Stock Picking Software & Fund Managers: Picking Stock & Staying Ahead Is Harder Than It Sounds
Picking stocks is easy. Picking winning stocks - not so easy. Even if you do happen to have decent stock picking software, the investment returns can be deceiving. Stock brokers and mutual fund companies (along with the agents that represent them) often don't much to bring clarity to the issue either. When your investment broker tells you he can earn you 10% a year, there are two other questions you want to ask him before you sign up:
1) Is that "net return" or "gross return"? Brokers love gross numbers because it doesn't show you what the costs of doing business are. The reality is that transaction costs and fees can be substantial depending on your investment. For most mutual funds expect anywhere from 1%-2% in fees (unless you are investing in low-load mutual funds, which can sometimes be cheaper). A 10% gross figure means you will probably average 8-9% long-term.
Most brokers wished they were that good. Sadly, 94% of all mutual funds under-perform the market. So, if you are earning 8%, your net could really be 6%.
2) What is the time horizon for these returns?
In other words, does your broker think he (or she) can average 10% over the next 5 years? 10 years? 20 years? The time frame makes a HUGE difference in how realistic your broker is being with you.
During a time horizon of 10 years, a 10% rate of return - gross or net - is normally not realistic. Over 20 years, your odds increase. Why? Well, consider your odds of hitting a 0% or negative returns over the short-term. The day to day movements in the stock market are almost completely random. Trying to predict stock prices day to day is like trying to predict where the roulette ball will land next.
The shorter the time horizon, the more uncertain your gains (or losses) are. Typically, if you are diversified accordingly, a reasonable 10 year return is about 6.5% net after fees. The longer you stretch out the time horizon, the more certainty you gain about your investment returns. Conversely, if your broker is recommending you invest in a "hot" sector right now, perhaps you should think twice before handing over any of your money. An industry that grows 30% this year may level off next year or crash. What you end up with in 5 years could be a big disappointment.
I'm not easily swayed by a "hot story" or exceptional sounding investment returns and neither should you. As you can see, there are a few things that can make a good-sounding investment sound terrible in the end.
If you do decide to start picking stocks in the hopes of comfortable investment returns, make sure you understand the basics of sound investing principles - namely fundamental analysis and value investing a la Warren Buffet or Peter Lynch. Model your strategy after those who are already successful.
About the Author: David C Lewis, RFA can help you become a better investor. Picking stocks is not always easy. Stock picking software can be misleading and give you a false sense of security in your picks. To learn more about a unique approach to investing, go to: http://www.twintierfinancial.com/valuetool/investing-in-stocks.html.
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Print Article | Download PDF | 10 views | Jul 07 2008
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