Stock Picking — A Loser’s Game

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In a recent New York Times article, an academic study was referenced that documents one of my long-held beliefs.  Here is the conclusive quote from the article/study:

Index funds are the only rational alternative for almost all mutual fund investors, according to the study’s findings.

But if you don’t accept that index funds and similar low-cost, well-diversified vehicles are the best way to build wealth over time, read the following excerpt:

Professor Wermers says he was surprised by how rare stock-picking skill has become. He had “generally been positive about the existence of fund manager ability,” he said, but these new results have been a “real shocker.”

WHY the decline? Professor Wermers says he and his co-authors suspect various causes. One is high fees and expenses. The researchers’ tests found that, on a pre-expense basis, 9.6 percent of mutual fund managers in 2006 showed genuine market-beating ability — far higher than the 0.6 percent after expenses were taken into account. This suggests that one in 10 managers may still have market-beating ability. It’s just that they can’t come out ahead after all their funds’ fees and expenses are paid.

Bottom line:  fees and expenses are important and often create too high a hurdle for even the most talented (or lucky) stock picker to overcome.