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

Episode Release Date: December 18, 2024
Host: Barry Ritholtz
Guest: Larry Swedroe, Head of Financial and Economic Research at Buckingham Strategic Wealth

Introduction to Stock Picking

In this episode of Masters in Business, Bloomberg Radio host Barry Ritholtz delves into the perennial debate of whether individual investors should engage in stock picking or stick to broader investment strategies like index funds. To unpack this topic, Barry is joined by Larry Swedroe, a renowned expert in investment research with over $70 billion in client assets under management and 20 co-authored books on investing.

The Pitfalls of Stock Picking

Barry opens the discussion by challenging the value of stock picking, asking Larry about the inherent problems with selecting a few standout stocks for one's portfolio.

Larry Swedroe responds at [01:26], "If it's done for an entertainment account... the evidence is very clear that stock pickers on average lose because of their trading costs, not because they're generally dumb." He elaborates that while stock picking can be tempting for its entertainment value, the average retail investor often underperforms due to higher trading costs and behavioral biases.

Swedroe highlights that retail investors are frequently drawn to "lottery-like stocks," such as penny stocks or high-growth small-cap companies, which generally underperform. He notes, "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." (02:48)

The Myth of the Great Stock Picker

Barry challenges Larry by citing legendary investors like Peter Lynch, Warren Buffett, Carl Icahn, and Bill Ackman, questioning why their success isn't easily replicable by the average investor.

At [03:08], Larry Swedroe acknowledges that while certain individuals like Peter Lynch and Bill Ackman have demonstrated exceptional stock-picking abilities, the broader market proves otherwise. He argues, "The research shows that Buffett generated massive out returns not because of individual stock picking skills, but because he identified certain traits or characteristics, statistics 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."

Swedroe emphasizes that modern investment strategies and mutual funds mimic these traits, effectively neutralizing the unique advantages once held by top investors like Buffett. He explains, "Buffett's Berkshire has not outperformed in the last couple of decades because the market is caught up to him and eliminated those anomalies, if you will." (04:52)

The Statistical Odds Against Stock Picking

Barry brings up the impressive returns of companies like Netflix and Nvidia, questioning if targeting such high-growth stocks can enhance portfolio performance.

Larry Swedroe counters this optimism at [05:13], "Only 4% of stocks have provided 100% of the risk premium over T-bills. What are the odds you're going to be able to find those stocks?" He further points out that while standout performers like Nvidia exist, the majority of stocks—approximately 96%—underperform the market. Swedroe states, "The odds are you're going to pick the underperformers, not the outperformance. That's simple math." (05:13)

This stark reality underscores the difficulty of consistently identifying and investing in the few high-performing stocks amidst a sea of underperformers.

Emotional Biases in Investment Decisions

Barry probes into how emotional biases might influence individuals to believe they can successfully pick stocks compared to investing in broad market indices.

At [07:58], Larry Swedroe addresses the psychological challenges, stating, "People tend to be over optimistic, overconfident in their skills... 90% of the people think they're better than average... but studies have shown people who thought they outperformed actually lost money in the years." Swedroe highlights the impact of overconfidence and selective memory, where investors remember their successes and forget the numerous failures, skewing their perception of their own abilities. (07:58)

The "Cowboy Account" Approach: A Cautious Experiment

Barry introduces the concept of a "cowboy account," where investors allocate a small percentage (less than 5%) of their portfolio to speculative stock picking as a hobby.

Larry Swedroe responds thoughtfully at [09:15], "Taking 5% of a portfolio is not likely to cause you great harm. And if you don't do a lot of trading and you build a little bit of diversified, you're probably going to get something like market returns." He suggests that while such an approach can satisfy the desire for active participation without significantly jeopardizing the overall portfolio, it rarely leads to substantial additional returns. Swedroe adds a philosophical note: "If you need to get enjoyment out of stock picking to have a good life, I suggest you might want to get another life." (09:15)

He emphasizes that the marginal gains from a small, diversified speculative account are minimal compared to the time and effort required, which could be better spent enjoying personal life activities.

Conclusion: The Case for Broad Index Investing

As the discussion wraps up, Barry summarizes the insights:

• Larry Swedroe asserts that investors aiming to outperform through stock picking face long odds, as the majority of stocks underperform broad indices.
• Stock picking introduces additional risk and volatility without guaranteeing superior returns.
• For those seeking the excitement of stock selection, allocating a small portion of their portfolio to speculative investments is acceptable, but the core of their investments should remain in diversified, low-cost index funds.

Barry concludes with a key takeaway: "Investors who think they could become winning stock pickers face long odds. If you wanna set up a cowboy account with a tiny percentage and play with it, knock yourself out, have some fun, just recognize that's all it is. And your real money should be locked away and working over the long haul for you." (10:05)

Final Thoughts

This episode provides a compelling argument against active stock picking for the average investor, backed by statistical evidence and behavioral psychology. Larry Swedroe's expertise underscores the value of disciplined, passive investment strategies over the uncertain and often counterproductive pursuit of individual stock selection.

Notable Quotes:

• Larry Swedroe [01:26]: "If it's done for an entertainment account... the evidence is very clear that stock pickers on average lose because of their trading costs, not because they're generally dumb."
• Larry Swedroe [04:52]: "Buffett's Berkshire has not outperformed in the last couple of decades because the market is caught up to him and eliminated those anomalies."
• Larry Swedroe [07:58]: "People tend to be over optimistic, overconfident in their skills... 90% of the people think they're better than average... but studies have shown people who thought they outperformed actually lost money in the years."
• Larry Swedroe [09:15]: "If you need to get enjoyment out of stock picking to have a good life, I suggest you might want to get another life."
• Barry Ritholtz [10:05]: "Investors who think they could become winning stock pickers face long odds. ... your real money should be locked away and working over the long haul for you."

This comprehensive analysis guides investors to critically assess the viability of stock picking, advocating for evidence-based, diversified investment approaches to achieve sustained financial success.