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Weekend reading: Why you probably shouldn’t be picking stocks (again)

Weekend reading

Good reads from around the Web.

A research company called Mebane Faber wins my lesser-spotted post of the week award this Saturday for You are not a good investor, its disassembling of the vanities of stock pickers.1

First, the article calls up a fascinating study – The Capitalism Distribution – which examined stock returns from the top 3,000 stocks in the US from 1983-2007 and found:

  • 39% of stocks were unprofitable investments
  • 19% of stocks lost at least 75% of their value
  • 64% of stocks underperformed the index
  • 25% of stocks were responsible for all the market’s gains

Mebane Faber notes:

Simply picking a stock out of a hat means you have a 64% chance of under-performing a basic index fund, and roughly a 40% chance of losing money.

Ah, but we stock pickers have no use for a hat! We select shares carefully!

Sadly, whatever I think of my skills and whatever you know about yours, we can say with certainty that most people are terrible at managing an active portfolio.

This is brutally shown in a follow-up chart from Business Insider, which uses data from BlackRock and the famous Dalbar Study of investor returns:

terrible-investing-returns

Incidentally, check out the return on homes.

I told you guys homes have been better investments for most people, but you insisted on making it into a debate about house prices… 😉

(This is US data but I’m sure the edge would be apparent in the UK, where we’ve had even stronger property booms.)

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Budget 2013

Budget roundups:

  • Budget 2013: At-a-glance guide – BBC News
  • At several more glances – BBC News
  • High earners lose out from tax changes [Search result]FT
  • Other winners and losers – Telegraph
  • What it means for you – LoveMoney
  • Get a third opinion – The Guardian

 Budget 2013 calculators:

  • An income focused Budget 2013 calculator – Telegraph
  • This one factors in spending – BBC News

From the blogs

Making good use of the things that we find…

Passive investing

Active investing

Other articles

Book of the week: Here’s a reading list for ISA investors. How many of these investing classics have you read?

Mainstream media money

Note: Some links are to Google search results – these enable you to click through to read the piece without you being a paid subscriber of the site.

Passive investing

  • Common diversification myths, part 2 – Mint
  • Largest US pension fund considers going passive – Investment News

Active investing

  • Is a stock market bubble brewing in the US? – Swedroe/CBS
  • How to invest in diamonds [Search result]FT
  • Taking stock of Apple – Fast Company

Other stuff worth reading

  • Six scary post-budget graphs – The Spectator
  • Will Help to Buy be used for second homes? – The Guardian
  • Cyprus’s banks: Too big to guarantee – The Economist
  • Britain’s 10 most affordable cities – Telegraph
  • Should my estranged wife be dodging all the bills? [Search result]FT

Product of the week: Barclaycard has launched a new 0% balance transfer credit card with no interest to pay for 26-months. The Telegraph says that’s the longest 0% initial period the UK.

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  1. Full disclosure: I am such. For my sins. []

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{ 12 comments… add one }
  • 1 gadgetmind March 23, 2013, 9:18 am

    “Should my estranged wife by dodging all the bills ” – “be dodging”?

  • 2 The Investor March 23, 2013, 9:40 am

    Thanks Gadgetmind. I was so busy re-thanking my lucky stars I wasn’t married that I got carried away. 😉

    (Seriously, is this the only blog in the world where we worry about typos? Long may it continue! 🙂 )

  • 3 BeatTheSeasons March 23, 2013, 10:38 am

    Does the 2.3% growth in ‘homes’ take leveraging into account? If not then the real return would be several times higher for anyone buying with a mortgage.

  • 4 Paul Claireaux March 23, 2013, 12:13 pm

    Ahhhhhh. The famous Dalbar study.
    A real pity that it’s been shown to be completely flawed!

    Be careful what analysis you choose !

    http://www.kitces.com/blog/archives/406-Does-The-DALBAR-Study-Grossly-Overstate-The-Behavior-Gap-Guest-Post.html

  • 5 The Investor March 23, 2013, 12:48 pm

    @Paul — Interesting article. Will investigate later this weekend — braving the snow at the moment.

    To be honest Dalbar is so widely quoted by the great and the good that I find it hard to believe a blog has entirely debunked it, but you never know. 🙂

    (I put the link into your first comment and deleted the others for tidiness)

  • 6 John @ UK Value Investor March 23, 2013, 1:47 pm

    Hi TI, thanks for the mention. I think “the capitalism distribution” is really important as it highlights the dangers of portfolio concentration. Unless you’re Warren Buffett, I think holding very few stocks is highly risky, and not just from a ‘beta’ point of view.

    The latest Investors Chronicle said that 15 is the ideal number of stocks, based on the exponentially shrinking reduction in beta that additional stocks give. I think this is very misleading. The point of diversification isn’t primarily to reduce volatility, it should be to reduce the risk that you buy a load of duffers which subsequently underperform or go bust.

    I have learnt from bitter experience that once a stock goes to zero it stays there forever, and the money you invested is never coming back.

    Avoiding big mistakes is rule number 1, and adequate diversification is the easiest way to stick to that rule.

    I guess I should say that I prefer a minimum of 30 holdings rather than 15, but I’m not saying that’s an ‘ideal’ number, it’s just a number that I think I can manage and which I wouldn’t want to go below because of the ‘duffer’ factor.

  • 7 Matty March 23, 2013, 1:53 pm

    I found this budget on the whole boring but in general I have an issue with the fact that politicians are allowed to make sweeping a raft of sweeping changes for political as well as economic reasons – as I can guess I really didn’t like the announcements to prop up the house market and offer interest free loans to home buyers… In my opinion the government should stay out of such matter and leave prices adjust as the market sees fit…

    On another point I really enjoyed the article you linked to mentioning Norway’s pension find and how it operates. We could all learn a lot from this.

  • 8 larryN March 23, 2013, 3:00 pm

    Yeah, we all think we can beat the market. Even professional stockpickers think they can, but from my recent experience I’m not so sure.

    Decided to have a go at trading CFD’s recently, via a reputable company who make stock recommendations. They have equal access to your CFD trading account, so once you say to go ahead, they place the trade. They also advise when to get out and take profits if there are any, and suggest stop levels, so you don’t go bankrupt.

    Started out with £3000 two months ago, and I now have approx £1000 of that left. Predicting which stocks are going to rise or fall on a daily or hourly basis may seem easy, but it isn’t, not even for professionals. Down to about £1500 after about three weeks, built back up to £2000, then along came the Cyprus crisis and wiped out everything I was holding.

    The commissions to the traders are much higher than you would pay if you just traded yourself, but that’s because presumably it gives you a better chance of being right – well, maybe!

    I calculate that I’ve paid out about £800 in commissions, so the traders are doing OK, that’s for sure. It’s got a lot of similarities to gambling, in that you can persuade yourself that you’ve just been unlucky, and if you keep trying, you’ll get it all back and more. And, like gambling, you might back that big winner – or you might lose the lot, chasing your losses.

    I went into this with my eyes open, knowing it was high-risk, so I haven’t been misled or anything like that. No complaints, just reflecting on which party is doing best out of it…

  • 9 Alex March 23, 2013, 4:57 pm

    @larryN:

    Scary stuff. Thanks for sharing your experience – very useful for others.

  • 10 diy investor (uk) March 23, 2013, 5:49 pm

    Last year, “Monkey with a Pin” highlighted where many small investors were losing out – high fund charges, buying at the top of the market etc.

    Personally, I like to think I can make a reasonable return from my individual shares but I try to stick to a tried and tested set of guidelines.

    I’m sure websites like this can help to move the odds in favour of the small investor – active or passive.

  • 11 Joe's Sustainable Portfolio March 23, 2013, 8:20 pm

    🙁 That is very depressing read. Almost feel like there is no point of picking stocks…

  • 12 Greg's numeracy test March 24, 2013, 7:48 pm

    Answers to last week’s questions:
    1) What’s the chance of rolling 3 sixes in a row?
    Answer: 1/216
    (1/6 * 1/6 * 1/6)

    2) The current UK death rate is 9.3/1000. If there is no change in life expectancy (currently 80.4), will this value go up, down, or stay the same over the next 50 years?
    Answer: Go up
    A little simplistic answer really, but if the population was stable then if life expectancy was 80.4, then the number of times an individual would die per century would be 100/80.4 = 1.24. So if we had 1000 people, we would expect roughly 1240 deaths per century, or 12.4 per year. This is more than 9.3 a year. In fact, the population age is not distributed evenly and we have a bulge of people who will naturally start dying at a much greater rate, so the death rate should go up significantly fairly soon (before falling again). I hope it isn’t used to “show” whatever is left of the NHS at that time is failing…

    3) All other things being the same, if we raised the motorway speed limits, would an individual’s chance of dying of cancer go up, down or stay the same?
    Answer: Go down
    Increasing the speed limit increases the number of deaths in road accidents. If someone dies of something else then they are less likely to die of cancer. It is a sign of a (relatively) healthy society that people die of cancer etc. rather than TB etc.

    4) Torytoffitis is a nasty disease affecting 10% of the population. There is a test (not knowing the price of 4 pints of milk) which will detect torytoffitis with a 99% success rate. However, it will give a false positive 1 time out of every ten. If I take a test which returns positive, what’s the chance I have torytoffitis?
    Answer: 52.38%
    Genuine positive 10%*99%=9.9%. False positive = 90%*10%=9%. Percentage of genuine positives out of all positive tests = 9.9/(9+9.9)=52.38%.
    This is conditional probability, which people always struggle with, even though Thomas Bayes worked it out nearly 300 years ago. Look at the history of the Monty Hall Problem! People are usually surprised by the low percentage number, which can get very low for very rare issues. Note this is why there is a ‘B’ test for doping.

    Internet points to Chris! (GoP forgot that the test will only flag 90/1000 that are not affected, not 100).

    How about this one then:
    If I have a lump sum portfolio that has the following annual returns:
    +10%, -20%, +5%, +30%, -5%
    What’s the value of the most appropriate annualised return?

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