So, you want to try your hand at stock picking? If that's the case, then you'll have only one aim in mind -- to beat the stock market.
Consistently beating the stock market over the long term is very difficult
It's a fact of investment life that around 80% of all actively managed funds undershoot the stock market average over the long term. Given that most professional fund managers, with all their research, industry contacts and experience, can't consistently beat the stock market, what chance is there for the novice Fool?
Don't believe that just because the professionals fail, the amateur stands a better chance. It just isn't the case. While the Foolish investor is more likely to take a longer-term view than the typical fund manager, there's no guarantee he or she will be able to pick the right companies at the right price.
Face it. Successful stock picking will involve a lot of time, effort and anguish.
Ask yourself the following questions before embarking on any market-beating quest:
Can I devote a significant amount of time to investing?
Golfer Gary Player once remarked "the harder I practice, the luckier I get". This quotation is tailor-made for investment. The more you read, research and learn, the better an investor you will become. Successful stock picking requires considerable dedication and effort. If you're not inclined to put in the required time and elbow grease, you'll lose money.
Do I want to learn about the intricacies of accounting and valuation?
Do you want to get your head around some of the complicated figures at the back of an annual report? Do you want to get a grasp on how to value a company's share price? A lack of inclination to become familiar with either will severely restrict your investment performance. And a lack of inclination to become familiar with both will mean investment ruin. Those with a fear of numbers need not apply.
Can I stomach one of my shares losing 50% of its value for no reason?
When you pick individual shares, you'll almost always endure a volatile ride. Expect your hand-picked portfolio to diverge significantly over the short term from the overall stock market. And if you're terrified that one of your shares could lose half of its value for no reason, then individual stock picking isn't for you.
Can I risk the possibility of long-term underperformance?
The stock market offers no guarantees. While successful stock picking requires considerable dedication and effort, it's not necessarily the case that considerable dedication and effort always leads to successful stock picking. Despite your best efforts, there's always the possibility of consistently under performing the market. Can you accept the possibility that, say after five years, you won't have beaten the market average?
So what's the alternative?
If you answered "no" to one or more of the questions above, then individual stock picking isn't for you. And there's certianly no shame in thinking that this whole stock picking game could be more trouble than it's worth. Quite the opposite, in fact.
It cannot be emphasised enough that the most Foolish investment decision in existence is the low cost Index Tracker. If we use history as our guide, then, over the long-term, an index tracker will outperform all other forms of investment, the majority of managed, and most other private investors too. Best of all, the tracker requires no time, skill or ongoing maintenance. On an effort-to-reward basis, it outshines all other investment alternatives hands down. So think about it seriously before you commit to buying individual shares.