The Peter Lynch investment mantra to “buy what you know” is just wrong, plain and simple, says Index Funds Advisors president Mark Hebner.
Not only that. He says stock picking, in general, is an all around bad bet.
Hebner lists a couple reasons:
#1 — Let’s Make a Deal
If someone wants to invest in stock A, he or she has to first find a seller of stock A. But, if said stock is such a great investment, why would anyone want to sell in the first place?
#2 — No Risk-Return Premium
Investing in individual stocks is much riskier than investing in a diversified portfolio.
“Essentially all stocks have the same expected return as the market which is roughly 9.5 per cent,” he tells Henry in the accompanying clip. “It makes no sense at all to buy an individual stock with this huge range of outcomes, when you can have the same expected return at a narrower range of outcomes.”
#3 — Information is “Baked in the Cake”
All investors and their information are basically created equal, says Hebner.
“Why would one individual think they know more than these millions of people all over the world whose opinions have already been aggregated in that price?” he asks. “What information do you know — or some investor know — that is not already baked in the cake?”
So, if you cannot consistently win — and win big — by picking stocks, what should you do?
Hebner says, forget stocks and mutual funds, “all you have to do is buy the market” by investing in a diversified portfolio of index funds that incorporate emerging markets, international markets and the U.S. market. And, with each of these segments, he recommends focusing on the asset classes that have had a historically higher return.