The Myth of Stock Picking


It is difficult for fund products to obtain profits that exceed the industry average now. Those top fund managers were in high spirits the year before, but were nowhere to be seen in the second year. Despite the high management fees charged by foundations, many large funds have never made satisfactory performance. At this point, we will inevitably doubt the level of those fund managers. After all, we also pay high management fees for this. If they cannot help us achieve returns that exceed the market average, then why not invest in index funds directly?


Picking Stocks in An Efficient Market

All investors who have been exposed to financial fundamentals courses will definitely have an impression of the efficient market hypothesis (EMH). Eugene Fama of the University of Chicago proposed this hypothesis in the early 1960s, arguing that financial markets are or may be efficient markets. The hypothesis assumes that market participants are savvy, rational, and will only make investment decisions based on the information they receive. Since everyone has access to the same information, securities are priced reasonably at any time. The theory does not deny the significance of picking stocks, but it holds that the stock price is already the feedback of all information, so investors are basically unlikely to rely on the advantage of information to obtain profits.

For example, an investment manager would buy a security if he or she believes that the present or future value of a security is higher than its present price. But with limited funds, he or she must first sell some securities. At this point, he hopes to make the most of the information that has not yet been reflected in the stock price. Burton Malkiel's book, A Random Walk Down Wall Street, expanded on efficient market theory and is now a must-read for every investor.


The efficient market hypothesis argues that there are three different forms of efficient markets: weak-form, semi-strong-form, and strong-form efficient markets. In a weak-form efficient market, the current market price is completely affected by historical prices; in a semi-strong-form efficient market, the current market price is accurate feedback of the financial data that investors can obtain; while in a strong-form efficient market, all information is already reflected in in the price of the security. If you agree with the weak efficient market hypothesis, you may feel that technical analysis is useless; if you agree with the semi-strong efficient market hypothesis, you will believe that technical analysis and fundamental analysis are meaningless; if you support the strong efficient market hypothesis, then you'll never be able to make a profit by investing, so it's better not to invest at all.

The Real Market


Although the efficient market hypothesis is very meaningful, the actual market is far from efficient. One of the reasons for the ineffectiveness of the market is that each investor has his own style and valuation method. Some use technical analysis, some prefer fundamental analysis, and some even rely on luck. Many other factors also affect the price of a security, including sentiment, rumors, the current price of a security, and supply and demand. Based on the corporate and securities regulatory issues exposed by the bankruptcy of Enron Co., Ltd., World Communications Corporation and other financial fraud incidents, the US legislature enacted the Sarbanes-Oxley Act, which was implemented in 2002. Its original intention is to make the market more efficient and prevent those interested parties from profiting from information monopoly. It's hard to say how effective the bill will be, but it has at least made people aware of the current problems.

Although the efficient market hypothesis denies information advantage, it does not deny the possibility of fund managers having excess profits by taking additional risk. Most investors are now neutral on the efficient market hypothesis. They argue that while most investors have access to the same information, there are differences in the understanding and execution of the information, and it is this difference that generates excess profits.

Picking Stocks

The process of picking stocks is the process by which analysts decide which stocks to trade and when. Peter Lynch is one of the most famous investors in the world. He used to work at Fidelity and is known for his successful investment strategies. Many people attribute his success to his intelligence and extraordinary decision-making skills. In fact, the prosperity of the stock market and his own luck also played a role. Lynch primarily invests in growth stocks, but he also incorporates some value investing strategies into his investments. This is actually the charm of picking stocks, that is, everyone's choices are different. For example, some people prefer growth funds. There are novel varieties, and there are many changes and combinations. So unless there are investors who stick to the same strategy, their investment criteria and models will change from time to time.

Does Picking Stocks Really Work?

It is not difficult to answer this question with practice. We can try to select a few stocks, form a portfolio, evaluate its market performance, and then see whether active management or passive management is better. In fact, at any stage, relative to all actively managed funds, the S&P 500 can outperform its average. That said, at least half of active funds underperformed the market average. Some people may feel that the stock picking behavior of fund managers is completely meaningless. If this is the case, then everyone can choose index funds to save time and effort and get good returns. In fact, management fees, transaction costs and the proportion of daily cash required will affect the performance of fund managers. These practical factors affect their performance.

If the management fee of the fund is not taken into consideration, the returns of stocks and index funds are actually similar. That’s why many individual stock investors will inevitably regret in the end, because it is better to invest in index funds from the beginning. But most investors can't resist the lure of the hottest funds. Each quarter, they move funds from previously underperforming funds to the hottest ones, and the cycle goes on and on.