The stock market has been very sluggish over the past several weeks, the indexes are near 2017 and 2018 depressions. The frightening news and financial professionals believe that the stock market can extend lower. Recent data and the business shutdown are evidence that a recession is possible. I believe this recession or fear of one is positive for the US economy. Though, remember, we have picked up signs of life before in every economic recovery, only to be disappointed. Regardless of where the stock market is headed in the short term, remember in the long term stocks will do well. In 2 years, the stock market can drop another 30%, but in 20 years, the market will historically provide a return 60% or better.
You are probably aware that studies show that professional investors have trouble outperforming the market through stock picking. But with any statistical data, be careful around the academic subjects that have selected bias. Most of these data consider 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. Pensions and endowment funds received 80cents 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, then the entire industry quickly turned negative. This is because interest rates remain depressed, and there’s an oversupply of commercial buildings, primarily shopping centers and malls. Malls were a great industry to buy between the 1970s and late 1900s; most developers focus their efforts to build out malls that are 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 hidden fees stock pickers.
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 individual or entrepreneur doesn’t make you an investor either. Being an investor is a line of work, just like it is an attorney. Anyone can be informed about their legal rights, but it doesn’t mean they have the knowledge to utilize the information to defend themselves in court.
Many lack the dedication to do investment due diligence. Anyone can attain a good above-average size return for a few years in 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 have long term holdings.
What are the 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 has been more knowledgeable. Novice investor spend time picking stocks without ever learning investment due diligence. Studying makes you informative but it’s a long process before you actually become knowledgeable to execute an investment. Being knowledgeable comes from information and experience.
Everyone on the internet is informed about politics, but not everyone is knowledgeable. If TV ran the news on Biology and Chemistry 24/7 like political news, we will all feel like we can discuss science topics like we are all Ph.D. 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 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 about 25% to 40%. 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 over short term cap gains. Most people get happy over short term profit (but pay income taxes on it).
I want to reiterate that it is important to remember that the average investor seldom realizes the returns they see on the chart of that stock. Taxes and Time can seriously erode performance, especially for frequent stock traders in higher tax brackets. Many 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.