By Evan Bleker
If you’re just starting to invest for retirement, you may be making a big mistake without even realizing it.
For decades, the industry drumbeat has been that stock investing is extremely challenging for individuals. These days, those on Wall Street picking stocks for funds have PHDs, or MBAs, on top of Chartered Financial Analyst (CFA) designations. Mathematicians, otherwise destined for NASA, have been lured away to build trading algorithms which crunch millions of data points per hour.
Since stock picking is mostly a zero-sum game (if I win, you have to lose), how can individual stock pickers fight these giants?
Jack Bogle agrees. Citing numerous studies, his best selling book “The Little Book of Common Sense Investing” shows how poorly individual investors fair at selecting individual stocks for their own retirement portfolio. (Hint: It ain’t good.) Faced with these stats, he argues that small investors should just buy American index funds.
Index funds are pools of money managed by a money manager who has the sole aim of mirroring the content and return of some market index, such as the Dow Jones Industrial Average or S&P 500. By buying index funds, Bogle claims, investors can claim their full share of profit and growth achieved by American business.
But, Bogle ignores the fact that you can’t abdicate your responsibility for picking investments. Even if you stick with American index funds, you still have to decide which index fund to buy. Fidelity, one of America’s largest brokerages, had 104 index funds to choose from in 2018. This is only one financial institution and your decision becomes far more complex as you begin to look at offerings from other institutions. Arbitrarily selecting from one institution’s index funds may lead to subpar results.
The same goes for sticking to America. While the US has the largest financial markets in the world, other modern first world countries, such as the UK, Belgium, or the Netherlands, have stock markets that predate those in the US. Rule of law and small investor protection in countries such as Canada, Australia, the UK, and Japan are at least as good as in the US. This makes the decision harder, but it’s not the biggest challenge new investors face.
By far, the most serious concern is valuation. You can’t simply “put your money in an index” and expect to do well long term. A lot of your success comes down to valuation. Pay too high of a price for an investment and you’ll likely lose money long term. By contrast, you earn your best returns when you pick up an asset (eg. an index fund, a stock, a bond, a car, or a house) for a cheap price. Valuation is a major factor in success or failure of your retirement.