Personal Finance

Are You Still Picking Stocks? You Are Ridiculous. Here’s Why.

Expertise: Real Estate News & Commentary, Real Estate Investing Basics, Mortgages & Creative Financing, Personal Finance, Personal Development
72 Articles Written
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Prior to learning about real estate investing, I thought that the best way to satisfy my need to take control of my finances was through investing in stocks. Specifically, I thought that I could improve my finances by researching and analyzing individual companies and placing careful bets on select stocks, with the expectation of beating the market.

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In this article, I want to explain how foolish stock picking is, especially for a young person worth less than $1 million. I want to describe how incredibly outmatched young investors like me are in successfully picking stocks, and how even an investing prodigy like Warren Buffet would be wasting his time picking stocks at a low level of net worth.

Instead, ambitious investors worth less than $1 million should focus on actively managed assets like real estate or small businesses, while less ambitious investors should simply put their money into passively managed index funds.

There is just no point in expending energy researching individual stocks for 99 percent of the population.

Below, I’ll illustrate two reasons why stock picking makes no sense and follow with an explanation as to how a similar effort directed at real estate CAN generate outsized returns for the beginning investor.

Two Reasons Why Stock Picking Is Ridiculous

Reason #1: The Competition Is Out of Your League

Let me tell you about a friend of mine who invests in the stock market. We’ll call him Matt.

Matt manages a pretty sizable fund at a well respected firm in New York City. He spends perhaps 80 to 100 hours per week studying his industry (technology stocks) and has done this for over a decade. He reads annual reports, market news, and press releases from his Bloomberg terminal, and studies investor decks the moment they become available.

He also attends annual shareholder meetings, networks directly with executive officers at the Fortune 500 companies that he invests in, and meets with other large stakeholders from all over the country. Matt is one of the most well-informed people in his entire industry and is therefore in perhaps the best position imaginable to predict the future success or failure of these companies.

After hundreds or thousands of hours of careful research and methodical number crunching, Matt leverages his research and his decade of experience to purchase tens of millions or hundreds of millions of dollars of equity in the companies he selects.

Matt’s target is to be correct just 60 percent of the time. If he hits that target, his fund will make hundreds of millions of dollars, and he’ll take home a fat bonus. He’s well incentivized to squeeze every additional basis point in return he can each year for his investors.

succeed-vs-fail

Matt is every bit as smart as you, and as an alumnus of an elite business school, he is better educated than you. He’s willing to work hundreds of hours per week and to do everything in his power to get access to critical information as soon as it becomes available. He studies the market all day long and goes home to dream about it at night.

He is training young analysts (also smarter, better educated, and working longer hours than you) in his approach to perform ever more thorough due diligence. Because of his training, expertise, resources and results, thousands of wealthy investors give Matt hundreds of millions of dollars to invest for them via his fund.

Matt’s fund has well over $500 million in assets under management. He buys and sells enough shares of multi-billion dollar companies that he can single-handedly change their market price with individual transactions.

Because of his efforts, resources, training, and expertise, Matt has beaten the market by about 1 to 2 percent per year throughout his history as an analyst. He charges high fees for this extraordinary performance, and his happy investors end up slightly better off than if they had invested in a passive fund investing in technology stocks. They are very lucky to invest with Matt because 85 percent of his competitors failed to beat their benchmark last year, after fees.

You will have to get up pretty early in the morning to match the performance of Matt’s fund with your own stock picking. Best of luck to you.

Reason #2: The Alpha Is NOT Worth It!

OK, you don’t believe me. Maybe you think Matt (who closely resembles one of my relatives) doesn’t exist. He’s a fairytale I invented to scare you. Even if he does exist, you can beat him. He’s TOO informed, TOO smart, TOO big. You’re better than him. You get what the small players are doing; you see the stuff the Wall Street guys can’t, or won’t. You are a prodigy.

I get it. I was the same way. I thought I could beat the pros, too. I thought I was the next Warren Buffet, only better!

I respect your ambition and confidence. But you’re just as ridiculous as I was. That’s because, like me, you aren’t mega-rich. Even if you are a stock picking prodigy—the greatest of all time—it is only worthwhile to devote a serious effort towards beating the market if you have well over $1 million to invest.

Related: 9 Reasons Why Investing in Real Estate Is Awesome (and Better Than Stocks!)

Ninety-nine percent of us don’t have a meaningful amount of capital to invest. Without a meaningful amount of capital, chasing above-market returns, especially those in the stock market, is a total waste of time.

Here’s a reality taken from my personal life:

I decided to try my hand at stock picking a few years ago when I had saved a nifty $5,000. I spent hours reading the annual reports of so-called “micro-caps” (companies with less than $100 million in market value). I read annual reports, got in touch with key executives, called up stores that sold or used their products, and performed all other types of crazy due diligence.

And guess what? In 2014, a year when the S&P shot up 11.4 percent, I managed to lose money. There are three possibilities as to why I lost: I’m either really unlucky, really dumb, or stock-picking is just really, really hard. It’s probably all three.

Let’s suppose that things had gone differently. Let’s suppose that I was a stock picking prodigy like Matt or Warren Buffet. Let’s suppose that instead of losing money, I earned a 25 percent return on my $5,000 investment and brought home a cool $1,250 in 2014. Let’s also suppose that I was able to beat full-time investors like Matt, Warren Buffet, and the rest of the market on just 10 hours of research per week in my spare time.

I might feel like a badass for getting that 25 percent return, but the reality is very far from badass. In this scenario, I would have beaten the market’s return of 11.4 percent by 13.6 percent. That additional 13.6 percent return (which, again, was a truly extraordinary achievement) is what investors like to call alpha. On a $5,000 investment, my alpha of 13.6 percent equates to $680.

Over 500 hours (50 weeks at 10 hours per week in my scenario) of research went into that alpha last year. That’s roughly $1.36 per hour.

I’d have been much better off working a minimum wage job, building a passive asset, or focusing on saving more money. Picking stocks was an utter waste of time from a profitability standpoint. I got hosed! Even if I’d done the same with $50,000 to invest, my returns in this scenario equate to just $13.60 per hour!

And let’s not forget: Realistically, even great investors only dare to hope for 1 to 2 percent above market returns over the long run.

Stock picking, even for a prodigy, is just a complete waste of energy for anyone with low net worth. Chasing alpha in the stock market only makes sense if you have millions, or better yet, hundreds of millions of dollars to invest.

But even with hundreds of millions, you still have to face off with Matt.

So What Should You Do With Your Money?

If you aren’t interested in working on your investments, then go with a passively managed index fund. It’s the simplest and probably the most powerful truly passive investment you can make over the long-term.

If you are interested in being an active investor and want to make the most of your money, then real estate is probably one of the better ways to go.

Here are some of the reasons why I invest in real estate instead of stocks at a low level of net worth.

Reason #1: The Competition Is Less Fierce

Remember Matt? Matt’s in New York. Matt’s also got $500 million to invest. He could probably beat me here in my local Denver market if he wanted to, but investing his $500 million fund $250,000 at a time in small Denver multifamily residences is not a good use of his time. Matt doesn’t have time for small fish like that.

He also can’t be bothered to learn about the new parks being built near my neighborhood, the light rail that will have a stop five blocks away, or the vacant lot that’s going to be built up next year. Those things give me an upper hand against the big money like him.

The investors I compete with are all smart, educated, and intelligent folks. But they’re also friendly faces, people I’ve met through BiggerPockets and local networking events. They don’t have hundreds of millions to invest, and even in the hot Denver market, there is opportunity to go around. It’s no picnic investing in real estate, but at least there aren’t many Matts around.

Reason #2: Unlike Stocks, Added Work Equals Added Returns

In the stock market, more research does not correlate with higher returns. As often as not, the investor who does his homework loses just as much money as the fool that throws his money at companies blindly.

In real estate or business, taking on the work yourself can and does result in increased returns.

When I bought my duplex, I spent weeks making the place look pretty with new cabinets, appliances, paint, plumbing, and drywall repair. I spent my weekends putting up new shutters, planting bushes, reseeding the lawn, and cutting out overgrown branches. These projects cost me time and money for materials. But I saved thousands of dollars by doing this work myself instead of hiring a contractor. For someone with a low net worth (like me), these savings are HUGE as a percentage of my overall wealth. A far greater per hour return than I could get researching stocks.

You can argue that my time might be better spent hiring and managing others to do work on my property for me, and you might be right. Handyman work may or may not be the highest use of my time. That said, I firmly believe that given the option of picking stocks and working on my property, working on my property produces a higher total return for me every single time.

Reason #3: Leverage

While it is possible to use leverage as a stock investor, it's very difficult to do so consistently over the long-term. That's because stocks are so volatile. Banks don't want to give you their money to play with for the next 30 years when there is a very good chance that the market will correct enough for your equity position to fall to zero at some point.

Real estate is much less volatile. While you can still lose money, real estate historically has been much more stable an asset class than stocks. Because of that, it’s possible and common to leverage. In my case, as an owner-occupier, I put down $12,500 to control a $250,000 asset. I am leveraged at 20:1 or 95 percent. While this creates risk for me, it also allows my work to have a far greater impact

Putting in the work to improve my property’s value 5 percent is worth thousands of dollars to me. Improving the return on a $12,500 stock investment by 5 percent is worth just $625. A vast difference.

life-on-half-income

Related: Why Warren Buffett’s Stock Picking Methodology Is Outdated (and Real Estate Is the Best Investment)

Conclusion

There is nothing inherently wrong with investing in stocks. Buying a little bit of Apple, Google, Facebook, or anything else doesn’t make you a fool. It’s fun to talk about and buy the big names, and heaven knows that people do far more foolish stuff with their money.

The foolish thing isn’t in buying individual stocks. It’s in thinking long and hard about investing in individual stocks and spending valuable time trying to pick the winners. Expending that thought, doing large amounts of research, and attempting to earn outsized returns is an enormously difficult and emotional task. Even if you are in the tiny minority of folks who succeed, you won’t reap the benefits of your expertise until you have well over a million dollars to invest.

Forget about it. Put your intellect, education, and your back into something more tangible.

Like real estate.

Are you weighing your options and choosing where to invest your money? Do you have experience investing in real estate, stocks—or both?

Leave your stories, opinions, and tips in the comment section below! 

Scott Trench is a perpetual student of personal finance, real estate investing, sales, business, and personal development. He is CEO of BiggerPockets.com, a real estate investor, and author of the ...
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    George Lui Investor from Palo Alto, CA
    Replied over 3 years ago
    Great article and very aligned with my recent way of thinking. I’ve done my stock investing over the past 20 years with varying results. However my recent participation into REI has really been an epiphany for me. I only wished I started 15 years ago!
    Wade Bronnenberg from Anoka, Minnesota
    Replied over 3 years ago
    There is a strategy that eliminates risk and losses in the stock market. It doesn’t matter what stock you pick. I use the NUGT which is a 3 times leveraged and make cash flow using weekly options. There is another component that eliminates the risk/losses. I have been making 1-2% per week. Not the tax advantages of RE but great returns.
    Lee S. from Northern, California
    Replied over 3 years ago
    The issue with stocks is you can’t beat the manipulation of stocks in the short term by the insiders, long term the fundamentals of a company will prevail however. I’ve been a stock/options trader the last 5 years along with doing real estate, the manipulation is obvious in the stock market when paying close attention. You can hit big winners however, I was in on Tesla fairly early on with a sizable amount of shares, it was obvious to me. The one advantage to real estate is getting access to off market deals which is an Information advantage that small players will never have in the stock market. I have an appt to look at 12 off market properties this week owned by a retiring investor that nobody knows about. Can’t do that with stocks! I will continue to invest for long term wealth in the market but look for short and long term gains/wealth in RE.
    Russell Gronsky Specialist from Baltimore, MD
    Replied over 3 years ago
    The writer of this article reaches far in order to push some of his points. Spend 500 hours for $1.36 an hour…yeah….maybe at first. You probably have to put in that time for a few months to get good at reading financial statements and figuring out what numbers are important and which can be ignored. But you think you’ll be reading those financial reports when you’re more experienced than when you first start? Think you’ll spend the same amount of time crunching numbers and studying the reports? Nope! You’ll be much more efficient. Comparatively, how much time did you spend analyzing RE deals the first few months when you got started as opposed to now? I bet you’re a lot faster, more efficient and you know what things to look for and what can be ignored when doing an analysis. I can keep going but I’ll stop here. I think you all get where I’m going with this.
    Logan Allec Accountant from Los Angeles, CA
    Replied over 3 years ago
    I was just reading a great article about this the other day: http://millennialmoneyclub.com/557/how-not-to-invest-in-the-stock-market/
    Kyle Scholnick from Boca Raton, Florida
    Replied over 2 years ago
    This article continues to annoy me everytime it pops up in my email. This is one of my favorite quotes: “I decided to try my hand at stock picking early last year when I had saved a nifty $5,000. I spent hours reading the annual reports of so-called “micro-caps” (companies with less than $100 million in market value). I read annual reports, got in touch with key executives, called up stores that sold or used their products, and performed all other types of crazy due diligence. And guess what? In 2014, a year when the S&P shot up 11.4%, I managed to lose money.” So because You did something and it didn’t work out that means the whole stock market is a waste of time? Perhaps YOU are the problem. I have been trading in the markets for years and have done fine. Nothing better than watching an index make 6% over a 15 year period, but if you know a little about stocks or trading you could make 20-30% in a few months and be out of the trade. I just cashed out of a couple trades the other week. One was an oil futures contract which I made about 16% in 2 weeks and the other was a few individual stocks I bought at the right time (no it is not luck, I knew when the right time to buy was because I know what I’m doing) and sold those for a 40% profit. “Well if you are so good why aren’t you a billionaire?” Because its still a grind. You make a lot when you start with a lot. If traders started with billions of dollars they would make a killing. But most of us, it takes a long time. If you start at 50k trading account and make 20% a year, after 8 years you only have a little over 200k. Hardly enough to buy my next airplane and mansion in Hawaii. Anyway, the point is, just because Scott has no clue what he is doing that somehow means nobody else can do it. I tried doing a rubics cube many times and can’t figure that out…guess it means its all rigged and nobody can do it right Scott?
    Steven Hostetter from Silverdale , WA
    Replied over 2 years ago
    Scott, First of all, let me say how much I appreciate your contribution to BP and now Bigger Pockets Money. Like yourself I am a big proponent of frugality. I have never had a car payment or credit card debt and house hacked my first fourplex in my twenties in the 1990’s. I’m a 55 year old retired firefighter and have made much more money in real estate than the stock market, but unlike many a real estate investor I like the market too. This year I bought my adult sons, both who recently graduated from college, two books. The first one was Set for Life and the second was The Motley Fool Investment Guide. I am writing you today for the sole purpose of encouraging you to consider reading this book. David Garden’s philosophy is counter to wall street and has made it possible for me to beat the market by owning shares of great individual companies. I pay for one of their services which cost me $99.00 (I think), and I don’t spend much time deciding which companies I want to own. I am not encouraging you to invest in the stock market. As stated, I believe that an active real estate investor that makes good decisions should trounce the market for many of the reasons you stated in your article. Having said that, if one doesn’t have the time or interest in real estate I believe the market is also a good choice. I concur that index funds are the way to go if one doesn’t want to spend time learning about the market, but the recent popular belief the it is impossible to beat the market by owning shares of individual companies is incorrect. In fact, individual investors have some advantages over institutional investors. I enjoy owning real estate as well as shares of companies. There is room for both in my portfolio. I enjoy listening to real estate podcasts as well as stock market podcasts. They make my world bigger and me a better investor. If you are interested in reading The Motley Fool Investment Guide to consider another perspective I’d be more than happy to send you a copy. Keep up the strong work at BP Scott and take care. Respectfully, Steve
    Scott S. from Tacoma, Washington
    Replied over 2 years ago
    Another 3yr+ old article being sent out again. These repurposed articles are annoying. At least update them or make the content relevant for today and not when it was written before you hit the send button.
    Raymond Jensen from South Bend, Indiana
    Replied over 2 years ago
    “After hundreds or thousands of hours of careful research and methodical number crunching…” Let me guess, he is still outperformed by a monkey picking stocks by throwing darts at the business page.
    Ka Pang Real Estate Investor from New York City, New York
    Replied 8 months ago
    Due to personal feelings and experiences, we are all leaning towards one camp over the other. I’ve done both and I personally feel it’s best to start with stocks and then allocate towards other instruments like real estate and even life insurance for the security. I don’t feel the issue here is which one is better. The issue here is having the right education from mentors married with the right focus in the first place. IMHO, stock’s or more so Options have a clear advantage over real estate. Part of the problem with most people is that they only focus on the fundamental analysis and not taking the time to learn the technical analysis as well or vice versa. Another problem is that people are driven by fear and greed more so in the market because it’s constantly fluctuating. People tend to go into it more like educated gambling as opposed to risk management. If you ask the average stock investor on how they hedge against a reversal, they wouldn’t have any clues let alone a plan. As for the hedge funds and big money comparison, I feel it’s a poor comparison as they abide by very different regulation rules that retail investors and traders simply don’t. We as retail investors we are riding on the coattail of big money as I assure you that our 100 shares are not the ones moving the market :) Having the perspective on both, I still feel stocks/options still beat RE...easily. Assuming you have the right mentor and edu for both, I can find an abundance amount of opportunities way easier than RE. With RE, you are also restricted by geographical constraints. I invested in out-of-state RE because I was living in NYC at the time, and I either have to drive 3hrs each way or rely heavily on middlemen/team which erodes the margins. With brokerage commissions at where they are today, it’s a no brainer. At even 6-9 CAP rate...on paper/projection...options have a higher % of beating that return significantly. Both will go through peaks and valleys. Therefore, supply and demand is a huge determining factor. With cheap money due to the current interest rate environment, RE prices has also been inflated to reflect that and people are fighting for low inventory on top of that. So if you are wrong on RE, you can’t simply go to your computer to liquidate without taking a huge lost AND pay more middleman. As to the argument of leverage, options is a leverage instrument and margins will provide 2 to 1 buying power. Again, I’m not saying it’s one over the other. However, if I have to pick one to start knowing what I know now, I would still go with stocks and then pick at opportunities in RE. Because for most of us, RE opportunities are not readily available for someone with small amount to invest. So consider yourself lucky if you even have one opportunity a year. My 2 cents.
    Marcus House Rental Property Investor from Woodbridge, VA
    Replied 8 months ago
    Mind blown!!! Like wow.
    Jeff Koller
    Replied 5 months ago
    This article personally annoyed me. I'm an investor with the vast majority of my retirement portfolio in individual stocks. I have beat the market for years and I know thousands of others that do the same. Why? Because I read books like Peter Lynch's "Beating the Street" or "The Motley Fool Investment Guide". It's not luck. Books like these give you a great framework for evaluating stocks and picking great investments. I advise that to you learn what makes stocks go up and down, what makes a great company, and how to build a diversified portfolio. The best strategy is to find great companies and hold for the long term as long as the company still is performing. Another important thing to consider is community. The best I know of is the Motley Fool. Another good one is Investor's Place. They let the community rate stocks, they have stock picking services, and give feedback and it's a great place for novice stock pickers to start. I love Real Estate (the tax benefits and leverage are great) and I have a couple rental properties myself. But don't sleep on stocks, even if you start with a small nest egg, averaging 20-25% a year or greater will eventually get you to the promised land. For some reason, personal finance or self help gurus like you or Ramit Sethi, who know nothing about stocks give advice that stocks are so dangerous. Well, yes, they are dangerous if you don't know the first thing about them.