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