Updated: Jan 17
At the late early stage of investing when we investors meet at a club or cafe we often discussed, whether index investing is better or stock picking. It's been a while since I wrote anything so I thought why not scratch this topic?
There can be various variables one can debate on but I think it is wise to touch on the simple ones. I gave it thought many a time and I come up with one simple question "What can go wrong"? In stock picking, two major variables where one can go wrong, is first, stock quality and second, Portfolio Management.
When we measure a portfolio the right way is to measure the performance of the overall portfolio rather than looking at a specific stock. In the case of stock quality one may have the best stock of the coming decade but his investment in that stock in terms of percentage of capital allocation is very less and its impact is merely significant in the overall portfolio, is not considered a wise investment. Though he was very good at stock picking yet he went wrong in terms of portfolio management. The reason for this can be anything that does not matter but at the end of the day, his portfolio is not yielding very much. In the same way, picking bad-quality stock and allocating a significant part of the portfolio could damage one's financial planning significantly.
Another major place where one can go wrong is trading very often without any clue of what one is doing, and when we see our portfolio at the end of the day, we don't know what we earned or what we lose. So, both Stock Picking and Portfolio management are the keys to a successful portfolio. A mistake in any one of these variables can impact your overall return.
Whereas, in index investing when we answer the question "what can go wrong"? Its answer is very easy the index may not move very much in the short to medium term but on the bright side in terms of investing one can invest in an index without any fear of going wrong which saves us from two major variables of what can go wrong in stock picking. Thus one can invest with confidence. It will also save from mistakes like trading too often.
Flashback story: When early investors such as me gathered today, we see that the market has given more than 100% return over the past years after the crash of 2020, but those who made mistakes in picking stocks and in managing their portfolios, are either in loss or made less return than the overall market in their portfolio.
Does this mean, I am suggesting index investing over stock picking? The answer is No, my sole objective to write this blog is to point out "what can go wrong".
Until next time,
The Humane Opportunist.