Buying Individual Stocks Doesn’t Math Out For Me

In a post earlier this week TheTailGunner posted his success buying individual stocks since 2004. From The Market has been good to me:

On July 16th, 2004, I opened this account with $11,107.66.

As of some time today, the account is currently worth $26,869.12.

That’s an increase of almost 240% in less than 4 years. Not too shabby.

He further goes on to take a dig at us ETF investors and then provides the secret of his success.

I can assure you that I don’t spend nearly as much time researching the stocks I own as I should. I don’t read financial reports, listen to conference calls, etc. I know I surely should, but I don’t. However, I think that to say I’m lucky with the above returns would also be missing the point. I look for good companies that have fallen on hard times (Apple a year or two ago being a good example), and ride them out.

I thought about how to respond to this post and I decided to do it with math. Since TheTailGunner mostly invests in tech, I’ll use the NASDAQ 100 as the benchmark index ETF for comparisons. From July 16, 2004 through June 25, 2008, this index went up 40%. Using this number it is clear TheTailGunner destroyed the index in returns.

  • TheTailGunner = 240%
  • NASDAQ 100 = 40%

The extra gain earned for individual stock picking over those four years was $11,318.4. Now TheTailGunner freely admits he doesn’t spend the one hour per stock per week advised by Jim Cramer. But we can’t all be so lucky. Most of us can’t be successful active investors without some time commitment.

Let us assume TheTailGunner listened to Cramer and set up a portfolio of 5 stocks and spent an average of just 5 hours a week doing homework, checking stock tickers and watching CNBC.

200 weeks * 5 hours = 1000 hours

$11,318.40 / 1000 hours = $11.32 per hour.

When I was active investing I was spending 15-30 hours a week on financial research and media. And I never got anywhere close to a 240% return. Most of us don’t beat the indexes. Most professional money managers don’t beat the indexes. Bill Miller of Legg Mason beat the S& P 500 for 15 consecutive years, then failed to beat it for the last two. Taleb stated in Fooled By Randomness that investors credit their investing skills when they are right and then blame bad luck when they are wrong.

As addicting as it is to play the market I stepped away from individual stock picking after coming up with this formula.

  (Investment * Rate of Return Above Index)
- (Value of Free Hour * Weekly Hours Spent Researching * 52)
  Net Benefit

The hours spent doing financial research have a value. Since the goal of investing is to make money, one way to value a free hour is by using our hourly billable rate. Every hour spent chasing returns is an hour we can’t devote to another billable endeavor. Some investors value their free hour less than their billable hour. Fair enough. Before one starts actively investing ask yourself how much you value your free hour then run the above formula.

I’ve ran the above formula using a wide range of values for Return Above Index and Free Hour Valued Rate and active investing never mathed out for me with the amount of money I am willing to actively invest.¬†One criticism of this approach is my use of Free Hour Valued Rate. Some investors absolutely love every moment they spend on financial education and media. For those investors, ignore this entire post. Even a negative return will be entertaining.

I don’t regret spending thousands of hours studying finance over the past four years. I’ve learned enough to know success is random and that spending another thousand hours on the game won’t guarantee me returns high enough to justify the effort. I now believe greater financial gain can come from pursuing another discipline with the same dedication I gave to finance.

Perhaps I should just hand some money over to TheTailGunner to manage and then spend my time learning Mandarian?


Add yours

  1. Additionally, there’s an increase of risk in single stocks. My man Dave Ramsey always advises listeners, ALL listeners to stay away from stock and stick to growth stock mutual funds as an investment. This is for long term investing.

  2. “stay away from single stocks” is what I meant up there.

  3. The one exception for me would be the occasional penny stock. High risk with the potential for super high reward can be worth it. I did have my entire trip to South America paid for off the profits from a penny stock. But you need to be prepared to lose it all, so only allocate a small amount.

  4. An excellent, insightful post, MAS. In general I agreed with your sentiment… you can’t beat the market in individual stocks and the effort isn’t even worth trying.

    However, sitting back and accepting average returns via mutual returns or ETF’s goes against human nature. We not only want to keep up with the Jones’s, we want to beat them. We want to ‘hope’ to beat the market…we want a chance. Which, when I think about it, is not unlike playing the lottery in some ways…although the risk is lower.

  5. Well said DHammy.

    Taking advantage of that human flaw keeps a lot of people employed and results in most people performing worse than the indexes.

  6. I think the average investor falls short of their goals due to lack of discipline in a few simple areas.

    -accept that you can lose 10% on any investment and be religious about setting stop losses at -10%, no exceptions
    -set a goal for your gains and sell your winners when you reach your goal.
    -never start a ground war in Russia in winter and NEVER hold any stock from May to August

    I like range trading and bottom feeding. Find a stock in a range and trade the range. Also, in August I think there will be plenty of bargains. Remember we’ll have a new President in November and sentiment will turn, even if fundamentals don’t.

    You can lump me into those who enjoy tracking stocks. I’m not terribly successful, but I get by enough to keep at it.

  7. Stuart – the point of this post was not to discuss strategies on how to beat the indexes, but to analyze if it is even worth our time to try.

    It takes time to look for “bottom feeders” and setting stop-losses. You time is worth X. Unless you are managing a lot of money or you have the secret sauce for stellar returns (no one does), then my thesis is it isn’t worth it.

    The reason most investors fall short isn’t primarily a lack of discipline, but arrogance that they believe they are smarter than the market.

  8. Maybe I am offering a strategy so my apologies for the derail. The point I was trying to make is that investing does not require an open ended time commitment. Whether an individual investor can beat any stock index is a matter of skill (or are we calling that luck?).

    A single GOOG can set someone up for life. With a stop loss, their risk is -10%. Is that akin to buying a lottery ticket? Maybe, maybe not.

    However, you raise an interesting point and I thank you for sharing it.

  9. I see your self education in finance is really paying off. Good for you.

    Reminds of a great quote: “There’s no such thing as a risky investment, only risky investors.”

    Translation: educate yourself and invest in things you understand.

    The best way to invest in my opinion is not to start investing. The best way to invest is to start your company and invest your money there and then learn how to make it very profitable and successful long term. Once you do that, you’ll know how/what to look for in other businesses which, after all, are what stocks are (chunks of ownership in other businesses … how they are put together is simply based on the marketer behind it — hedge fund, ETF, socially responsible fund, alternative energy fund, etc etc):

    So: (1) learn how to create a profitable business, (2) do it, and (3) invest in other businesses (or groups of businesses) that make sense to you and that you like the ‘ins’ (financials, management team, etc) and ‘outs’ of (market, e/p ratios, etc). Also, I think it’s very important to understand your own risk spectrum and allocate your investments across that spectrum. I, personally, have most of my money in either very liquid investments like money market accounts and in real estate because that’s my business (and then I have my own ‘intra-investment risk spectrum’ … for example, for real estate: 10% in development projects, 60% in cash flowing apartments and shopping centers, 20% in turn around projects, and 10% in highly speculative projects such as raw land).


  10. Great advice Matt.

  11. Thanks, MAS. By the way, I just read about this website for those of you who like to ‘play the game’: (sort of like a social networking site for stock pickers/day traders).

  12. I’m calling BS on this one …TheTailGunner got lucky.

    If people could spend such a small amount of time and get 60% returns every year then everyone would do it …until it finally reverted back to the mean. Nobody would even bother to go to work.

    I don’t have much respect for money managers or investment banks …they have done some pretty boneheaded things these past few years. However, the idea that someone can spend an hour or two a week and significantly BEAT people that do this as a profession is silly. If someone offered to remove your appendix after doing surgery for an hour a week what would your response be?

    I personally like the 2* shorts and longs …gives you closer to the return of an individual stock without the significant added risk of a single missed earning or bad news report that can potentially cripple a company’s stock price for a long time.

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