Stock picking has a terrible track record and it’s getting worse. BobPisani speaks with Buckingham Wealth Partners' larryswedroe.
That's the thesis of Larry Swedroe and Andrew Berkin's book, "The Incredible Shrinking AlphaSwedroe is chief research officer for Buckingham Wealth Partners and author or co-author of 18 investment books.
There are several reasons. First, active stock picking is based on a false notion — that the market is somehow mispricing stocks. The evidence is that the market is highly, though not perfectly, efficient — available information is digested rapidly and reflected in market prices. Stock pickers can't identify underpriced stocks with any regularity.
We know from all the research that retail money is dumb money on average. The research shows that on average, the stocks they buy go on to underperform after purchase and the stocks they sell go on to outperform. And now there are fewer dumb investors to take advantage of.So how do you explain the small group of superstar investors who do outperform — the Warren Buffetts of the world?
In the past, executing that strategy — buying high quality stocks that are cheap — used to require a lot of work. But today, you can replicate a lot of this with an ETF at a very low price. You don't need to hire Warren Buffett or pay a hedge fund manager a 2% fee and 20% of the profits. That doesn't take anything away from the fact that Buffett is a great manager who was doing this decades before the academics uncovered his secret sauce.
There's a broader problem: Any time there is a trend, it tends to be eliminated by competition among investors for higher returns.If you want to get that yacht, yes. After that, if the strategy is successful, everyone copies you and it gets progressively more difficult to get outperformance.You said Buffett was successful because of his value and quality strategy.
Yes. Years ago, some people figured out that if you tilted a portfolio toward small caps, or toward value, you could produce some outperformance. But these investors weren't producing much alpha — they weren't picking stocks — they were picking investment styles, what we call factors today. These factors can now be replicated cheaply, and the more people pile into them, the less effective they will become.
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