from 1983 to 2007 and determined that 39% of stocks were unprofitable! Unprofitable during that long and great 24 year bull market period! Meanwhile the S & P 500 index went up 829% (not including dividends). Therefore if you only owned perhaps about 10 stocks there was a real risk that you might have picked too many of the 39 percent!

 

The study also found that 19% of stocks lost at least 75% of their value and 64% simply underperformed the market.

 

How About Following Jim Cramer's Free Picks

 

Jim Cramer is a former hedge fund manager. He's an expert on evaluating companies! So is following Jim Cramer's stock picks on MSNBC's Mad Money a good strategy? An article called “Jim Cramer still won’t make you rich” concluded that “there's no evidence of any stock-picking skills -- his picks are neither good nor bad”. Again, this is the efficient market hypothesis in action. Stop trying to pick individual stocks. Even Jim Cramer endorses index funds to those who don't have time to research stocks. I think we can take it a step further and says that history strongly suggests that everyone should just invest in plain old index funds. Use that extra time and money saved to enjoy life!

 


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