Even The Experts Can’t Pick Stocks. Can You?

Even the Experts Can't Pick Stocks - Can You

There’s a lot of investment advice out there. Much of it has to do with building an investment portfolio by picking individual stocks. Most of the advice makes stock-picking sound fun, easy, profitable and generally pretty badass.

Today I want to present some simple facts that will help you decide whether trying to pick stocks is actually the right way for you to invest.

Some quick terminology

Before we get into the data, a quick terminology lesson.

An index is simply a defined selection of securities (e.g. stocks, bonds, etc.). A common index is the S&P 500, which is the set of stocks representing the largest US companies. There are also indices representing the entire US stock market, the entire US bond market, the entire international stock market, and almost any other portion of the market you can imagine.

An index fund is a mutual fund that simply attempts to match a particular index.

An active fund, on the other hand, is a mutual fund run by a person or team of people who are trying to outperform the “market”. In other words, they are picking stocks, bonds, or whatever in an attempt to get a better rate of return than if they just invested in an index fund.

Active funds typically cost more, so for the cost to be worth it they would have to outperform their comparable indices.

A fund’s comparable index is called its benchmark. So an active fund’s goal is to outperform its benchmark.

Can active managers pick the right stocks?

The surprising fact is that, on the whole, these active managers, who have spent years accumulating expertise, are paid handsome salaries, and have access to boat-loads of information, still under-perform simple indices year after year. In other words, they are unsuccessful in picking stocks that perform better than the market as a whole.

Every year, the S&P Dow Jones Indices organization publishes a series of reports analyzing this exact phenomenon. You can see the 2012 report here: SPIVA U.S. Year-End 2012.


The screenshot above is just a snippet of the information in this report. The numbers shown in the three right-most columns are the percentage of active funds that were outperformed by their benchmark. As you can see, in almost all cases the majority of active funds lost.

They do this analysis every year, for all different types of US stock funds, for all different types of US bond funds, and even for international funds. They analyze 1, 3 and 5 year performance periods.

Every year, the results are the same. Active funds keep losing.

The best funds don’t keep winning

The simple retort to the information above is that it only shows that the majority of funds lose to their benchmarks. There are still funds that are outperforming. So the simple conclusion is that there are some fund managers that are picking the right stocks and the rest just aren’t as good.

But this is my favorite part. The same organization also publishes another report called the Persistence Scorecard. You can see the most recent one here: Persistence Scorecard: December 2012.

Like the one above, this report has a ton of information in it and this screenshot only captures a small piece of it. But it is illuminating.

This report is comparing the top and bottom 50% of active funds over one 5-year period to the top and bottom 50% of active funds over the next 5-year period. So over the first 5-year period, there were 798 funds that fell into the top 50% in terms of performance.

The next column, titled “Top Half %”, is the good part. It shows the percent of the top-performing funds from the first period that remained in the top performing half over the second period. If there were legitimate skill being shown, this would likely be in the 70-90% range. In other words, most top performers from the first period would continue to be at the top in the second period. If it were a pure coin flip, then this number would be 50%, as half would continue to out-perform and half would subsequently under-perform.

The result is 40%. Less than half of the top managers from the first period remained a top performer in the second period. This is worse than pure chance.

The implication here is that there is no real skill being exhibited. It’s simply a matter of luck that some professional stock-pickers manage to outperform others or outperform the market over a given time period. And again, they publish these reports year after year and the results are always the same.


All of the above is fact. There is no theory, agenda or emotional appeal involved. It’s all the simple result of running the numbers.

Professional stock pickers can’t beat the market. They can’t even do it at the rate of pure chance. They actually lose out to a flip of a coin. And the ones that win over one period are more likely than not to lose over the next period.

So if they can’t do it, do you think it’s a good idea for you to try?

**Note: This doesn’t mean that you should avoid investing. There is a very attractive alternative to stock picking. It takes much less time, much less effort and will perform much better. It’s also a lot less glamorous, but we can’t have it all, can we?

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23 Comments... Read them below or add one of your own
  • Laurie @thefrugalfarmer May 1, 2013

    Matt, can’t wait to see your next post. As Rick and I work toward paying off debt, we are also working on eductating ourselves about investing, and I have to say, the thought of it overwhelms me a bit. Looking forward to learning more. 🙂

  • Matt Becker May 1, 2013

    Thanks for sticking around! I hope I can continue to be helpful.

  • William_Drop_Dead_Money May 1, 2013

    Here’s an interesting aspect you might want to address later: experts who pick for their own account seem to so a WHOLE LOT better than experts who pick for your account.

    There’s actually an official name for that: agency theory. It boils down to the fact that all of us put our own interests ahead of those who pay us to put theirs first. A realtor, for example, push for sales that benefit them, not you. Money managers, likewise, invest in a way that puts the most money in their pockets, not yours. Sometimes there’s an overlap, but it’s smaller than they would want you to believe…

  • Matt Becker May 1, 2013

    I’d be interested to see some research showing that experts achieve better returns for themselves. Could you point me in the right direction?

  • Brick By Brick Investing May 1, 2013

    There have been proven methods of how to outperform the market over long periods of time. I agree with William that “experts” will typically do better with their own portfolios as it is in their own self interest to do well.

  • Matt Becker May 1, 2013

    Can you point me to some of the research on these proven methods? My own investigation hasn’t found anything that is proven, repeatable and able to be consistently applied to beat the market, especially over long periods of time. There are certainly people that have done it, but that would happen anyways simply by chance. I’m certainly open to some research I haven’t seen though.

    You and William have both mentioned this concept of experts doing better on their own. It certainly sounds logical, but again is there research to back this up? This isn’t something I’ve seen before beyond investment experts touting their own numbers.

  • Pauline May 1, 2013

    I don’t trust the experts much and prefer to invest in index funds or other things like real estate. You never know what the “expert” really knows..

  • John S @ Frugal Rules May 1, 2013

    I would tend to agree with you Matt. There are some funds out there that are ok, but are VERY few and FAR between. However, too many funds are just bloated with fees and even if they can beat the market one year that means nothing for the next. This is part of the reason why it’s so important to stay on top of your investments and not just put money into a fund month after month and blindly accept it’ll do great. I have seen too many investors do that in my line of work when they would be much better served to go with some solid index funds.

  • Matt Becker May 1, 2013

    Great point about staying on top of your investments. This is one of the reasons I love Vanguard’s index funds so much. You still have to stay on top of what they’re doing, but any variation is likely to be much smaller and/or slower than with an active manager who has discretion to do whatever.

  • Matt Becker May 1, 2013

    I think your distrust is well-earned. Thanks Pauline!

  • The Frugal Path May 1, 2013

    I think that some at home investors have an upper hand over professional brokers. If you’re investing for yourself, your investments are tiny compared to big institutions. This allows you to get in and out relatively quickly. Plus, if you have a long-term view, then you can stick with a stock over the long haul.

    Professionals have a lot stacked against them. They need to constantly do well, for fear of losing investors. This means making moves that can cost them.

    Also, big money requires time to buy and sell in and out of a stock. This can present another problem for big institutions.

    I’m not saying that at home investors don’t have challenges, most people don’t really have any business buying individual stocks. But if you’re smart about it, you can beat the market. But it takes a lot of time.

    I prefer index funds myself.

  • For realtors, it’s been shown that the average amount of time that a realtor owned home is listed in MLS is on the order of about 2 weeks longer than a non-realtor owned home and get sales prices about 3% higher. (If I’m remembering Freakanomics correctly.) They have less of an incentive to make a quick buck and move on because they are 100% invested in the deal rather than 3% invested.

  • Brick By Brick Investing May 2, 2013

    Certainly! Read James O’Shaughnessy’s book “What Works On Wall Street” it’s absolutely phenomenal!

  • Holly Johnson May 2, 2013

    I agree with Pauline. I don’t trust anyone who generates a fee when they sell me an investment. There are too many conflicts of interest.

  • Matt Becker May 2, 2013

    Thanks for the input Justin. I agree that your points about individuals vs. professionals sound good. I just haven’t seen hard evidence that they actually bear out in any kind of consistent manner. Maybe you have, in which case I’d love to see it.

  • Matt Becker May 2, 2013

    I’ve heard that about realtors as well. It’s certainly something to think about. I haven’t seen evidence that shows this same phenomenon with investment professionals, but it may be out there. If so please feel free to share.

  • Matt Becker May 2, 2013

    I agree that there are many conflicts of interest when investment products are being sold. I do think there are times when it can help to pay for advice, but that’s a very different relationship.

  • Cash Cow Couple May 2, 2013

    This is a great post Matt! Really, fantastic post.

    I’ve been meaning to write a bit on passive index investing as I’m tired of seeing so many of the personal finance blogs praising stock picking. If the professionals can’t outperform an index, why could you or I?

    Stock picking has it’s place, right alongside other speculative investments. Or at least that’s my current position in the market today.

  • Matt Becker May 2, 2013

    I do believe each person should choose their own course, but I agree that the odds are stacked highly against you in the stock-picking world.

  • Cat Alford May 2, 2013

    Really interesting! Like anything I really believe that we are the only ones who really truly care about our money so it’s good to do our own research for sure!

  • Matt Becker May 2, 2013

    Definitely important to do your research and understand what works and what doesn’t.

  • cashRebel May 3, 2013

    Isn’t it crazy that the general public doesn’t realize this yet? If you’re trying to predict the market, you’re really just flipping coins. I know it’s not a good idea for me to try to beat the market, so I’ve never tried. Just index funds for me.

  • Matt Becker May 3, 2013

    Just index funds for me too. There’s just so much evidence in their favor, and I’ve never seen real evidence that an active approach can be consistently and successfully applied.

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