Team Favorite At the Money: Should You Be A Stock Picker?

We know it’s challenging, but should you try your hand at stock picking? It's fun, it gives you something to talk about at parties, but is it profitable? Larry Swedroe, Head of Financial and Economic Research at Buckingham Strategic Wealth, which manages or advises on $70 Billion in client assets, speaks with Barry Ritholtz about the challenges of picking stocks. Only a few people have been successful at it over time, and they have become household names. Most of the rest have not earned their costs. See omnystudio.com/listener https://omnystudio.com/listener for privacy information.

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Speaker 00

  At KKR, we've spent 50 years understanding what matters to our clients and companies. From pioneering private equity to investing across credit, real assets, insurance and sports, KKR has built the experience to navigate complexity, the judgment to recognize opportunity, and the conviction to create lasting value. Because when people and institutions are counting on us, understanding what matters isn't just important, it's everything. KKR, understanding what matters. Visit kkr.com/whatmatters.

• 0:30Speaker 01

  When you're a business owner interested in expanding to new markets, there's a lot to consider and countless questions to answer before making the call. The most important one being, are you ready? That's where ChatGPT comes in. Give it a goal, add your files, and ask chat to help you map out different scenarios for the future of your business. So when growth is on the table, you've got an expansion plan ready to implement. Get started at ChatGPT.com.

• 0:58Speaker 01

  Bloomberg Audio Studios. Podcasts, radio, news.

• 1:10Barry Ritholtz?

  I'm Barry Ritholtz, and on today's edition of At the Money, we're going to discuss whether or not you should try your hands at stock picking. 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 Swedroe, Head of Financial and Economic Research at Buckingham Strategic Wealth. The firm manages or advises on over $70 billion in client assets, and Swedroe has written or co-written 20 books on investing. So Larry, I know you're not a big fan of stock picking. What's the problem with throwing a couple of great stocks into your portfolio?

• 1:52Speaker 03

  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 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,

• 2:35Speaker 03

  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 in 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.

• 3:14Barry Ritholtz?

  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 stock picker, Carl Icahn, Bill Ackman, all these different fidelity fund managers have been great stock pickers. How hard can it be? Why can't we just go out and pick a few great stocks and that's our portfolio?

• 3:33Speaker 03

  Right. Okay, so let's start with the premise that markets are not perfectly efficient. There are a few people who have 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 Buffett being a great stock picker, taking nothing away from what Buffett did, but the reason... 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

• 4:16Speaker 03

  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 them 50 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 Berkshire has not outperformed in the last couple of decades. Because the

• 5:00Speaker 03

  market is caught up to him and eliminated those anomalies, if you will, you can do the same thing. So, takes nothing away from Buffett. He gets all the credit for figuring it out 50 years before everybody else. But it wasn't stock picking, and it certainly wasn't market timing.

• 5:18Barry Ritholtz?

  So, I know the indexes will give me 8%, 10% a year annually, and those are great returns. But Netflix is up like 1,000% over the past couple of years, and Nvidia is up 3,000% over the past couple of years. Wouldn't that goose my returns if I can own companies like that?

• 5:38Speaker 03

  Yeah, that's certainly true, Barry, but we got a couple of problems with that. 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 100 years virtually of data in the US, only 4% of stocks, 4% have provided 100% of the risk premium over T-bills. What are the odds?

• 6:12Speaker 03

  We're going to be able to find those stocks. Problem number two is people cite the Nvidia's, but they also forget that last year, a good example, while the S and P was up 26 and a half percent, 10 stocks underperformed by at least like 60%. At least 60%. They're down at least 32. 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 4% of all the stocks account for all the outperformance, that means the average stocks underperforms the average.

• 6:55Speaker 03

  So the odds are you're going to pick the underperformers, not the outperformance. That's simple math. Uh, so the more stocks you own, the better your odds of earning the average.

• 7:08Barry Ritholtz?

  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?

• 7:17Speaker 03

  Should expect a performance that if you are familiar with asset classing, uh, 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 200. So you could have what's called tracking variance around that of 5 or even 10%. But the more stocks you own, the closer you're going to get to that index. So why bother? You're better off just owning the index at very low cost. 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

• 8:01Speaker 03

  with your wife and your kids, enjoying a nice round of golf or 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 in the market.

• 8:13Barry Ritholtz?

  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?

• 8:24Speaker 03

  Yeah, there's certainly that emotional biases are part of the reason people think they're going to outperform. The research shows, for example, that we're human beings and we tend to be over optimistic, overconfident in our skills, so that 90% 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 lost money in the years.

• 9:09Speaker 03

  Not only did they not outperform, so selective memory creates a problem as well.

• 9:15Barry Ritholtz?

  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 wind, they take less than 5% 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?

• 9:40Speaker 03

  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. And if you follow the research as presented in 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...

• 10:23Speaker 03

  Need to enjoy your life, you might want to think about where your values are. Again, I say that with tongue in cheek, though.

• 10:31Barry Ritholtz?

  So, so to wrap up, investors who think they could 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 and working over the long haul for you.

• 11:13Barry Ritholtz?

  I'm Barry Ritholtz and this is Bloomberg's At the Money.

• 11:30Speaker 00

  This podcast is brought to you by Navy Federal Credit Union. Their flagship premier card gives you four times points on all travel. Earn on flights, hotels, ride shares and more. Plus, the flagship premier card doesn't require you to use any booking portals and has no rewards limits. It's all the travel, none of the baggage. Visit NavyFederal.org/flagshippremiere to find out more. Navy Federal is insured by NCUA. Terms and conditions apply for rewards.

• 11:57Speaker 04

  If you listen to financial news, you know a lot of time is spent thinking about what's next. The next opportunity, the next investment, the next move. But sometimes what matters most is being ready for what you never saw coming. For more than 75 years, Cincinnati Insurance has worked with independent agents to help protect businesses, homes, valuables and more. Because planning for the future isn't only about knowing what's next, it's about making sure you're ready for what you can't predict. Let Cincinnati Insurance make your bad day better. Find an independent agent at C I N F I N dot com.