Stock Picking Vs Investing In Mutual Funds

Investing is more often considered an art rather than a pure science. It is important to understand whether one possesses sufficient skills to pick stocks.

Investing is more often considered an art rather than pure science. It is important to understand whether one possesses sufficient skills to pick stocks. Warren Buffett puts it very clear that those who are not acquainted with the basic financial information must simply park their money into ETFs. He reiterated this once more during his famous bet again hedge funds recently saying:

“A number of smart people are involved in running hedge funds. But to a great extent, their efforts are self-neutralizing, and their IQ will not overcome the costs they impose on investors. Investors, on average and over time, will do better with a low-cost index fund than with a group of funds of funds.” 

Even if were to simply ignore Buffett and simply go ahead, the number speak the same story. Most of the activity/active investing fail to outperform index investing in the long term. Therefore, it is good for amateurs to keep away from picking their stocks or even investing into hedge funds or very actively managed funds. It is recommended that one may invest in ETFs or a select group of mutual funds when not fully aware of the subject.

Returns posted by individual investors and members in WhatsApp investment groups can be highly misleading in nature. The spectacular returns posted by these people are probably false in the first place and more so, these are not sustainable. Bull markets create a wave of self- proclaimed experts who seem to have the golden touch and inspire people to try their hands at this skill. In the bull run that is currently ensuing, almost all and any of the stocks that one was invested a few years backed churned out pretty good returns. However, this must not be considered a testament to one’s skill and decision making. It is the entire market that has progressed as a whole. The most important element of making returns is sustainability, which is a real indicator of stock picking success.

Stock picking by itself may often offer lucrative opportunities, but there is inherent risk associated with indulging in it, from the ignorance involved with diversification, asset allocation to the information that is not available to the average Joe. For passionate folks, the better approach is to allocate a small portion of one’s portfolio initially to invest in individual stocks based on personal ‘research’ and to invest the remaining into good quality mutual funds or ETFs. Once the individual gathers enough knowledge and confidence to personally invest, the allocation can be slowly increased.

The ultimate result of outperforming the markets and yielding good returns is clearly not simple and entails crucial decision making, remaining cautiously active and mostly passive. This is beyond the range of a financial illiterate and one of the very reason stock markets have been unable to break much ground among Indians. The current optimism regarding the swelling coffers of mutual fund houses is a good sign, but not indicative of the Indian perception towards stocks as an asset class. This is supported by this clear graphic that displays how Indians throng to the markets during bull markets, making nothing since the markets have already gone up and then retire during the fall, losing everything when rationality returns.

While even though the exact definitions of bull and bear markets are not well defined and the markets offering no safe havens for investments, it is upto the Indian investors to take calculated and informed decisions with their money. In this wave of prosperity coupled with vast number of options clouded by uncertainty between picking stocks and getting rich or investing in mutual funds and being wise, it is important that one simply does not compromise rationality for greed and stick with mutual funds managed by the market experts or the ETFs that mimic the markets until one is really ready to outsmart the markets.