(MarketWatch) Can you successfully pick stocks with a dart board? The writers at The Wall Street Journal thought so.
To test their idea, the writers threw darts at a stock list in the newspaper. From those random hits they built a portfolio to stack up against highflying financial elites.
Those elites meet at the Sohn Investment Conference, held in New York each May. The attendees are full-time active investors, people who spend 365 days and nights a year thinking hard about what investments to own and why.
So how did the dart-throwing journalists do this year? “The results were brutal,” recounts Spencer Jakab of the Journal.
The random writer picks beat the pros by 27 percentage points in the year through April 22. “Only 3 of 12 of the Sohn picks even outperformed the S&P 500 Jakab said.
Now, consider what had been happening over the previous 12 months. A growing trade war, political infighting in Washington, dramatic regulatory changes. You might think a savvy stock picker would know how to capitalize on so much uncertainty.
In fact, more than a few pundits loudly proclaimed last year that a “stock-picker’s market” was finally at hand.
I can tell you this for sure: Not one of those pundits would have said “a dart-thrower’s market” was coming. That would have been career suicide.
Jakab rightly remembers that it was Burt Malkiel, the Princeton professor and author of “A Random Walk Down Wall Street”, who first suggested that monkeys could pick stocks better than human advisers.
Malkiel’s point isn’t that monkeys are smart but that random stock selection is just about as effective as sitting around and thinking hard it — and can be more effective. The writers figured darts were easier to manage than live monkeys, with good reason.
Secret sauce
Malkiel serves on the investment committee of my firm. You might wonder why we even have an investment committee if we are so devoted to portfolio index investing. It’s a reasonable question. The answer is that not all index funds operate exactly as advertised, so understanding what’s under the hood matters.
The secret sauce, of course, lies in determining how much of each index fund to own in a given portfolio, what’s known as asset allocation. It turns out that just selecting asset types has a lot to do with your success as an investor.
What you own in each asset class is nearly irrelevant, as the dart throwers show us. Rather, investing is about owning the right asset classes in amounts that reflect your personal ability to withstand volatility — the ups and downs of the market — over time.
We use index funds because they are very low cost and because index funds are broadly diversified, that is, they represent the best expression of an asset class, be it stocks, bonds or something else.
Most important, index funds get our clients more return (thanks to low fees) while taking less risk (thanks to diversification). More return at a lower risk is what academics call “the efficient frontier.” Stray beyond that frontier and you begin to experience is more risk without necessarily adding return.
Embedded fees
Our investment committee’s job is to identify the funds that give our clients the most bang for their buck, then choose how much of each fund to own for a variety of client goals. Needs range from long-term growth to immediate income and everything in-between.
It’s vitally important to make sure that the portfolios we build perform as expected. Managing money is about creating a consistent experience that delivers what investors really want — security that the money they have today will grow and serve them tomorrow.
Paying a costly financial adviser to hire even more costly fund managers to try to “beat” the market can result in a better return for some investors, some years, to some degree. After subtracting their various embedded fees, however, most funds do not.
Remember, win or lose, up year or down, investors who choose the active path pay those high active management fees every quarter. They unwittingly elect to compound their costs to the detriment of their own financial future.
Low-cost index funds are the answer. Just ask any monkey with a dartboard.
