Following up on my initial article outlining my current "dividend-for-financial-independence-seeking" portfolio, I have received a lot feedback directed at the fact that I presumably own too many stocks (that I cannot properly manage), and should rather invest in funds or trim down positions.
Now, having done some research on this and having read multiple valuable articles on the behavioral aspect of investing, I discovered three stunning and remarkable facts:
- On average smart money does not exist, i.e. "the selection of stocks is more like rolling a dice than like playing poker" and that "stock pickers are playing a game of chance".
- "Trading is Hazardous to Your Wealth": The higher the number of trades on average the poorer the results which implies that less active traders earn higher returns
- "Boys Will Be Boys": Men are trading significantly more and are more confident than women but are achieving considerably worse results
What Does This All Mean?
Here is a selection of thoughts that immediately popped up:
- "Wow, an entire industry is apparently compensated for based on luck rather than on skill? All these highly paid Wallstreet professionals receiving hundreds of thousands in bonuses may achieve good results but on average only by chance?"
- "So, where is alpha if average stock selection is uncorrelated to skill?"
- "If stock picking is like rolling a dice why am I even bothering with that and not invest in funds and ETFs?"
- "Even with low commissions, had I invested all money in let's say 10 funds each at 2,000 USD and 10 USD fees I would have saved more than 50% of total paid fees and saving hours and days of research."
- "The overconfidence bias, especially among men to which I count myself, is really strong and statistically results in poorer results. Alright, so let's look for funds managed by women."
Hence, digesting these thoughts I initially concluded "okay, it is not only time-consuming to research several dozen companies, to monitor them and to act accordingly, no, it is also not really worth it as overall any above-average returns are rather by chance". That was somewhat disappointing and I already started doing some mental accounting related to how I can now shift from stocks to funds and what this means for my journey.
I was puzzled. While I already knew that behavioral finance is vital to one's investment career and success and that people feel and fear losses far more than they value and rate gains I still believed that it is possible to beat the market, to seek alpha while also being better diversified. In the end that's it why we are all here, aren't we?
But, let's wait. Is that really the right conclusion?
What Does It Really Mean?
One of the most important lessons I have learned in life is that you should not jump to conclusions too quickly. This applies to personal situations such as "My girlfriend is not responding to my messages. What is going on?" as well as to professional situations, e.g. "If the market is crashing you need to get yourself out and avoid losses". So, I took a step back and slowly started to see the bigger picture in which I had to integrate my own ideas, values and principles. As per se values cannot be wrong, instead you can only agree or disagree with them, this is the picture that evolved:
- I feel better to invest the time in managing my equity portfolio of dividend stocks rather than just passively observing a fund or ETF to perform.
- I am very much aware of the fact that I will make mistakes but I want to learn from them.
- I do not want to trade in the literal sense of buying and selling frequently, which e.g. index funds are doing to replicate the performance of the underlying index.
- I am willing to make many transactions on the buy side with which I feel comfortable as long as the fees do not take away more than 0.75% of yearly performance.
- Primarily I do not want to invest in hundreds or thousands of companies others are controlling and instead seek alpha by acknowledging and following the knowledge and experience of the community (= the wisdom of the crowd).
- I am not a woman and thus tend to be overconfident.
What does this now mean to dividend investors as myself?
- Be aware that one tends to be overconfident and that on average individual stock picking performance is like rolling a dice.
- Decide for yourself what makes you feel better: Owning several (no limit) companies you carefully chose (by following or replicating others' investment decisions, by your own research or by gut feeling) or investing in several (no limit) companies others control for you?
- Decide if you want to actively manage your equity portfolio and invest time or let others do the work and seemingly avoid accountability for the performance.
- Be aware that when starting young time is your best friend and you have enough time to learn from your mistakes, perceptions and biases.
- Consider looking for funds run by women and compare their performance with the one of their male counterparts. Seriously!
- Be aware that whatever statistics tell you these are results and conclusions based on averages. This means that there are individuals and cases (e.g. Warren Buffet) who consistently demonstrate skill and achieve higher returns and some who do significantly worse.
Sources:
- Brad M Barber and Terrance Odean, "Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors", Journal of Finance
- Brad M Barber and Terrance Odean, "Boys Will Be Boys: Gender, Overconfidence, and Common Stock Investment", Quarterly Journal of Economics (2006)
- Daniel Kahnemann, "Thinking, Fast and Slow", 2011 edition