Why people stock pick and why they shouldn’t

Written By Pratyush Rastogi

In most cases (and we mean more than 85%+) we believe that most people shouldn’t stock pick. Why? Let us take you through some statistics.

  • In March this year S&P posted data to show that after 10 years 85% of large cap funds unperformed the S&P 500. During the past 15 years, that number rises to 92%[1]

  • Small cap and Mid-cap funds did not fare much better, with 85% and 88% underperforming the benchmark over the last decade.

What does this mean? This means that professionals (people who dedicate their entire careers; amount to thousands of hours a year) are not outperforming the benchmark. These are investors who painstakingly go through annual reports, speak to management, create complex financial models, and do on-the-ground research. A lot of the best investors we know spend months on a single company before they invest. And yet, after all this hard work, nearly all of them fail to outperform the market. There are a number of reasons why this is true, and to flesh that out we would need to write another article (and maybe we will), but suffice it to say, the odds for any individual outperforming the market are very low. (Also note this data is skewed with Survivorship Bias, failed funds don’t have data to present, so you can assume that if you did account for that, the numbers would look even worse!)

So then – faced with this reality why do individuals try and stock pick? Wouldn’t they be better of just buying index ETFs?  Well, we believe that the answer lies in deficiencies in human behaviour, which we attempt to explain below. If you see yourself in one of the below examples, do know its VERY normal, and we all fall prey to some (or all of them).  


1) The Overconfidence Effect.

In a survey conducted on US College students, 93% estimated themselves as “above average” drivers. And 68% of faculty at the University of Nebraska rated themselves in the top 25% for teaching, and 84% of Frenchmen estimate they are above average lovers[2].

As humans we are taught to believe and want to believe that we are special (otherwise what’s the point?). Thus despite what the data might say, the average person feels that this truth doesn’t apply to them, and believes that they will be successful at stock picking. But the truth that most people don’t want to believe is that when it comes to most tasks, they are likely just like the rest of us, average.

2) The Propensity to Gamble

Casinos are revenue generating machines, with the global gaming industry expected to reach half a trillion dollars by the end of 2023[3]. This is despite the fact, most gamblers know that the odds are stacked against them, and yet each year they ‘give away’ their hard earned money to casinos. Then why you might ask, why would any rational person, ever step foot inside one? The answer? The human propensity to gamble is a hugely powerful force. When we win at the slots or the craps table our bodies fill with dopamine (that feeling of rush you get). In fact, you don’t even have to win, a ‘near-win’ (ah so close!) is enough to trigger your dopamine pathways[4]. The stock market can have a similar effect. When you see that stock you bought double in a few months – you feel on top of the world, and that keeps you coming back from more (when you should instead chalk your winnings up to luck, take your money of the table and run away).

3) FOMO – the Fear of Missing Out

Remember Netflix in the first half of 2018? Or Bitcoin in 2017? When you see those around you making huge amounts of money hand over fist, it becomes hard to resist plunging in headfirst. However investing when you’re feeling FOMO is probably the worst time you can invest, as by then stock prices have run up to unrealistic levels and the forthcoming crash will be brutal (Remember Netflix in the second half of 2018? Or Bitcoin in the first half of 2018?). But FOMO is a powerful force, and when people feel it they can’t resist calling their broker to place a few orders.

But one must remember – people only brag about their wins, they’re rarely very open about their losses. The truth is we love to highlight our successes, but if you examine the portfolio of a given braggart as a whole overtime, we would be willing to put good money on the fact that they would have underperformed stock benchmarks (or if they have outperformed - they’ve done it in amounts so small to not impact their overall net worth).

4) Could have, should have, would have

Does any of this sound familiar? “Oh Man – I was going to buy this stock and now its up 60% - I was right, I should have invested!” , “I was talking to this banker and he told me to buy  stock X and now its up 5 times – I would have made so much money” .             

Thinking about investing and actually investing are two very different things. When you ‘paper trade’ you don’t put yourself through a true experience of investing. The panic you feel when a stock falls 20% in one day, or the greed that overcomes you when you know you should sell but feel that the stock can keep rising. Judging your skill at stock picking by reflecting on what you could have or would have done is like thinking you could be an excellent boxer because you’re very good at the punching bag.

Unfortunately this backward looking confidence is what causes many to jump into the stock market only to see that confidence severely tested.  

5) Following the leader

Monish Pobrai, a famous value investor, believes that people should be copycats. If you know a few excellent investors – just copy what they do. Why bother doing the work? They’ve already done it and they would have done it better than what you have done. On the surface this makes sense, but we believe this is a bit of trap luring people into stock picking.      

The problem with copycatting (no disrespect Mr. Pobrai) is that when things go bad (and they will) you wont know what to do. You’re likely to sell when you shouldn’t or buy when you really shouldn’t. Without doing your own homework on the business you are buying, you won’t be able to ride out the volatility inherent in public markets. Also the investors you follow are under no compulsion to tell you when they buy more or sell (and 13Fs, or their global equivalents, only come out every quarter), so by the time you get to know what action they have taken, it might be too late.

Lastly just to drive this point home - In “The Art of Execution” Lee Freeman-Shor gave some of the best investors in the market money to manage so that he could track how they invested. What was the combined success rate (stocks which made money) for this elite group? Just about 50%.

In Conclusion

In the end despite might what be written here, people will still try and stock pick. Human nature is hard to fight, as following it, for the most part, has kept us alive and prosperous. That said, if you are going to stock pick be aware of the biases, risks, and odds listed here, and make sure you do your own homework. We wish you all the success (no matter what the odds are!).

And remember - if you do outperform overtime and start a fund, let us know, we’re always on the lookout for rare opportunities :)

Pratyush Rastogi
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