Are Stocks Worth It?

With diligent research, rational and emotionless decision-making, and unwavering persistence, it’s possible to manage a portfolio that regularly ‘beats the market’, whatever market you may be referring too. Beating the market is the name of the game in the investing world. If you can do it on a consistent basis, you’re winning…right?

Not necessarily.

There are several important, but often overlooked, factors to ponder.

1.) Time-

If you aren’t actually passionate about deeply researching investments, then the use of that time must be justified by other reasons. I myself am not particularly fanatical about poring over financial statements and slogging through annual reports. Therefore, I’m not going to spend 5-10 hours a week doing just that unless I reap significant rewards because of it.

Let’s assume the benefit of foresight. Over the next 10 years, the S&P 500 will return an average of 8%. With my 5-10 hours of weekly research and active investing techniques, I average 10%. Was that worth it? For me, the answer is probably no; I’ve sacrificed far too much time for a result that isn’t all that much better than I could have gotten by simply buying the indexes. However, if I were to average 20%, easily trouncing the market return, the decision is a bit more interesting.

Time is the most precious, finite resource we have. It needs to be accounted for. Passive investing is attractive because you can match the market with a very, very small time investment.

If you outsource your investing to a financial advisor, you save time for yourself, but your advisor will make sure his or her time is adequately compensated for through substantial commission costs, far higher than what you will pay through a quality online discount broker.

2.) Stress-

A buy-and-hold index fund strategy is about as stress-free as investing can be. The global economy as a whole, as well as any sectors you may be playing with ETFs, are your sole concern (admittedly, worrying about the global economy can become stressful).

If you hold individual companies though, you clearly have an interest in the general health of the economy as well, but there are also many smaller variables at play; management decisions, lawsuits, recalls, patents, competitors, acquisitions, mergers…the list goes on and on. It’s a tedious (and pretty much impossible) process to stay informed of all the important developments related to your investments, and all these extra variables are a potential source of stress.

If Merck is a cornerstone in my portfolio, I’m naturally going to be alarmed when a newly released drug leads to a recall and widespread lawsuits. I might even lose some sleep when my shares plummet 10-15% in a single day. On the other hand, if I own every single publicly traded stock in the United States, these micro-variables aren’t worthy of my concern.

Needless to say, many investors thrive on the thrill that active investing can be. I’ll be the first to admit, putting money down on stocks is far more exciting than dollar-cost-averaging in index funds, and for many the higher risk is part of the fun. For others though, working to beat the market isn’t worth the added stress; they have no desire to burden themselves with unnecessary worries.

3.) Taxes- (for taxable brokerage accounts)

An actively managed portfolio will include more transactions than a passive one, as the investor takes profit on winners, cuts losses on losers, and rebalances from time to time. This means a more time-consuming and pricey experience come tax season. Uncle Sam gets to enjoy your success as well.

With a strict index buy-and-hold strategy, the only taxes you have to pay on a yearly basis are on any dividends received or the occasional capital gain distributions. If you do sell some shares at some point, it’ll probably be a long-term capital gain (> 1 year), meaning a much lower rate. In contrast, a heavily managed portfolio is bound to incur much higher short-term capital gain taxes.

Then there’s the time and money spent on actually having the taxes prepared, which isn’t insignificant either.

Unless your returns beat the market by a fairly sizable margin, the government’s cut can ensure that you do no better than the indexes. Never forget to leave taxes out of the equation; the IRS sure doesn’t.

Also keep commissions in mind. For both taxable and tax-advantaged accounts, those commissions will add up over time depending upon how much trading you do. Between taxes and commissions, a big chunk of profits from active investing can be quickly eaten up.

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All in all, I think there is more than enough reason to question the standard of investing, especially when so few people have a proven track-record of beating the market. This is a bit troublesome for someone who not all that long ago could see myself working one on one with clients in a fairly typical financial advisor position. How many financial advisors do you expect are out there advocating strictly passive investing? Probably none that are still in business- it’s hard to earn much in the way of commissions doing that!

Personally, I don’t have any desire to pore over financial statements and annual reports for hours on end, looking for often deeply hidden clues that could indicate the difference between a successful and a poor investment. There’s a reason why I quickly dumped accounting after briefly considering it as a second major; I find it boring. I love studying fundamental economic variables, but I lose interest quickly in a sea of data.

At this point, unless I knew I had a high probability of significantly trouncing the market on a consistent basis, I’m not going to consider active investing to be worth my time. I’m not suggesting that everyone automatically do the same. What I am recommending is a thorough consideration of this issue.