Losing Stocks Continue Their Winning Ways

How are the biggest losers doing?

Readers, I asked you to create a portfolio of stocks that you thought would be hopeless. You put together 23 big, bad and ugly businesses which we compiled two weeks ago. Of course, as mentioned before, one man’s junk can be another man’s treasure. That said, the stocks you selected have had (as a group) a dismal track record over the past 10 years. It was such an ugly portfolio, that if you had invested $3 million in this portfolio of stocks ten years ago, it would be worth roughly $495,000 today, with all dividends included.

You also selected 10 great mutual funds that you felt would make great gains in the years to come. Then I created two portfolios with $500,000 each (one portfolio representing an even allocation in the great mutual funds and the other portfolio an even allocation in the 23 lousy stocks). We decided to track them forever. They would compete: the $500,000 portfolio of super mutual funds vs. the $500,000 portfolio of terrible stocks. You can see the respective portfolios here: … Read More

Do you believe in the efficient market theory?

If you’re a firm believer in the efficient market theory  you’ll reckon that the professionals can’t pick a financial dog from a financial star. You’ll believe luck and chance play the biggest role in success, and not stock selection.

There could be something to that. After all, the mutual funds you selected are all “low turnover”, “low expense” funds—except for the 5.75% front end sales load associated with 3 of the ten.

And studies have suggested that the only reliable determiner in predicting future mutual fund performance is a low fee structure—and low portfolio turnover. The funds you selected all fit the bill.

So if low fees are the only reliable, determining factor in predicting mutual fund performance, then the actual “stock picking skills” of the fund managers don’t count for a hill of beans. But is that true? We hope to find out.

The portfolio of losers has taken a huge early lead in the past two weeks

The $500,000 professionally run mutual fund portfolio would now be worth $498,832.86

The $500,000 “loser stock” portfolio would now be worth $514,595.29

The losers are beating the professionals by $15,762.43

But it’s hard for me to believe that the markets are entirely random. My guess is that they’re probably 95% efficient, and from time to time, you can take advantage of discrepancies between value and price.

That said, I’m going to stick to my early hypothesis: the portfolio of 23 “lousy” stocks created by my readers will still beat the collection of professionally managed funds my readers put together. I believe in the efficient market theory enough to surmise that fees will anchor the professionals, and that many of the stocks you chose had prices that reflected their worth—perhaps even understating their true worth (which is why I only believe the market is 95% efficient)

So what do you think? Will this collection of lousy stocks still be ahead of the pros after 5 years? Do you think you can beat the market over the long term? With all due respect, beating it over a short period of time proves nothing. Can you really stay ahead of the market with your own stock picks? If not, do you believe that you can beat professionally managed mutual funds? As a group, we know that they can’t keep pace with the market.

Andrew Hallam

I’m a financial columnist for Canada’s national paper, The Globe and Mail, as well as for AssetBuilder, a financial service firm based in Texas. I’m also the author of Millionaire Teacher: The Nine Rules of Wealth You Should Have Learned in School and Millionaire Expat: How To Build Wealth Living Overseas. My mission is to educate, motivate and inspire people on basic retirement planning and best practices for investing, using evidence-based strategies. I'm happy to comment on your questions.

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4 Responses

  1. Hi Andrew,

    So do you think that Warren Buffett is gifted, or merely lucky 😉

    I sometimes wonder what it would really take to beat the index… passive investing will get you the returns of the market, so surely if you put a lot of effort into something you should be able to do better, right? This is what makes it seem like a paradox that simple index investing can actually beat the active pros.

    My current strategy is using the simple index investing, since it works (I think in a way you are actually free-riding off the pros, since the pros set the price through their activity, but you don't have to pay them commission in the form of fees), and finding where to focus my active energy to where it can make the biggest difference for me 🙂

  2. Andrew Hallam says:

    Hey Kevin,

    Well…. I figure the markets are probably 95% efficient. Buffett is definitely amazing. I, however, am not–yet I have beaten the indexes with my personal money for 8 straight years and our investment club has beaten it for 7 straight years.

    Mostly, I think those represent lucky runs. Buffett? I think that was more than luck.

    But I'm also open to the concept Buffett discusses in "The Superinvestors of Graham and Doddsville".

    I'm obviously cautious, which is why 70% of my own money is indexed–even though my non indexed money has done so well.

    I just have to respect the component of luck that I've had, and respect the odds of beating the market over time–because they are very slim odds.

    Thanks for adding your comment Kevin. I think your own strategy is pretty sound. Keep it up!

  3. @Kevin and Andrew – I'm a firm believer in EMT, call me "converted" from a few years back. I'm with Kevin, trying to use simple index investing for my RRSP and TFSA, and compliment that with my dividend payers in non-registered accounts to supplement what is hopefully a healthy retirement income. I too, believe index investing works pretty darn well.

    As for Buffett, is he lucky? No. Extremely opportunistic? Absolutely.

    To my knowledge, Buffett has only a handful of times in his investing career, dared to predict what the markets will or won't do. I can't recall if it was in his "The Snowball" book for not, but he once said something to the effect that he never hoped to 'get lucky' with (managing) other people's money. If he wasn't attuned to the market environment, he didn't play the game. He never really speculated. Rather, he bought companies he knew and understood very well. Buffett has forever felt that market forecasters make fortune tellers look good. To this end, he bought simple, straightforward, sound companies and took major advantage of these companies when Mr. Market had a sale. Over time he diversified his holdings amongst all major market sectors. Buffett won the ovarian lottery in that he lived in an age where markets experienced tremendous growth. I'm not convinced for the rest of my life we'll see the same growth rate, on the same order of magnitude, but markets will be continue to move upwards and index investing or purchasing great dividend-payers IMO seems like a safe bet against the gaggle of mutual funds and other professionally managed products out there.

    Love that quote:

    "There seems to be some perverse human characteristic that likes to make easy things difficult." – Warren Buffett

  4. Hey Andrew,

    Any update you can provide on this challenge? 🙂

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