I was a stock-picker for about 12 years. In the early years my habits were very effective for protecting my ego and maintaining my confidence. However, as time passed I began to slip. Reality invaded my thoughts. I was no longer blind to my real skill level. Eventually, I couldn’t pick stocks any more. I’ve turned my cautionary tale into a checklist for those who want to feel good about their stock picking.
1. Don’t calculate your returns.
In my first few years of stock picking, I never calculated my return on any stock investment. I just had the vague warm feeling that I’d made some good picks. This was helped greatly by some extremely good early luck in 1998 and 1999.
2. If you must calculate returns, do it separately for each stock.
When I first made the mistake of examining my returns, I looked at each stock separately. I also managed to not calculate the returns for picks that worked out badly. This had the advantage of allowing me to focus on my wins and not think about the losses. I felt great about my abilities.
3. If you must calculate portfolio returns, exclude anomalies.
When I started to calculate overall portfolio returns, I didn’t quite include all the stocks my wife and I picked. I tended to group only a subset of my accounts together. The fact that our worst picks were in the accounts I excluded was just a coincidence. It’s amazing how great your results look when you drop out a couple of real stinkers.
4. If you must calculate complete portfolio returns, shop for a good time period.
As I began using spreadsheets to calculate overall portfolio returns, it became more difficult to justify excluding a few bad results. But it was easy to choose a favourable time period. Because my initial results were so strong, I always looked at my total returns from the beginning. This way, a few recent bad results still left me with good overall returns. This method of always starting the clock before a period of strong returns is very helpful for the ego.
5. If you must calculate annual complete portfolio returns, don’t compare them to benchmarks.
As I began computing my annual portfolio returns, it became harder to ignore poor years. But I found solace in knowing that things could have been worse. There were stocks I passed on that would have made my annual return even lower. At least I was doing better than some of my friends who picked some real dogs.
6. If you must compare your annual returns to a benchmark, shop for a low benchmark.
It’s amazing how much flexibility there can be in choosing a benchmark. If you own stocks in Canada and the U.S., you can use just an index of Canadian stocks, or you can use a blend of Canadian and U.S. indexes. There are a number of U.S. stock indexes to choose from, and you can choose whether to factor in currency exchange rates or not. By choosing the method that gives the lowest benchmark return and rationalizing why this method makes sense for the current year, you can make your own results look good. The key is to choose your benchmark at the end of the year rather than in advance.
7. If you must compare your annual returns to an appropriate benchmark chosen in advance, just give up stock picking and invest in broad indexes.
When I finally removed the last remaining wiggle room from comparing my returns to a sensible benchmark, I had to face my poor investing record from the year 2000 on. I’ve been steadily shifting to investing in low-cost broad index ETFs since about 2010. The process is nearly complete today.
No doubt readers have figured out by now that I’m not serious about this advice. I don’t advocate deluding yourself into feeling good about failed attempts to beat the market through stock picking. If you’re one of the extremely rare people who actually compare your annual returns to an appropriate benchmark chosen in advance, and you show positive alpha over many years, then good for you. However, others should seriously consider giving up stock picking.