Tags: Buffett | stock | picking | index

MarketWatch: Forget Trying to Be a Stock Picker Like Warren Buffett

Friday, 13 Sep 2013 08:44 AM

By John Morgan

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Investors who follow the stock-picking mantra of Warren Buffett to "buy what you know" are actually playing Russian roulette and are probably doomed to failure, according to MarketWatch columnist Jeff Reeves.

Picking individual stocks rather than index or broad-based funds is popular now, according to Reeves, in part because correlation has dropped between sectors and asset classes, and because data on the economy is unclear.

But investors can never really know enough about individual stocks to be insulated from unwelcome developments at a company.

Editor’s Note:
5 Reasons Stocks Will Collapse . . .

"Every company is at risk. Thinking you truly 'know' a company is the kind of hubris that costs investors real money after they get overweight in a doomed stock or throw good money after bad when shares decline," he warns.

Wall Street history is full of stocks like Borders and Blockbuster that very quickly "went from decent buys to doomed companies," or that imploded like Worldcom after they were revealed to have "blatant accounting shenanigans," Reeves writes.

Various academic studies have found that diversification across sectors and asset classes produces the best profit results over time, a result Reeves advises heeding.

"Before you hurl Coke cans in defense of Buffett or malign me for my personal investment decisions, let's be clear: my biggest point is that you can never truly know a stock or the market, and that risk is inherent in the market no matter what you tell yourself about a company's balance sheet or business model."

Investor site NerdWallet.com reports that from 1926 to 2012, the U.S. stock market returns provided a 9.6 percent compound average annual return, as measured by the Center for Research in Security Prices 1-10 Index.

NerdWallet acknowledges the return would be even better if investors only picked the stocks that were going to perform the best, perhaps only the top 10 percent performers, but the odds of doing so were daunting.

"So it's clear that picking the right stocks could be extremely lucrative, but betting on all stocks in the index is also very likely to build wealth, as well," NerdWallet concludes.

Index mutual funds and their kin, index exchange-traded funds, have done better than most actively managed funds have over time, another chink in the stock-picker argument, according to Kiplinger's Personal Finance.

In general, index funds have lower average expense ratios than actively managed funds do, and the transaction costs are less than active stock picking by an individual investor.

Editor’s Note: 5 Reasons Stocks Will Collapse . . .

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