Before discovering index funds, I was a stock picker. And I was quite good at it.
I’ve had my share of failures, but even with those accounted for, my performance significantly outpaced the indexes.
Here’s something even more incredible, emphasized in large font:
Stock picking is a bad idea. I now firmly stand with index funds.
I understand you might be puzzled right now. Allow me to explain.
How I Learned to Stop Picking Stocks and Love Index Funds
First, let’s review what an index fund is. It’s simply an investment that tracks a specific index’s holdings. If you own an S&P 500 index fund, you own all the holdings in the S&P 500 index.
This differs from actively managed funds, where fund managers pick the holdings. Due to the lack of active management, index funds have very low fees.
In the long run, fees have a massive impact on portfolio performance. Equally important, it’s hard to pick consistently outperforming stocks over the long term. To understand why index investing is such a wise strategy, I recommend the excellent book “The Little Book of Common Sense Investing.”
Despite my success, I no longer pick stocks. The reason is simple: I believe I can make more money in the long run through index funds. Here’s why:
Professionals Can’t Do It: Most actively managed funds can’t beat the index. These funds are managed by Ivy League MBAs with research teams. If the world’s smartest people can’t beat the index, what chance does the average person have?
I Was Lucky: So why was I so successful? I fully admit that at least part of my success was due to luck. I bought Google stock because I thought the company was cool, and its search engine was useful for my work. I didn’t anticipate Google would continue to develop products with over a billion users each. Luck played a role in my success.
The Speed of Disruption is Accelerating: Innovation is happening faster than ever. Remember how cool and improved the first iPhone was less than 10 years ago? It’s incredible, but the fact is, all phones will become dinosaurs as technology shifts to other form factors utilizing augmented reality and artificial intelligence (watches, glasses, implants).
Car companies are a prime example of disruptive impact. There were hundreds of American car manufacturers, but only two have never filed for bankruptcy (Tesla and Ford). Now, all car manufacturers are on the brink of massive disruption by autonomous taxi fleets.
Disruption means stock pickers have to be smarter than ever.
You’re Right: I mentioned I bought Google stock in 2004, twelve years ago. I’m only 42 now, so I have well over half my life left. Will Google, Facebook, or Tesla be important in 40 years? I’m not sure any of them will be important in 5 years. It’s easy to see disruption after it happens, but by then, your stock has taken a beating. Can you foresee it coming? Probably not.
In 2007, BlackBerry and Nokia dominated mobile technology. Where are they now?
Do You Have the Time (or Will) to Research? I bought Facebook stock based on hundreds of hours of research. I read every Facebook article I could find years before the company went public. I studied Facebook’s plans. I studied its young leader, Mark Zuckerberg. I read articles by those bullish on the company and formed my hypotheses based on them.
More importantly, I also read the detractors’ articles (“They can’t port their site to mobile.”) and tried to figure out if my assumptions still held. To be good at stock market research, you need time and passion. Most people don’t have it.
Warren Buffett’s Advice: Billionaire Warren Buffett is the most successful investor in history. His holding company, Berkshire Hathaway, has a return rate of 20.8% since 1965 (the S&P 500’s return rate is 9.7%). If you had invested $1,000 in Berkshire Hathaway at its inception, you would be worth over $10,000,000 today.
Notably, Buffett advised LeBron James to do the same thing.
You’re not a better investor than Buffett, so you’d better listen when he speaks.
I’m an Index Investor
So now, I invest new money into index funds. I’m slowly selling off my stock portfolio and reinvesting it into index funds. I look forward to the day when I no longer hold individual stocks. I just don’t believe I can beat the index over the long term.
After you embrace index funds, my final piece of advice to you is:
Save aggressively. Find your “enough” level and reach it as soon as possible. Never forget that money is just an enabler. Once you have all the money you need, let your life move in the direction of your dreams.