Rich on Money

Financial Freedom through Debt-free Real Estate Investing

You Are Not Awesome at Picking Stocks!

To illustrate how un-awesome you are, let me first share how awesome I am.

When I was just getting started out investing in 2001, I put all the money I had, $4,000, into an index fund. I called my bank and said put it in the S&P 500 index. Warren Buffett taught me well.

The savvy salesmen on the other end of the phone who was clearly more experienced than Warren told me I was crazy to invest in that. I could make money twice as fast if I invested in their aggressive growth fund.

NOW I’M AWESOME!!!!!!

The internet bubble exploded a few weeks later.

Stocks plummeted.

Let me tell you the cool thing about the aggressive growth fund. When stocks rise 10% in a day, aggressive growth rises 20%.

AWESOME!!!

Unfortunately, the inverse is also true.

When I noticed my $4,000 had dropped about 50%, I sold and locked in those losses.

It was the best thing that ever happened to me!! I’m so awesome!!!!

Wow! What’s the worst thing that’s ever happened to you????

I’ll give an example of what I think the worst thing that can happen to someone (financially) is.

You are just getting started in your financial life. You have a decent job. You’ve been saving money to invest.

You sometimes read the Wall Street Journal. You subscribe to the Motley Fool. You keep up with financial news. You’ve read many investments books, been watching the stock market for a while, and are ready to jump in!!!

morningstar

I recommend Morningstar.  Because past performance always indicates future performance. (Not)

You have $10,000 to invest.

You get a hot tip from a friend who makes a ton of money in finance. You do lots of online research and the tip on this stock makes sense .

It also “feels right” to you.

You buy $5,000 of the stock. It shoots up 50% over the next three months. You sell and lock in those profits.

You are AWESOME. You are SMART. You timed the market perfectly.

Too bad you didn’t invest all $10k!!!!! Don’t doubt yourself next time!

          Let me ask you a question.

What is the worst thing that could happen to this person the next time they invest?

If you are reading my blog, you probably know the answer to this question, but it’s good to have a reminder once in a while.

IF THIS PERSON MAKES MONEY ON THEIR INVESTMENT, THEY ARE TOTALLY SCREWED!!!!

          Why are they totally screwed? They’ve made some easy money??!?!?!? They clearly have the gift!!

They will start believing they have the rare ability to pick winners.  They have a knack for investing.

After their third of fourth successful investment they are convinced they have an uncanny ability to sense the direction of the market in the short term.

Perhaps they’ve mastered the techniques taught in a stock trading course or maybe read a book like the one below.

stock-market-wizard                   This book must be awesome.

I DON’T THINK SO.

This is dangerous thinking. Maybe you don’t think you are THAT awesome, but you at least think you are a little bit awesome.

Somewhere in the back of your mind you do. You think you are awesome.

(Rich Screaming:) ADMIT IT!!!!!!

There are thousands. Not hundreds. THOUSANDS of professional mutual fund managers with access to TONS of research, news, analysis, and what one might consider inside information in their particular field of investment.

Despite all this, most PROFESSIONALLY TRAINED AND PAID INSTITUTIONAL INVESTORS fail to beat the S&P 500 over the short term, and they do even worse in the long term.

            What does that tell you?

Statistically, it makes MORE SENSE to let your money ride randomly in the stock market (S&P 500 Index) then to guess which small portion of mutual fund managers will beat the market.

Those few managers that do better than the S&P 500 over the short term are probably doing so based on luck. A small amount of traders will beat the market based on luck.  Their strategy happens to correlate with what the stock market ends up doing.

Don’t mistake this for clairvoyance.  They are not actually wizards.

This luck balances out over the long term. The truly random nature of the market eventually takes that money back, and they lose ground to the S&P 500.

It’s the same way you can make money in blackjack over the short term, think you are awesome, and then keep playing and end up in the negative.

            O NO!!! We suck again!!!!!

When you play blackjack over the short term, you can sometimes have an extreme run of luck and double or triple your money. It’s a pretty awesome feeling. I’ve done it. I’m that good!!!

HOWEVER, if you play blackjack over a long enough period of time, it is a mathematical certainty that you will eventually lose money!!!!

If you play blackjack using the perfect strategy (easily available on the internet), the house still has a 1.5% advantage over you. If you once in awhile throw in some intuition and deviate from the rules (which everybody does when they think they are awesome), it swings that percentage even more into the house’s favor.

Picking your own stocks and mutual funds, and deciding when to buy and sell them, is a lot like gambling.

The more short term your investment strategy, the more unstable and dangerous your returns are.

          WHY?

Because, in the short term, price movements have little or no correlation to reality. They can move up or down for no discernible reason. This is why day trading is the awesomest way to throw your money in the trash in the quickest way I can imagine.

Next to that, buying and selling individual stocks over timeframes of weeks or months is also a horrible idea.

Even a professional buying and selling conservatively over the long term with a well-thought out and researched system will still not beat the S&P 500 over the long term. There are a few that do, but it probably has a lot to do with luck in those rare cases.   There is no way to know who that lucky guy or gal (or investment banker) is ahead of time.

So what the hell can we do, Rich?

GO WITH THE S&P

Do what has the best statistical chance of winning over the long run. Investing in the S&P 500 long term.

When Warren Buffett dies, he instructed his money be put in S&P 500 Index for his wife.  He doesn’t suck at investing.

It’s a great strategy, but it shouldn’t be your only strategy. Nothing in life is certain.

Despite popular opinion, stocks will not keep going up forever.

GO WITH REAL ESTATE

Wisely invest in cash flow producing real estate.  This is what I focus on. It’s provided my financial independence early in life.

These investments are not tied to the random nature of the markets. If you get a good deal on a property and you do your homework ahead of time, you can be fairly certain about the return on investment you will get over the long term.

If will not vary much. It won’t be much higher or lower than what you calculate.

You can’t say that about stocks. Stocks can vary widely up or down over months or even years.

KEEP SAVING AND EARNING

Far more important than any investment strategy is the ability to set money aside to invest. This is done simply by increasing the gap between what you spend and what you earn.

For this reason, it’s best to live frugally as you dig out of debt and build up a nest egg.

Even more important than being frugal is the ability to increase your earnings. There is a limit to how much you can cut back on your spending, but there is no limit to how much you can earn. This will make the biggest difference. Side hustles, second jobs, you’ll figure it out.

          So Rich, why did you say you were awesome for losing a bunch of money???

Maybe awesome isn’t the right word. I was lucky.

The sting of failure I received early in my investing career has kept me from ever believing there is a way to predict future movements of the market.

Billions are spent on newspapers, courses, articles, news networks, tv shows, books, etc. all on the premise that you will spend money to get their useful information so you know the direction of the markets and can make easy money.

Good luck with that.

If those billions spent on advertising is wasted on you, you are doing well. You understand the truly random nature of the market. You won’t be a sucker.

Just remember, when it comes to picking stocks, you are not as awesome as you think.

And once you understand that, you are getting awesomer (poor grammar) at money.

Rich on Money

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3 Comments

  1. I do like that real estate doesn’t have instant transactions. The transactions are slow and painful, which makes you think twice before unloading a property at the bottom of the market.

    Great post!

    • rich

      Thanks Brian. Real Estate has lots of advantages. Picking stocks yourself has always scared me!

  2. Looking back over the last 10 years or so, I can confidently say, although it sounds counter intuitive, that I am where I am now because of failures. Like you say, these early sucker punches were enough to keep me level headed, and I never lost sight of the bigger picture. Nice post Rich!

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