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Would you play a game that you knew you were probably going to lose? What if you knew it was a game unlike most games in that you would be going up against the very same opponent the professionals face? And what if these professionals, who have devoted entire careers to becoming experts at this game, and who work at it all day every day, nonetheless mostly lose year in and year out -- how eager would you be to play that game?
The game I'm talking about is of course investing, and that fact changes everything. For if you're like millions of Americans, you play this game seriously, fervently, perhaps fanatically, despite those traits that make it such a seemingly insane way to spend your time. By investing I mean picking stocks in hopes of beating the market, and if you don't believe you can beat the market, then what kind of American are you?
Yet the evidence remains overwhelming, I'm sorry to report, that you probably cannot beat the market -- probably cannot beat it at all, even through blind luck, and certainly cannot beat it in any systematic way. This uncomfortable fact comes through relentlessly in the thoroughly revised new edition of Burton J. Malkiel's great book, A Random Walk Down Wall Street, just reissued on the 30th anniversary of its original publication. Read it, and you find yourself asking, and eventually answering, the question of why so many people play this crazy game.
Just to remind you of how depressingly huge are the odds against you, consider a few facts. Year after year, through good markets and bad, two-thirds of professional money managers fail to beat the market averages. These are trained professionals, the ones who get paid big salaries, sometimes millions of dollars a year, to do just one thing: beat the market. Now if you figure these folks account for most of the trading and therefore are mostly trying to beat one another, you'd think the stock market would be like the NFL: the average team would, by definition, win 50 percent of the time. But it's even worse than that, since traders incur research and transaction costs. Thus this remarkable game in which most players are losers.
Look into it further and it seems there's more going on that just average luck made worse by the costs of participating. There's evidence most professional money managers are - how to say it? - positively, aggressively bad. The troubling news is in the figures showing the cash positions of mutual funds over the past 30 years. If fund managers knew what they were doing, they would pour money into stocks, leaving little or none in cash, when the market was at its low points, about to rocket higher. And they'd bail out of stocks, holding large positions in cash, when the market was at peaks and about to plunge. Needless to say, this is not what they did. But what's so remarkable is that they did just the opposite. Market troughs, when they should have held the least cash, are precisely when they held the most cash. And at market tops, when they should have held the most cash, they held the least. That is, they were much worse than clueless. Not only did they fail to get it right, they got it exactly wrong.
To repeat, these are the professionals.
So why on earth do we play this game? What could possibly make us think we'll win, in the face of evidence that was overwhelming when Malkiel published his book 30 years ago and is even more so today? Malkiel tells us the answer, or at least part of it, in a few commendably frank passages. Investing is fun. Trying to pick stocks is gambling, pure and simple, an activity that extends its appeal deep into millions of souls, always has, and always will. And there's nothing in the world wrong with getting fun and excitement from gambling - as long as you know what you're doing.
Malkiel knows. He keeps most of his investments in boring old index funds - by far the most sensible choice in light of the facts. But he also sets a bit of money aside for the fun of picking stocks. How has he done? Just okay, he said when I asked him recently. But that's looking only at the dollars. It doesn't count the fun. Include that, and he figures he's done just great.
We all need to remember that picking individual stocks in hopes of beating the market is a game -- nothing more and nothing less. It provides rewards and satisfactions that can't be measured in dollars. And on average it's a much better game than you'll find in Las Vegas or Atlantic City, where casinos take a big cut. So by all means play this game if you like. Just know that that is what you're doing, and play it smart.
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