Archives for February 2006

Thanks to everyone who shared why they do or do not trade individual stocks. Here’s what I think. I believe there are market inefficiencies that can be taken advantage of. I also think that unless you understand how to read a company’s financial statements and investor psychology, it is highly unlikely you can beat the market over time. Since I don’t know either of those things, I have no business trading stocks until I do.

But! I think a more important question is whether spending all that time looking at stocks is worth it. Not only do you have to build up your knowledge overall, you then have to constantly monitor the markets for new developments. After all that, by how much are you really going to beat a well-balanced mutual fund portfolio? I personally feel that unless you have a real passion for it, most people would get a better return on their time pursuing other things like career advancement or more entreprenurial activities. So I think I’m gonna do that instead.

I’m conflicted. Lots of people trade individual stocks. I do. My friends do. Maybe you do. I used to dream of watching CNBC tickers, making quick trades on my PDA, getting in on IPOs. But so far, I’ve just made the occasional trade based on some loose predictions, a good story, or love for their product. But the more I read, the more I think – why bother at all? The average active mutual fund manager cannot beat the market over time. These people have finance degrees, experience, lots of underlings, and I’m sure some smidgen of intelligence for them to be managing millions of dollars in capital. I don’t see myself as any better.

So my question is – why do you do it? Is it entertainment value? Maybe you work in the industry so you know it better than the managers? Do you believe the articles from a $5 subscription to Forbes are actually cutting edge advice? Maybe everyone else just didn’t read enough Benjamin Graham or Berkshire Hathaway annual reports? What makes you think that you can beat the market? Even though I used some sarsasm back there, I really do want to know.

This is a pet peeve of mine, and I am seeing it more and more as the dot-com crash of 2001 fades into the distance. As I read various money magazines, I see mutual fund companies taking out full page ads touting their 1-, 3-, and 5-Year average annual returns. How they beat the S&P 500 Index or Lipper average to a pulp. Then, in the fine print below, you will always find these required words: ‘Past performance does not guarantee future results’. You know why? Because it’s true.

Sure, I could make up a MyMoneyBlog Alpha, Beta, Kappa, and Zeta Mutual Fund with different holdings, and one of them will probably beat the market too just by the odds. Heck, I have personally beaten the S&P 500 since I started trading stocks five years ago, even neglecting dividends. Does that mean you should trust me with your money? If so, please send it to… Historically, just because a mutual fund has beaten the averages for a recent time period, it does not mean it will in the future. In fact, due to mean reversion it is likely to do even worse than average.
[Read more…]