Investors: Researching Stocks Is a Total Waste of Your Time

There are a lot of myths about investing. They all share these common traits: On the surface, they make sense. They're fairly easy to implement. They give you a sense you are doing something positive. They provide a false sense of empowerment. They require closely monitoring the financial news. The most insidious of these myths is that researching individual stocks is the key to investing success. Unfortunately, many believe this fairy tale to be true. CNBC's Jim Cramer, for example, recently established it as his "golden rule for long-term market prosperity." Like many other "gurus" in the financial media, Cramer counsels investors to obtain "a solid understanding of a company's fundamentals by looking at earnings reports, reading news stories and parsing through Wall Street analysis." He believes doing this "homework" is the key to profitable investing. It's an appealing theory, and it resonates with investors. In most areas of life, hard work and careful research do pay off. But when it comes to investing, all that "homework" is actually counterproductive. Is Ignorance Bliss in Investing? I consider myself a sophisticated investor. I've written six books on investing, two of which made the New York Times bestseller list. I am a registered investment adviser representative and have been a wealth adviser for many years. I have written thousands of financial blogs and have read hundreds of peer-reviewed articles on investing. I have never done any research on any of the stocks in my own portfolio. I am familiar with many portfolios that consist solely of mutual funds. The stock portion of these portfolios often own more than 10,000 equities. They frequently include most publicly listed domestic and international stocks. I have never done any research on any of the stocks in my own portfolio. I have no interest in the fundamentals of these companies. I have even less interest in the views of Wall Street analysts or pundits who appear on TV. I am content to capture the returns of the global marketplace. According to New York Times blogger Carl Richards, the average U.S. stock mutual fund had a 10-year average return of 8.18 percent at the end of 2013. The average investor, however, earned only 6.52 percent on his or her investment. The gap is caused by investors who attempt to time the market, often in response to the views of "investment pros" who believe they have the ability to accurately tell you when to buy and when to sell. There is similar evidence that investors in individual stocks earn lower returns than investors using a buy-and-hold strategy because they also typically buy and sell their stock holdings (often at the wrong times) rather than holding on to them. Investors (in both mutual funds and individual stocks) who pursue a buy-and-hold strategy should rebalance periodically to keep their risk profiles intact. They should have no interest in how the markets are performing today, next week or even next year. Doing Research on Stocks Makes No Sense The concept of doing research on particular stocks makes absolutely no sense to me. As an individual with limited resources, what are the chances my "homework" will uncover something that has been missed by hedge fund managers, mutual fund managers, Wall Street analysts and others with far greater resources than I could imagine? Vanishingly small. Meanwhile, even with all the resources they have available, the track record of these institutional investors demonstrates that their research often does not permit them to beat a simple index. For the 12-month period ending June 30, 60 percent of large-cap active mutual fund managers underperformed their benchmarks. Over the prior 36 months, 85 percent underperformed. Think about that data for a moment. The most sophisticated fund managers in the world struggle to select stocks from among the S&P 500 that will beat the returns of the index itself. This dismal performance is not an aberration. Over the past five years, more than 70 percent of all actively managed funds failed to deliver returns higher than their benchmarks. Information Is Immediately Incorporated Into Stock Prices It's not difficult to understand the reason for this underperformance. We live in a world where information is disseminated almost instantaneously. All the news that could possibly affect the price of publicly traded securities is already known to the millions of traders engaged in buying and selling stocks. And it is immediately incorporated into the price of stocks. The possibility of an individual uncovering something these traders have missed is infinitesimally small. Even if you concluded, based on your research, that a stock is underpriced, there must be someone on the other side of the trade willing to sell that stock to you. That person or institution has reached the opposite conclusion. Why would you assume you are right and they are wrong? Here's the request I encourage you to make of anyone who is telling you to research stocks in an effort to "beat the market": Show me your data. You are unlikely to receive anything meaningful in response to this demand. Conversely, the weight of evidence against trying to pick stock "winners" is overwhelming. Consider this sampling of studies. The Takeaway on Doing Research to Pick Stocks Instead of engaging in the high-risk exercise of stock picking, you would be better off buying index funds with low management fees in a globally diversified portfolio. Your focus should be on your asset allocation and not on doing "homework" in an effort to "beat the market." You will be in good company. Some people who agree with this approach to investing include: Eugene Fama (Nobel laureate) Merton Miller (Nobel laureate) Harry Markowitz (Nobel laureate) Daniel Kahneman (Nobel laureate) William Sharpe (Nobel laureate) Warren Buffett Peter Lynch In future blog posts, I will deal with some other pervasive investing myths. Next up: The myth that great companies make great investments. Daniel Solin is the director of investor advocacy for the BAM Alliance and a wealth adviser with Buckingham. He is a New York Times best-selling author of the Smartest series of books. His latest book is "The Smartest Sales Book You'll Ever Read."