Index Picking Is The New Stock Picking
It’s commonly said is that stock picking was easier a long time ago (50, 70, or 100 years ago) but the market is getting more efficient so it’s harder to beat an index by picking individual stocks now. This has led many investors to use index funds these days, and I’m among them. But in investing every success is self-defeating when it goes too far. This could lead to opportunities for investors who are informed and have the right emotional balance.
It seems that markets are moving more and more as a whole, especially in the last 10 years. This comes from a variety of effects. Individual investors will frequently sell their stock funds (which are either index funds or closet index funds) causing the whole market to go down since their funds cover most of the market. Or institutions that have a very broad asset exposure and get into trouble will sell one asset class to rescue another, causing a whole market to drop for reasons that have nothing to do with it. On the other side I’m not sure yet if a rising market would draw in more indexed capital or if people would try picking stocks for even bigger wins (see 1999).
In reality the fundamentals have not changed. A large part of the market is driven by emotion (even professional investment administrators at institutions that pick other professional managers to handle the money have to face the emotions of justifying their job every year). The actual amount of capital that’s driven by rational investors seems pretty small sometimes, although they do have a tendency to make money over time and have more to work with. What’s happened (starting around 40 years ago) is that instead of individual stocks bouncing around wildly on top of peoples’ shifting emotions, this effect is being transferred to markets as a whole.
This has interesting implications for thoughtful investors. If stock picking is dead, is “index picking” the new opportunity? This could include a variety of ways to adjust weightings between different indexes. I keep substantial positions in the indexes that interest me and adjust the allocations slightly when I think there’s an opportunity. Someone who’s more confident might only be invested in 4 of the 10 indexes they’re interested in depending on the current conditions.
Stock picking also may not be dead. With increased index following stocks may move together more often and with more active managers the opportunities may be smaller and shorter. But if a whole market is driven down or pushed up it’s likely that some of the individual companies in it don’t belong in the same boat. I’m not interested in stock picking at this point though because the best picks can be dragged down when the whole market is punished. Using indexes allows me to work at a higher level and have more options for diversification without having to do a lot more research.
What’s really required to “beat the average” is to have a better emotional balance than the average influencer (not the average investor since some investors answer to someone else). For example this might mean making decisions on a 10-year time-frame while everyone else is thinking about the next 3 months. If you can do this there are many ways to apply it.
The math is clear: the average person is not above average and never will be. When it comes to advice that anyone can follow, the average returns from the capital markets are generally fair and we’re lucky to have them available to us. If I have to “settle” for average returns that’s perfectly fine. But if I can put the cold metallic side of my heart to work and earn a slightly higher return I’m willing to experiment with that.