The stock market has been very sluggish over the past several weeks: the indexes are near 2017 and 2018 depression levels. The frightening news cycle and frantic financial professionals believe that the stock market can dip even lower. Recent data and the business shutdown are evidence that a larger recession is possible. I believe this recession, or fear of one, is positive for the US economy though. Remember, we have seen signs of life before, in every economic recovery, only to be largely disappointed. Regardless of where the stock market is headed in the short term, remember in the long-term popular stocks will always do well. In two years, the stock market could drop another 30%, but in 20 years, the market will historically provide a 60% or better return.
You are probably aware that studies show that professional investors have trouble outperforming the market through stock picking. But as with any statistical data, be careful around the academic subjects that have selected bias. Most of this data considers professional investors as anyone who can open a fund. Many well connected or trust fund babies like Chelsea Clinton’s husband, Marc Mezvinsky, always underperform the overall market. Pensions and endowment funds received 80 cents back for every 1 dollar of investment from Marc Mezvinsky. Most of these professionals are wealthy enough to utilize their capital or connected well enough to raise money from close networks. Only rarely do these groups of wealthy or connected professionals do the required investment due diligence. Buffet famously said, “Wall Street is the only place that people ride to in a Rolls Royce to get advice from those who take the subway.”
In that respect are many hidden costs of stock picking. Remember when Real Estate Investment Trusts (REITs) were the best performing industry from 2010 to 2017, the entire industry quickly turned into one of the worst investment opportunities during and after the crash. This is because interest rates remain depressed while there was an oversupply of commercial buildings, primarily buildings such as shopping centers and malls. Malls were a great industry to buy between the 1970s and late 1990s; most developers focus their efforts to build out malls that are quickly becoming empty shells and debt load. So why am I talking about real estate? If you didn’t know about the real estate information before reading this blog and you were buying REITs, then you are one of these stock pickers that got taken advantage of in the form of hidden fees.
Nevertheless, too many people consider themselves a stock-picking genius. A majority of people will find themselves intelligent enough to invest, but being smart doesn’t compensate for higher investment returns. Being a business oriented individual or an entrepreneur doesn’t automatically make you a good investor either. Being an investor is a line of work, just like being an attorney. Anyone can be informed about their legal rights, but it doesn’t mean they have the knowledge to utilize this information to defend themselves in court.
Many individuals lack the dedication to do investment due diligence. Anyone can attain a good, above-average return for a few years in a bullish time. To be clear, I define a stock picker as anyone who can’t explain the commercial enterprise model, can’t read a financial statement, often has short term gains in their portfolio, and a majority of their portfolio doesn’t include long term holdings.
What are the other hidden fees of stock picking? I called it the T&T problems Time & Taxes
- The first cost is Time. If you have little knowledge and try to spend time learning, then you are running against the clock against someone that is simply more knowledgeable and prepared. Novice investors spend time picking stocks without ever learning about their investment through due diligence. Studying makes you informative but it’s a long process before you actually become knowledgeable to execute an investment. Being knowledgeable primarily comes from information and experience.
Everyone on the internet is informed about politics, but not everyone is knowledgeable. If TV ran the news on disciplines like Biology and Chemistry 24/7, like they do political and financial news, we would all feel like we can discuss science topics like we are all Ph.D. certified scientists. I have another upcoming blog that will talk about the difference being informed and knowledgeable. If you keep picking stocks without being knowledgeable, you will underperform the market by 5% or more a year (50% in potential missed gains over 10 years).
- The second cost is Tax, if you’re trading in a taxable account. The difference between short-term and long-term capital gains is generally substantial. When trading stocks, it can be tempting to exit positions doing particularly well after only a few months. Doing this frequently results in higher tax costs and it is something I avoid. Capital tax gain taxes are 0% to 20% vs income taxes that can be around 25% to 40% depending on your tax bracket. Think about how much money you will leave on the table if you are paying income taxes on your investment returns. My investment strategy is to target long term positions over short term capital gains. Most people are happy to see short-term profit (but they don’t realize that they pay income taxes on it).
I want to reiterate that it is vital to remember that the average investor seldom realizes the returns they see on the chart of that stock. Both taxes and time can seriously erode performance, especially for high-frequency stock traders in higher tax brackets. A lot of economic research studies show that these and other mistakes made by the ordinary investor can reduce returns by 4% or more a year relative to a stock index (which haven’t included the short-term tax fees). My mission is to give you the best possible after-fee and after-tax returns that matter for your long-term investments.