A Costly Mistake: Why Stock Picking Could Be Sabotaging Your Wealth

Every week, you’ll find an avalanche of enticing stock picks on social media. Respected investors and self-proclaimed stock gurus alike claim to predict the next parabolic ticker. For a while, a lot of novice investors either got lucky or very, very unlucky.

Now, if you’re one of those who were able to ride the wave in the past, you may be actively hunting the next AMC and GME. However, if you’re not into high-risk-high-reward trading, you may be thinking that the safest way to wealth would be finding the next Amazon or Tesla. But what if I told you that this seemingly safe strategy may actually be sabotaging your investment?

The overlooked factor

Many investors associate success with picking the right stocks or financial instruments. This belief often leads them to chase after hot tips and trends, thinking that the next big winner will make them rich. While choosing good investments is important, it can distract from something even more crucial: how much you invest.

Focusing on picking stocks can be exciting and give a feeling of control, but it's also risky and unpredictable. The market doesn't always behave as expected, and even expert investors can't consistently choose winners. This can lead to stress and disappointment when things don't go as planned.

The unlikelihood of beating the market

Finding the next big stock sure feels exciting. It feels proactive, and it gives a sense of control over one's financial future. However, recent data paints a sobering picture of just how challenging it is to consistently outperform the market.

According to a 2023 study by Lipper Alpha, a staggering 65.99% of actively managed funds underperformed their respective benchmarks. The average underperformance was 2.40%, with about two-thirds of this shortfall attributable to fees and expenses. This means that even professional investors, with all their resources and expertise, struggle to consistently beat the market.

Further emphasizing this point, Morningstar's research covering 2013 to 2023 revealed that only 10% of mutual funds saw more than half of their stock picks beat the index. In other words, 90% of funds picked more losing stocks than winners. Even more telling, only 44% of large-cap fund positions and 46% of small-cap fund positions outperformed their respective indices over their holding periods.

While the data clearly shows the difficulty of beating the market through stock selection, it begs a crucial question: If picking winning stocks is so challenging, what factor actually drives investment success? To answer this, let's shift our focus from return rates to an often overlooked aspect of investing.

The faster route to your financial goal

Imagine Alex and Taylor taking their first steps into investing. Alex opts for a straightforward strategy, putting away $200 monthly into a broad S&P 500 index fund, known for its stability and historical performance. Taylor, meanwhile, invests $100 each month, hoping to outsmart the market with higher returns from carefully picked stocks. But who ends up with more after ten years?

Let’s just assume a 10.5% annual return for Alex since that’s the S&P 500 average of the last 30 years. Then, let’s just assume that Taylor successfully picked stocks that have higher annual return, an extremely optimistic 13%. After 10 years, Alex ends up with ₱42,162.96, while Taylor accumulates only ₱24,403.69. Now, that’s a massive difference!

Now, you might think that Taylor’s higher return rate would eventually catch up with Alex’s investment. Let's extend our analysis to see how the race goes.

When investing $100 a month at 13%, it will take 36 years for Taylor to outperform Alex.

So, what does this scenario mean for you?

Perhaps, if you started investing early, you could still enjoy significant returns before you turn 60. But if you want to see a significant investment sooner than 36 years, you’re better off with the surer, less-stressful strategy which Alex also used.

Aside from the lengthy period you’ll have to wait to achieve your goal, you should also consider the odds of actually beating the market consistently throughout your 36-year investment. It would be very unlikely for a stock to achieve those higher returns consistently over such a long period. In fact, there is a huge possibility that your average annual return may be a lot lower than expected. The truth is that you’re still not in control of those stocks you have carefully picked at the beginning of your investment.

A Simpler, More Effective Approach

For most individuals, the ability to increase their savings rate is much more within their control than their ability to consistently outperform the market. This doesn't mean that seeking good returns isn't important. Rather, for the average investor, prioritizing higher contributions can be a more reliable path to long-term financial success.

This strategy offers several advantages. It provides broad diversification, reducing risk by spreading investments across numerous companies. It typically involves lower fees compared to actively managed funds, allowing more of your money to work for you. Perhaps most importantly, it frees up time and mental energy that would otherwise be spent on researching individual stocks or timing the market.

Maximize Your Contributions

When investing becomes a fundamental part of your financial life, it ceases being an optional add-on. This means creating a budget that prioritizes investing, looking for ways to increase income (such as taking on additional work or negotiating a raise), and automating investments to ensure consistency. It also involves taking full advantage of employer-sponsored retirement plans, especially those offering matching contributions - essentially free money that many investors leave on the table.

The fear of missing out

Investing in the S&P 500  or an index fund might mean missing out on the next big market winner. While it's true that you might not catch the next Amazon or Apple in its early stages, the reality is that consistently identifying such winners is extremely difficult. The potential gains from a few winners are often offset by losses from many losers, as the Morningstar data shows.

The boring way

Others might find the idea of simply investing in index funds boring. But are we investing mainly for the thrill of it? Remember, the primary goal of investing should be to build wealth, not to provide entertainment. The "boring" approach of consistent, broad market investing has proven effective for many investors over time, including legendary investors like Warren Buffett, who has long advocated for index investing for most individuals.

The Bottom Line

While it's natural to want to find the best investments, the reality is that for most people, the amount invested is far more important than the specific investments chosen. So, instead of chasing after the next big mover, concentrate on finding ways to grow your monthly contributions. Then, put that money in low-cost, diversified index funds to build a solid foundation for long-term wealth accumulation. Remember, the best investment strategy is often the one you can stick to consistently over time, allowing the power of compound interest to work its magic.