Why ETFs Beat Stock Picking: The 12-Step Program for Active (Stock-Picking) Investors

Mark Hebner of Index Funds Advisors is author of Index Funds: The 12 Step Program for Active Investors. Here's his summary of the book in one page; readers will find many of the ideas consistent with The Radical Guide to Investing:

Step 1. Active Investors: Recognize an active investor. Active investors hope to pick winners among the many stocks, times, managers or investment styles. But, the problem with the methods deployed by active investors is that markets are moved by news. News is unpredictable and random. Therefore, the movements of stocks, markets, managers, and styles are unpredictable and random. Markets are also efficient, meaning that news is rapidly reflected in market prices. As a result, active investing is not a viable strategy. The only reliable source of long-term returns is from consistent exposure to economic risk factors that have nearly 80 years of history.

Step 2. Nobel Laureates: Recognize that Nobel Prize winners researched the market. Nobel Prizes have been awarded to academics for their analysis of how stock markets work. The allure of their findings is that they’re not biased by a need to earn a commission or sell you an IPO, magazine or newspaper. More than a hundred years of academic research has concluded that index funds are an investor’s best investment. Sadly, the great majority of investors have never read these academic studies so they continue as active investors.

Step 3. Stock Pickers: Accept that stock pickers do not beat the market. The primary factor influencing the success of a stock picker is simply luck. In numerous studies, only about 3% of stock pickers beat their benchmark. Most stock pickers invest in stocks that have done well recently; however, those same stocks do poorly in subsequent periods. The performance of stocks is random, just like the news that influences their prices. Therefore, it is not possible to consistently pick stocks that will be top performers in the future.

Step 4. Time Pickers: Understand that no one can pick the right time to be in or out of the market. When 32 market timing newsletters were compared to the S&P 500 Index over a 10-year period, not one of them beat the broad market index. The primary reason for this inability to time the market is the high concentration of returns and losses that occur in a time period of a few days. In a 10-year period, about 88% of the total gain was highly concentrated in just 40 days. It is impossible to pick those 40 days in advance. Professors studied 15,000 predictions by 237 market timers and concluded that “There is no evidence that [market timing] newsletters can time the market.

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