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Should I be picking my own stocks?

Our answer:

Picking your own stocks is not a requirement for investing. Investors put their money behind individual companies because they think they can outperform the overall market average. Picking good stocks isn’t easy, but it can be done.

Why does it feel like I’m supposed to be picking stocks?

Because that’s the business. The financial industry makes money from transactions and advice. They’re selling trades, ideas, and recommendations. It’s not necessarily ill-intentioned. It’s just not necessary for most people. It’s extra.

If we advised you to purchase the most basic total stock market fund and forget about it for a decade, we wouldn’t make much money from you. You, however, would have tripled your savings in just ten years.

Professional investors must be good at it, right?

Rarely. Even the best investors are not getting it right. Over the last ten years, only 13% of US Large Cap professional fund managers survived and outperformed the average index fund. US Large Cap refers to the biggest public companies in the US, like the S&P 500 index.

Professional fund managers are the best stock pickers there are. They build such strong expertise in evaluating stocks that people start giving them money to invest on their behalf and paying them millions of dollars each year in fees. These investors have teams of full-time analysts researching every available stock to pick which one might grow faster than the rest. And still, 87% fail to perform better than the average return of an index fund that simply holds shares of every available company.

And that’s not just picking a random period. The success rate falls to 9% when we go back twenty years. Last year, only half of the professional fund managers beat the market.

So it’s not worth it to invest in individual companies?

That’s not exactly right. It’s possible to pick winners. It just isn’t easy to do it consistently. In our experience, it’s easier to pick above-average companies if we’re buying and holding for the long term. Professional portfolio managers often trade a lot. They’re getting paid to trade, but trading more frequently isn’t positively correlated with better performance. Stocks are volatile. By trading more frequently, we not only have to pick the right company but also the right moment in that company’s trajectory.

We have good odds of picking a winning stock if we stick with it. Over the last 40 years, 66% of stocks performed worse than the Russell 3000 index, the main index used to represent the “total market.” There have usually been about 3,000-4,000 public companies in the US at a time, hence the “3000”. So over the last 40 years, essentially 34% have grown faster than the average. Those are still pretty good odds to pick one or two good ones in our portfolio.

Finding big winners in the stock market can be easier than the lottery. Over those 40 years, about 10% of stocks have been “mega winners,” growing 5x more than the index. So 1 in 10 stocks could bring us those lottery-like returns. Those are much better odds than picking the correct Powerball number.

So I should pick my own stocks?

We don’t have to, but it can be fun. (Yes, that’s nerdy🤓). It's exciting to put our money behind a company we believe in, especially when it succeeds and takes us along with it.

Investing in individual stocks is not step one. It's way later. It’s an add-on to a diversified portfolio. Individual stocks are very risky. Any company can go out of business or lose most of its value in a matter of days or hours. The last few years have challenged all of our assumptions about stability. Diversification is about spreading our investments to as many companies as possible, decreasing the risk any one company can have on our overall wealth. For example, buying a share of a total market fund will invest our money across every company in the market. So as the whole market grows, our money grows with it.

By first investing in a diversified total market fund, we benefit from the average growth of all the stocks in the market. The average has been good. Those average returns are what 91% of professional investors struggle to outperform. For example, the Vanguard Total Market Fund has grown by 200% over the last decade. It’s hard to say whether that return will continue, but $1,000 invested in that fund ten years ago would be $3,000 today. Adding $100 per week to that fund for the last ten years would be over $90,000 today.

Once we own every stock in the market, we’re not adding new stocks; we’re increasing the size of our investment. We can identify which companies we believe in and buy individual shares that give us voting rights and direct ownership of the company.

Remember, picking stocks is optional. It’s not easy, but it’s exciting. Always start small. The riskier the investment, the smaller slice it should be in our portfolio. If you need help finding stock ideas, Motley Fool has been a reliable source for us. Not every one is a winner, but we use it as a reference to find exciting companies.

Good luck!

You’re doing great,

The Scoop Team

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