Two Factors That Make Picking Stocks So Hard

07/08/2011 0 comments

Lowell Herr at ITA Wealth Management published an excellent article on SeekingAlpha.com on the difficulty of picking stocks. In the article, he gave the following two factors:

  • There are too many metrics to measure a stock such as growth, value, cash flow, momentum etc. Let's say there are 10 metrics to pick a stock and you would like to choose only two metrics out of these ten. This would mean that you have 10!/3!*(10-3)! = 120 ways to select these two metrics, let alone for each metric, you have to again arrive correct threshold numbers.
  • You are trading against great investors like Warren Buffett. This further diminishes your odds of winning.

He concluded that the best way for average individual investors to invest is through diversified index funds and focuses on asset allocaitions (we might add). See how a simple asset allocation strategy with only 6 ETFs (VTI, VEU, VWO, VNQ, DBC, BND) as candidate funds would beat many pros. The following shows the performance comparison among Six Core Asset Strategic and Tactical Asset Allocation moderate portfolios and some balanced funds such as Vanguard Balanced Fund Index (VBINX), Vanguard 500 Index (tracking S&P 500) and Fidelity Asset Manager 60% (60% in stocks).

Portfolio/Fund Name 1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe
VFINX 28% 222% 4% 11% 3% 7%
VBINX 19% 244% 6% 31% 5% 27%
Six Core Asset ETFs Tactical Asset Allocation Moderate 17% 191% 10% 72% 15% 105%
Six Core Asset ETFs Strategic Asset Allocation Moderate 20% 234% 5% 24% 8% 39%
FSANX 24% 253% 7% 35%  

For more performance comparison info, see here.

Symbols: VTI, VEU, VWO, VNQ, DBC, BND, VFINX, SPY, VBINX, FSANX, Asset Allocation

Exchange Symbols: (VTI), (VEU), (VWO), (VNQ), (DBX), (BND), (SPY)



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