Sunday, January 27, 2008

Sunday dollars+sense: Good at picking stocks. Not.

Had a bad week on the share market? I’ve words of reassurance. Even the experts do badly. Most of them worse that what you would do if you picked stocks using a dartboard.

The last two financial years were actually quite good ones for the experts who run our super funds. SuperRatings says they made 15 per cent and 16 per cent.

But the share market index itself climbed 19 per cent and 25 per cent...

(And many of shares in the index paid dividends as well.)

That’s right. The experts who we pay to pick stocks for us would have done better had they done nothing and just held on to the stocks in the index.

It’s not just that they sometimes select the wrong stocks, it’s that they chop and change (showing off their expertise) at the wrong time.

In the American Economic Review last year Ilia Dichev of the University of Michigan compared the returns that investors had actually received buying and selling stocks to those they would have received if they hung on to those stocks all along.

In 18 of the 19 worldwide stock markets examined the investors had done worse by buying and selling.

In Australia in the two decades to 2004 the typical stock grew in value by 12.3 per cent a year. But the amount actually made by Australians buying and selling stocks in those two decades was only 11.7 per cent a year.

Economist Andrew Leigh from the Australian National University says we make the same sort of mistakes when we decide to switch queues at the supermarket. We would usually be better off staying put.

Occasionally we will switch to the right queue. Occasionally when I toss a coin and bet on ‘heads’ it comes up.

But an important finding from other research is that those few funds managers who do do well in any period of time (there will always be some) tend to do badly in the next period of time. ‘Heads’ doesn’t keep coming up.

Why is picking stocks and picking and working out when to buy and sell them almost impossible?

For the same reason that picking queues in the supermarket is almost impossible. Other people will have already picked the good queue before us slowing it down.

The price of one stock already incorporates everything that’s known about its future. So does the price of the next stock.

So there’s little point in switching, unless you fancy yourself as someone with superior insight, or a super fund manager.

HT: Andrew Leigh

Ilia Dichev,
What Are Stock Investors' Actual Historical Returns? Evidence from Dollar-Weighted Returns, American Economic Review, Volume 97, Number 1, March 2007, pp. 386-401(16)