Here’s your best bet to beat a ‘rigged’ market
Commentary: To make money in stocks, time is on your side
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By Tadas Viskanta
INDIANAPOLIS, Ind. (MarketWatch) — Is Wall Street a “rigged
game,” too difficult for anyone but the professionals? This is a common argument
used to explain the defection of the individual investor from the stock market.
Who's been naughty in the fund industry?
Some fund-industry members deserve lumps of coal in their stockings this Christmas, says MarketWatch's Chuck Jaffe. (Photo: AP)Felix Salmon at Reuters , in a discussion of falling trading volumes, writes something extremely similar: “Nowadays, however, the message is sinking in: it’s a rigged game, you can’t win, and you’re better off with a passive strategy.”
Games investors play
There's nothing wrong with a passive investment strategy. Indeed I devote much of my book, “Abnormal Returns: Winning Strategies from the Frontlines of the Investment Blogosphere,” to discussing how for the vast majority of investors a largely hands-off investment strategy focused on index funds is the best answer to their investing needs.Yet in some respect, simply owning index funds outsources your portfolio to others to deal with the “rigged market.”
If the market were rigged you’d expect to see the professionals post better results. For now, these managers are having a difficult time beating the market over any reasonable time frame.
Nor are investors necessarily fleeing the stock market en masse. Since the onset of the financial crisis persistent outflows from actively managed equity mutual funds have been more than offset by inflows into equity exchange-traded funds. Some argue that this says more about the preference of investors for index funds more so than equities. Read more: 5 top stock funds raking in your cash.
Salmon at Reuters argues that what we are seeing is the decline of individual stock picking . He notes how this "upper-middle class hobby" of stock picking resembles that of golf.
There are in fact some strong parallels between investors and golfers. One is the belief that a new piece of equipment (golf) or newsletter (investing) will somehow change poor underlying results. Salmon notes the high cost of online services and newsletters focused on individual investors and their generally poor performance. Readers of the Hulbert Financial Digest, a service of MarketWatch, which tracks the performance of newsletter writers will not be surprised by this assertion. However a strict focus on performance may well be misplaced.
In contrast with golf, which is a strictly discretionary activity, investing is an important responsibility. As I wrote in the introduction to my book : “Whether you are saving for your retirement, a child’s education or simply looking to build a better life you need to possess some basic investment skills. Some argue that investing is in a certain sense dead. Investing isn't dead, but the odds are stacked against us all. Whatever the odds, we need to make an effort to save and invest for our futures.”
Time and money
For some people, saving and investing comes in the form of individual stock-picking. If the challenge of competing against the world's biggest investors motivates you, so be it. The motivation to read and learn about investing is far more valuable than the potential underperformance against the Standard & Poor’s 500-stock index /quotes/zigman/3870025 SPX +0.66% or some other benchmark.There is in fact research which shows that investors who stick with it tend to learn from their investing experiences . That is why getting young adults to start their investing careers sooner rather than later is so important.
Even index-following investors need to continually educate themselves. Enough things change in the financial markets over time such that a entirely hands-off approach to investing is increasingly risky. And if you rely on investment advisers for the heavy lifting, you still have an educational imperative. You can't be a thoughtful consumer of financial services without having some background in the basics of investing.
I would argue that much of the confusion over individual participation comes from a mismatch over time frames. David Merkel at the Aleph Blog notes in a post about being "well-off in life" the importance of taking moderate risk, having a long time horizon and not trading too aggressively. In that type of approach, a do-it-yourself investor has a chance of achieving moderate success.
Nat Stewart at NAS Trading , in addition, notes how many of the problems investors face reveal a conflict between perceived investing time horizons — which are long — and realized time horizons — which are much shorter. This mismatch tends to push investors to abandon sound portfolio strategies in search of the hot new thing. I would argue that consistently following a sub-optimal investing strategy is far preferable to flitting from one hot ticket to the next.
So, is the stock market rigged? Maybe at the shortest of time frames. Is stock picking dead? The trends show a marked decline in interest. That said, investors can't simply turn their back on the market. The lost decade for stocks has for sure discouraged investors, but what is the alternative? Treasury bonds yielding 2%? Not investing at all? Neither of these are a sustainable long-term solution.
Indeed the emphasis on the long haul is important. At the shortest of time frames, individuals have little chance against institutions and high-frequency traders. But individuals with a long time-horizon have a marked advantage against benchmark-focused institutions.
We may not yet be in a golden age for stock picking but there has never been a better time to be an individual investor .
Tadas Viskanta is the founder and editor of the investment blog Abnormal Returns , and author of “Abnormal Returns: Winning Strategies from the Frontlines of the Investment Blogosphere.” Follow him on Twitter at @abnormalreturns
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