Buy Index Funds, Not Stocks

Moolanomy has a regular feature called “Ask The Expert With Larry Swedroe” in which readers ask a question related to investing.  Last week the question came from the host of Gather Little by Little, who insists on calling himself  Glblguy.  Apparently in earnest, he asked “When deciding to purchase NYSE floor Old - Crop individual stocks, what process do you go through to determine if the stock is a good buy or not?”

Swedroe was firm and to the point in his reply.  “No one should own individual stocks.”

As painful as it is for me to write this, I basically agree.  Painful not just because agreeing with others is against my nature, but because I love buying individual stocks.  Few things are as much fun.  The stock market is an ever-changing universe of stories, ideas, and theories of the future where I can match wits with other participants and actually bet money on the proposition that I am smarter than everybody else.  Awesome.

But I am a professional.  I trade stocks for a living.  (Or at least I used to, before, uh, certain unfortunate developments.)  You,  I am assuming, are a productive member of society with a job producing a thing or service of value.

Just to be clear, I have no problem with you investing in the stock market, just with picking stocks.  A non-professional should invest in an index fund, essentially buying a tiny bit of every stock in the market.  That will give you the market’s average return, which over long periods has been shown to be pretty good.

In order to decide to pick stocks rather than invest in an index fund you would have to either a) believe that you were a better than average stock picker or b) realize you are not, but enjoy picking stocks as an expensive hobby.  And when I say average, I mean a weighted average, weighted by how much money each stock market participant has.  That means that how you compare against other amateurs is meaningless, as collectively the non-professionals account for only a very tiny fraction of the trading.  To be above average, you need to be better at it than the average person who does it for a living.

Statistically speaking, that’s unlikely.  (And would imply a poor choice of career on your part.)  Further, even if you are more talented than the average pro, the pros have some advantages you don’t, such as access to better computer systems and lower brokerage fees.

Then again, I am serious about the expensive hobby thing.  Picking stocks is fun and as long as you “bet with your head, not over it” and aren’t exceptionally bad at it, it’s not the most expensive hobby you could choose.  It’s a wonderful game.  Just don’t expect to win very often.

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