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Team Favorite At the Money: Should You Be A Stock Picker? · Masters in Business

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