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Investing Basics

Stock Picking vs. ETFs: Who Wins?

Hey it’s Mike here, the CEO of CreditCardForum. Although I normally write about credit card offers, today I’m going to address the debate of picking individual stocks vs. going with investments that mimic the indexes.

Articles by Betterment Editors

By Betterment Editors
Betterment  |  Published: February 13, 2012

In middle school and high school, a typical hobby for most boys would be football, basketball, or some other sport. For me however – it was all about investing.

During the average week, I would spend over a dozen hours screening stocks and performing extensive due diligence on those which made my shortlist. I would dive into a company’s SEC filings and carefully study several years’ worth of quarterly and annual reports. A very time consuming process usually involving hundreds of hours.

How Did I Do?

Well not to toot my own horn, but I usually did quite well. Sure there were the occasional blunders, but overall my returns were rewarding. It got to the point where neighbors and friends would just ride my coattails and buy what I did.

But then I got sloppy. At age eighteen I was in a severe car accident, which left me with years of surgery and a long recovery. And oh yeah… now that I was an adult, I had to pay my way too (translation: earn a living).

 

Cutting Corners = Disaster

Unlike earlier when I’d been able to devote my time to picking stocks, I was only able to spend a couple of hours per weekend on research. I got sloppy…

One such example was Orthodontic Centers of America (OCA). With a P/E that hovered in the mid-single digits, a high book value, and perfect growth history… it seemed like a sure thing. If I had done my proper homework, I would have spotted the red flags long before the company’s demise.

In short, the company was front-loading revenues and back-loading expenses. When everything finally unraveled, there were investor lawsuits galore and an eventual bankruptcy. But even if I wasn’t cutting corners, the odds that my winning streak would have continued in the long-term are slim (I’ll explain why in a moment).

One Disaster Can Wipe Out Your Gains  

Is it possible to do well picking individual stocks? Yes. But in order to be successful at it in the long run you need to make it a full-time job. A word of warning: even if you choose to devote your time to picking stocks, all it takes is one major blunder (i.e. OCA) to wipe out all your gains.

Is It Really That Hard To Beat The Market?

Did you know that the vast majority of investment professionals fail to beat an unmanaged index each year? And over the long term, their performance is even worse.

So if professionals (who do it for a living) perform so miserably, do you honestly think an amateur can do better? Over a 10, 20, or 30-year period, the chance of beating the market is slim!

This is why Benjamin Graham – the father of value investing and Warren Buffett’s mentor – advised people to buy the 30 stocks of the Dow in equal amounts when they didn’t have the time or inclination to do the necessary research. Fortunately these days, we have an easier way of mimicking the indexes  – thanks to ETF investing.

The Value of Working vs. Researching?

Last but certainly not least is one other point to consider… the value of your time.

Let’s say you had $25,000 to invest and chose to put it into individual stocks. Earning a 10% gain ($2,500) on that in a given year would be an accomplishment. If you spent just 5 hours per week doing research to get there, over the course of the year you would have spent 260 hours. That equates to around $9.62 per hour. Is that price worth your time?

Perhaps your time is better spent picking up additional hours at your job, getting a second job, or starting your own business.

These days I make my living by blogging about personal finance topics like how to achieve a good credit score or maximize your credit card rewards. I wouldn’t have had time to succeed with my blog if I’d been researching stocks. Could your time also be spent doing something better? I bet it could.

Conclusion

With some things in life, simplicity trumps complexity. This is so true when it comes to investing and the statistics demonstrate that. Unfortunately many people don’t know that, because the endless ads from brokers and mutual funds try to convince us otherwise.

Betterment fully manages the account, while making it simple and efficient to use. These  are the reasons I’m such a huge fan of their approach and their investments.

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