“Know your circle of competence, and stick within it.”
Warren Buffett
One of the most insidious aspects of sites like eToro and Robinhood is the impression they give that making money through trading stocks is easy.
Of course, placing a trade is easy; you can do it in seconds with just a few clicks. What isn’t easy is profiting from it.
The global financial markets are extremely efficient. There are millions of trades every minute; and every one of them provides us with the latest best-guess estimate of what a particular asset is worth. The chances that you, as an individual investor, have valuable insight or information that no one else does are extremely slim.
To make things even harder, the vast majority of trading nowadays is done by professionals. Unlike amateur traders, they work full-time; they have the latest data and technology at their disposal. The best ones are hugely intelligent and they have vastly more skill and trading experience than you do.
As William Bernstein wrote in his book, The Four Pillars of Investing, “trading stocks is like playing tennis against an invisible opponent; what the investor doesn’t realise is that he’s volleying with the Williams sisters.”
Behavioural finance expert Meir Statman used the same analogy when I interviewed him at a conference in California a few years ago. “The stock market is like playing playing tennis with Djokovic on the other side,” he said. “It’s not like playing against a training wall. And so you always have to ask yourself, What is the advantage that I have over Djokovic? Do I have an extra-size racket? What do I have? And for most people the answer is nothing.”
The simple solution
So what’s the answer? Traditionally, financial advisers and journalists have encouraged investors, instead of trading stocks themselves, to pay active fund managers to do it on their behalf. The problem is that, once you factor in the cost of using them, only a tiny fraction of those managers succeed in beating the market in the long run. We can all see who the winners have been in the past, but identifying them in advance is all but impossible.
No, the logical response is not to play the active management game at all. Instead, just sit on the sidelines and settle for the market return by using low-cost index funds. Though I use the term “settle for”, bear in mind that, over decades of investing, you will save yourself a fortune in compounded fees and charges — and that will leave with with higher net returns than the vast majority of active investors.
No, it’s not always easy. It requires patience and discipline. It means keeping your head when all about you are losing theirs. But it’s beautifully simple. And, as Part 3 of How to Invest, our videos series for Wealth Matters, explains, it’s the most efficient, and the most rational, way to achieve your investment goals.
Remember: you might dream of serving like Ivo Karlovic or returning like Rafa Nadal, but you wouldn’t want to step on court with them.
ALSO IN THIS SERIES
How to Invest, Part 1: Understand risk and return
How to Invest, Part 2: don’t chase performance
NEW TO INVESTING?
If you’re new to investing, TEBI founder Robin Powell and fellow financial blogger Ben Carlson have written a book that you really ought to read. It’s called Invest Your Way to Financial Freedom, and it’s published by Harriman House.
Primarily written for a UK audience, the book has no hidden sales agenda and is based on peer-reviewed academic evidence. It explains, in simple terms, how young investors can develop good habits, save a fortune in unnecessary fees, and achieve financial freedom many years earlier than they otherwise would.
You can either buy the book direct from the publisher or via Amazon:
For those in the UK,
Buy the paperback via Harriman House here
Buy the paperback via Amazon here
Buy an audio version on Audible here
For those outside the UK,
Buy the Kindle version via Amazon here
Picture: Shep McAllister via Unsplash
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