Monkeys as Expert Stock Pickers

The most recent item posted compared performance results between random stock picking and the expertise of professional stock pickers. Please refer to "Overconfidence, Dumb Luck and Expertise."

The message is that there is a profound difference between long term investing in the future performance of good solid companies and engaging in casino like frequent trading and stock picking in the shares of those same companies.

As Warren Buffet once said of the stock market, in the short term the market is a voting machine but in the long term it's a weighing machine. Over a long period of time, a company's earnings performance will determine its relative share price performance. In the short term, however, that's often not the case.

More evidence for the fallacy of believing we can successfully trade shares in the short term and outguess other guessers consistently comes from Can a monkey pick a hedge fund?.

The article confirms the foolishness of trading frequently and betting that you or your "expert" short term oriented stock picker will consistently outperform another person or that person's "expert" stock picker.

Here's a sample:

"The managers also compared the performance of actual fund of funds to randomly selected groups of funds. The differences were minimal.

They conclude that the fees associated with funds of hedge funds wipe out any added value. And their comparison of funds of hedge funds with randomly selected groups of hedge funds “would moreover suggest that such hedge-fund picking skills are on average close to non-existent in the first place.”

And this game isn’t penny-ante stuff either. These funds have about $560 billion invested in them, after peaking at $1.2 trillion in 2007.

Adding insult to injury: Most of the underlying hedge funds themselves aren’t adding value either — at least, not to the investors.

As Ilia Dichev at Emory University and Gwen Yu at Harvard found, after looking at hedge-fund performances over the past 30 years, the average has done worse than a stock-market index fund — and not much better than a simple basket of Treasury bonds."

Accordingly, the best advice for an individual investor is to start with an S&P 500 index fund or something similar. In essence that's a diversified investment in the entire market of stocks.

Later he can begin to buy selected shares in companies and monitor the companies' earnings performance while resisting the urge to trade frequently.

When buying the shares of specific companies, the individual should diversify and own shares of companies in many or all of the ten industry sectors which include technology, consumer staples, consumer discretionary, health care, materials, industrials, financials, energy, telecommunications and utilities.

The investor should also make an effort to buy when the shares of good companies are cheap or out of favor, then hold on, collect the dividends, sit back and watch the shares appreciate as time goes on.

Thanks. Bob.