Stock Picking vs. Funds
Ben doesn't know much about finance, but on the advice of his older brother, he's been religiously putting money away into an index fund each month for the last year. However, at work and at family gatherings, he keeps hearing comments like "He made a killing on the stock market last year" and "I picked a few stocks, and I doubled my investment." He hears about incredible returns on stocks and how Bitcoin has shot up. Ben thinks about the modest growth of his own investments and wonders if he made the wrong choice. From a financial perspective, where should a person invest their money?
Individual Stocks. A Good Idea?
To the unaware, picking individual stocks to invest in seems simple. After all, self-driving cars, AI, and Apple are all obviously growing. They assume that if you're smart enough, you can pick the best stocks and end up making a lot.
Anyone with a little bit of knowledge of the stock market knows that this information is erroneous.
It's extremely difficult to make money consistently off individual stocks. J.L. Collins, author of The Simple Path to Wealth, went to work at a top financial analysis firm. Each analyst focused on a few companies in one industry and spoke to everyone involved, from the CEO to the managers to the customers to customer service. They knew everything about the company. And yet, even with all this research, this firm couldn't beat the market consistently.
As a general rule, picking individual stocks falls under the category of gambling instead of making smart financial decisions.
But Why?
There are several reasons.
First, it's impossible to know the future. Right now, AI seems to be on the rise, but anything and everything can happen. The individual stocks one invested so much in might crash, or even the entire industry could be surpassed by a new technology like quantum computers. Over the long term, diversification is smarter.
In addition, every prospective buyer has access to the same information because insider trading (getting information that isn't available to the public) is illegal. When ChatGPT came out, stock purchasers were willing to pay more for stock in the company, making the price go up accordingly. If we would know the future, then it may have been possible to get a deal, but since we don't, the general rule is that when a company is doing better or is expected to do better, the price reflects that. This is known as the efficient market hypothesis.
Furthermore, investing in individual stocks requires a wide range of knowledge. Are you a farmer, scientist, economist, lawyer, accountant, computer scientist, analyst, psychologist, supply-chain expert, and geopolitical expert? All of these fields play a role in understanding which stocks will succeed. And even if someone was all those things, nobody knows what the future will bring, so nobody can predict it with 100 percent certainty.
For example, a company manufacturing a simple product in China can be affected by Chinese politics, shipping prices, dock workers' unions, inflation, foreign currency exchange rates, droughts, tariffs, pirates, and more.
If you aren't all these things, did you at least do extensive research on the company and the other companies in its industry? Or did you just hear about it at the water cooler and decide to go for it?
Finally, when you pick a stock, you're competing against PhDs, economists, and supercomputers trained by world-class traders making millions of trades a second. The average investor don't have that level of experience or access to resources.
But People Do It
True, there are people who made it big on the stock market. But did they make money for the long term, or did they lose it all a few months later? Did they spend a few hundred dollars and get lucky, or have they been successfully picking stocks for decades? The latter is highly doubtful.
Warren Buffet is one of the few people who have managed to beat index funds by picking individual stocks, but even he hasn't been able to beat them in recent years. Also, he himself advises most people to go with index funds.
Humility is important in the stock market. To paraphrase an expression, "Humble yourself so the market won't have to." It's important to realize that it's nearly impossible to beat the stock market.
Even mutual funds that advertise that they beat the market don't usually beat the market consistently over several years. It's usually just for one year or a little longer. And the fees required can often eat out of your earnings.
The ETF Option
While an index fund is usually the best choice for a layman, there's a newer type of index fund called an exchange-traded fund (ETF). An ETF is an entire fund that is traded on the stock exchange.
ETFs usually have all the benefits and even some advantages over a traditional index fund. What are they?
You can often buy a share for as low as one dollar, as opposed to an index fund, where there is usually a minimum investment amount. They are also ‘no load,’ so there's no commission. The expense ratio, the expense charged for running the fund, is often slightly lower than index funds, and they usually have lower taxes.
Summary
The money you invest should go into index funds or ETFs that track the S&P 500, for example.
If you're still determined to play around with stocks, then set aside a small amount of money-money that could be classified as discretionary-and do it as a hobby. Taking it further than that can be detrimental.
