How to Pick the Best Stocks

You think you can pick winning stocks consistently, and I’m here to tell you that you can’t. But even if I cannot convince you that you can’t pick stocks, I hope to at least convince you that it is not in your best interest to try. We look at examples like Warren Buffet and see how much success he had “stock picking”. But the funny thing is that Warren Buffet believes that the best strategy for most investors is to buy low-cost index funds.

Bad Advice

The most dangerous advice in investing is often that which seems most practical, which is why the worst investing advice you will likely ever receive is that you should try to pick “good” stocks and sell “bad” ones. Yes it seems very sensible and almost too obvious that you should try to do this. You will get this advice like this from innumerable sources, including a lot of investment advisers, friends, work associates, and most especially Wall Street/investment media. But…You should ignore it.

If you pursue a stock-picking strategy, you are almost certain to lag the market.

Stock pickers always underestimate the number of variables that are involved in the pricing of stocks. There are literally trillions of variables that could occur on any given day that could change the price of a stock instantly. Stock prices are based on every single investor which all have different feelings about companies, reasons for investing, and regional bias.

The big problem for investors is that even though stock-picking usually hurts returns, it’s extremely interesting and a makes for a great conversation. If you are wanting to wean yourself of this bad habit, the first step is to understand why it’s so rarely successful. The quick answer is that the overall market provides most investment returns, not particular stock picks, so stock pickers get credit for gains that came merely from being invested in stocks generally.

Although it is relatively easy to pick stocks that beat the market before costs (just like a monkey you have a 50% chance), it is much harder to do so after costs are added in. So lets say you happen to pick stocks well enough to boost your return by a couple of points, the expenses you rack up along the way (ie. research, trading, taxes) will usually more than offset your gain.

Most stock pickers believe that they are among the 1% of investors who happen to beat the market after costs, and, for inspiration and encouragement, they point to legends such as Warren Buffett and Benjamin Graham. But as I mentioned before, such investors often don’t know that even Buffett has said that the best strategy for most investors is to buy low-cost index funds and that the great Benjamin Graham eventually changed his mind to advocate a passive approach to investing.

Stock picking is not only a dangerous activity for you to be involved in as an individual investor, but it is also dangerous to invest in mutual funds that employ stock picking strategies. These stock picking strategies are used in a lot of the mutual funds out there, also known as active investing. These mutual fund managers think they have a crystal ball and can predict the best stocks and drop the worst ones.

The Opposite of Stock Picking

Instead of stock picking, invest in a globally diversified portfolio managed by a low fee investment coach that will help to educate you on the investing process. Instead of constantly turning the portfolio over by stock picking and active trading, buy and rebalance when necessary. Long term you will see the fruits of your decision.

By Jimmy Hancock

References

1.Blodget, Henry. “Why the World’s Greatest Stock Picker Stopped Picking Stocks.” Slate Magazine. N.p., 22 Jan. 2007. Web. 28 Jun. 2016. http://www.slate.com/articles/arts/bad_advice/2007/01/stop_picking_stocksimmediately.html.

2.Stock Market People. Digital image. Opinion-forum.com. N.p., Aug. 2012. Web. 28 June 2016. <http://opinion-forum.com/index/wp-content/uploads/2012/08/stock_market.jpg>.



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