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Stock-Picking and Index Investing: Why Broader is Better

Stock-Picking and Index Investing: Why Broader is Better

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Many people think that they can make a mint by stock picking—choosing the next big growth stock that will blow up and earn them huge returns. While it’s always possible that your stock picking instincts could be on the money, experts typically recommend you stick to index investing instead.

We’ll get into why in a minute. But first, let’s consider how difficult it can be to pick a winning stock by using the NFL and the Super Bowl as a frame of reference. 

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Stock picking is like trying to pick a Super Bowl winner

Imagine it’s the beginning of the NFL season, and you’re placing a bet on which team you think will win the Super Bowl. There are 32 teams, so broadly speaking, you have a 1-in-32 chance of picking correctly.

Of course, you’ve done your homework, and you know that some teams are better than others. There are some teams that are favored to win their divisions, conferences, and the Super Bowl at the beginning of the year—while they’re no sure-thing, it’s probably wise to bet on those teams.

But what if you could broaden your bet? Say, bet on a division (four teams) to win the Super Bowl—if any one of those four teams wins the Super Bowl, you win, too. Or how about an entire conference (16 teams)? Heck, what if you simply made the bet that “an NFL team will win the Super Bowl this year”?

While not practical, that would be a bet that almost anyone could take, especially if it led to the same returns in the end.

Well, that’s basically the difference between stock-picking and index investing. Why try and choose individual winners when you can bet on the whole market instead?

Stock-picking vs. index investing

You can think of stock-picking as betting on the Seattle Seahawks to win the Super Bowl. It may not be a bad bet, but chances are, you won’t win that bet in any given year. Index investing, then, would be betting on the Seahawks’ division (the NFC West), or conference (NFC) to win the Super Bowl. Your odds of winning, in that case, are much higher. It’s similar to diversification, in a way.

And again, if you simply bet on an NFL team to win the Super Bowl, you’re assured a victory! So, how would that actually work, though?

You know that you can buy individual stocks—shares of companies that you think will be successful. For instance, you can buy Tesla stock, Ford stock, or GM stock. Choosing one of those, and effectively “betting” on the stock to increase in value, is a practice in stock-picking.

But what if you, instead, bought an index fund or exchange-traded fund (ETF) that tracks the entire auto industry? In that case, you’d likely see a good return if some auto companies do well, and others flounder a bit. You might not see explosive returns, necessarily, but your risk would be lower, and you’d probably still see a good return, if things went your way.

That would be akin to betting on an NFL division to win. How about betting on the entire NFL? What would that look like to an investor?

You could bet on the whole market to go up by buying index funds that track the whole market, such as S&P 500 index funds or ETFs. Yes, they’re out there, and just about any investor has access to them!

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Why index investing is probably a better bet

At Money Vehicle, we have a saying: “Be average. Index!”

That means that we generally think index investing is a better option for most investors, rather than trying to pick out individual winners. Again, it’s true that you may pick the next Bitcoin, or Tesla, or Amazon—but odds are, you won’t.

The odds are in favor, however, of the entire stock market going up over the long term. Yes, there are downturns, corrections, and crashes, but throughout history, the market has always bounced back. That’s why index investing may be your best bet. 

So, how do you get started? Simply look up some index funds or ETFs for the entire market (say, the S&P 500—there are tons of them) or a specific industry that interests you. There is a multitude of options out there, it’ll just take a little research!

But the important thing to remember is that it’s difficult to pick a winning stock (or NFL team). But if you can broaden your bet, you’re likely better off and could increase your chance of earning a positive return. In that sense, broader, as an investor, is better!

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