You’re a weekend poker player. You like to play, and you’re actually pretty good. While visiting a friend, he describes an online poker site he’s been using:
- There’s a $5 fee to play,
- You get to pick the game,
- You get to choose the maximum and minimum bets, and
- You don’t get to know the identity of your opponent.
Are you interested in playing? If so, how much would you be willing to stake on a game?
And, do your answers change if you know that, more likely than not, your opponent is a professional poker player?
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Good comparison. I believe there are appropriate times and situations that people may want to invest in a particular stock, but much like gambling, I think you have to decide “how much can I afford to lose?” because that may or may not be the case when you are fully vested in one stock. Personally, I tend to agree with your Index Investing, but have picked up a couple stocks now and again…but always with money I was willing to lose in worst case scenarios.
Most people are best suited to invest in indexes without question yes.
Depends upon a few factors though. If you invest in specific stocks and have enough diversification it is possible to do better with taxes and fees. People always argue these are the two reasons pick indexed over actively managed. Yes I’m aware there are funds that are tax efficient and is another possible option. It is possible with buy-n-hold stocks that you have zero in taxes until you sell, no tax efficient fund would have this.
This assumes you are in a taxable account. If you are in say a 401k or IRA you are usually best to keep with indexing.
No one wants to go up against a pro as a weekend player. I get the analogy. Although I’m a fan of low cost indexed funds I still allow clients up to 20% invested in individual stocks (2% max per name)/esoteric ETFs for two reasons. First, there are people out there who seem to be able to sell in raging bull markets and buy when everyone is throwing in the towel. Secondly, some clients have an expertise that gives them an edge. One client sold drugs for 30 years and , I swear, knows more about the industry than the top analysts on the Street.
Even getting it a little right makes a huge difference. I, of course, read clients the riot act before allowing them to go this route and emphasize that it is up to them to follow the stock, decide when to sell etc.
With the invariant disclaimer that index funds have been shown to be best for most investors – including me, no doubt – I think you give these professionals too much credit, Mike.
Set up a side portfolio with a tiny fraction of your wealth and have a go. Poker is fun, and so is reading the papers and dabbling in stocks as long as you’re not threatening your financial future.
You’ll find it’s pretty easy to beat the professional consensus on even massively well-traded stocks a lot of the time, albeit it through skill, contrarianism, luck, pig-headedness, or whatever.
What really kills a decent stockpicker in my experience include trading costs, not backing the right sector (e.g. you do well with your tech picks but energy stocks that you don’t invest in do all the running some year), and being unlucky with companies blowing up or massively disappointing, which naturally hits a small portfolio hard.
It’s certainly not constantly being trodden on by clever superinvestors.
They’re wrong often (roughly half the time!
) from crude observation. Any advantage they get as a group I’d argue is at most a small incremental edge over time (which may be sufficient for your point, but perhaps not for the poker analogy?)
All piffle and waffle I know, but my point is that why I’m happy to concede ‘nobody can *expect* to beat the market – even the professionals*’, I’m much warier of ‘nobody can *expect to beat the market – especially the non-professionals’.
Anyway, just a bit of ammunition for you to run with my friend.
Fair enough. I submit to you this alternative analogy:
You really enjoy flipping coins. So does a friend of yours. He takes you to a local casino where you can play the following game:
Do you play? And if so, how much do you bet?
For me, the answer is still “no.”
If it’s a game of pure chance, not only do I have no reason to expect success, but it also removes the fun. There’s no longer any chance to prove my wits to be superior to somebody else’s.
I guess I see it as one of two scenarios:
It’s not only skill and resources (this then makes the assumption a trade is always a win-lose proposition, which it isn’t), but is the stock market always efficient and are traders always rational? As we saw the lows in March 09 the answer is clearly no. Many thought the world is going to end. This is not only professional traders, but how many stories did you read of 401k investors pulling all of their investments into cash? Many who pulled out where either close to the March 09 lows.
Valuations can also be too high. The 1996-1999 is a good example of this.
Personally I’m in the camp that the market can be inefficient in the short term but efficient in the long term. Short term can be hours, days, weeks and even some cases even years.
Do not take this thread the wrong way, I’m a big proponent for indexing
For what it’s worth, I’d disagree with the assertion that March ’09 proved that the market is inefficient. And my reasoning is exactly what you stated, “Many thought the world is going to end.”
There was real concern among many investors that the future of the economy was bleak, to say the least. An efficient market would reflect that with severely depressed prices.
A market made up of irrational players can still be efficient.
Anytime, anything that has a very high chance (probability?) of making me loose money, I will always be miles apart from it.
That being said, I like the analogies Mike provided
I agree. The market is efficient at reflecting the irrational beliefs of its participants.
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