Stockpicker Investing is Gambling Says Vanguard Icon

by Darwin on June 9, 2009

I read with interest some statements from Vanguard founder and former CEO John Bogle, comparing individual stock and bond picking as an investment method to gambling.  While he doesn’t shy away from courting controversy and usually touts Vanguard’s flagship low-fee funds and ETFs over individual stock-picking due to performance and fees, this is the first time I’ve heard him put it on the same level as gambling.  According to CNBC, he stated:

“Nobody should buy a stock and nobody should buy a bond”…”You’re betting on prices — you’re betting on buying them from those who don’t know how much they’re worth and selling them to somebody who thinks they’re worth more”…”That’s speculation and it’s short term. It’s influenced and driven by supply and demand, and not by the worth of those companies whose value lies underneath that stock price.”

While he may be on to something with some investment instruments like trying to time 3X leveraged ETF moves or buying out of the money options hoping for a payday (see how I predicted a 6000% move overnight on a takeover but didn’t buy the options myself!…or the 2000% move in the death of ethanol that I didn’t play right, but recommended in advance! – at least I have a sense of humor about it), I tend to disagree with a blanket statement that stock picking is like gambling.  I think it’s a rather rudimentary, self-serving statement, which incidentally, conflicts with the brokerage arm of Vanguard – so did Bogle found a company that’s out to swindle investors out of money by generating fees on gambling?

Why Stockpicker Investing is NOT Gambling

While I agree that for many investors, low-fee index mutual funds and ETFs are a much better vehicle for long term investing due to fees, tax consequences and the fact that most professional money managers can’t even beat the index they’re up against, trading stocks/bonds can provide  higher returns to savvy investors when done right and they provide opportunities that index buy and hold investing doesn’t (don’t people who sold Financials/Stocks in general in 2008 feel better than the rest of us now?). 

You can’t always get the actual performance out of an ETF or mutual fund that you’re looking for.  For example,

High Yield:if you want high yield stocks, but want to steer clear of financials, you’re probably out of luck with most high yield stock ETFs.  By buying say, a tobacco or industrial that’s held its value during the downturn, you had a much better return than blindly buying a high yield ETF or “income” mutual fund that actually performed as bad or worse than the S&P500 due to heavy reliance on Financials.

Special Situations:  you may want to exploit a situation where the risk/benefit equation is very favorable based on your calculations.  That’s what I saw when I shorted Treasuries which, while I utilized an ETF to do so, it was clearly a trade, but an educated trade – not gambling (this play continues to hit new highs each week incidentally).  You may see similar plays in arbitrage opportunities, selling options with high volatility just prior to earnings like this Google earnings example, and more.

Easy Diversification: statistically speaking, it only takes about 15 or so individual stocks across various sectors to provide virtually the same diversification as an entire index (law of diminishing returns hits very quickly with over a dozen stocks – I’ve performed the proof/calcs in MBA programs – at least “historical data” demonstrates this, but you can never predict the future).  The most obvious example here is that one our most venerable indices, the Dow Jones Industrial Average, relies on just 30 stocks and has never lost its relevance as one of the most prominent benchmarks in the world.

I had considered the investing gambling question previously with mixed feelings on the topic, but it’s evident where I fell out.

What are your thoughts?

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Carnival of Financial Planning - Edition #95 - June 27, 2009 | Good Financial Cents -Jeff Rose Certified Financial Planner and Investment Advisor, Carbondale, Illinois
June 27, 2009 at 12:57 am

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1 Brad Castro June 11, 2009 at 10:59 am

My thoughts – to put it mildly, I think John Bogle is an ass. Let’s look at what index fund investing really entails:

“Let’s see, I’m an investor who plans to invest for 30 or 40 years. So I want to own shares in the best, the strongest, the most profitable and durable companies in the world. I plant to consistently add new money to my investments. That, coupled with the power of compounding returns, should grow my wealth astronomically over the long term.

“But, just to be safe, I think I should also make sure I own all the average companies, too, the moderately profitable ones that just limp along year after year, And cyclicals. I better own those 100% of the time. And to be extra, extra safe, I better make sure I also own the crappiest companies, too. I don’t care how debt-laden, unprofitable, cash-hemmoraging they are, I want to own them all just to be on the safe side.

“Now, if I could just find the right investment vehicle that would give me all that. I know! I’ll invest in a Vanguard index fund. Since the fees are so low, I’m bound to be super rich in no time at all!”

Bogle looked reasonably smart during the last great bull market (1982-1999), but buy and hold index fund investing has been disastrous since then.

I agree that trading is essentially gambling and that most “investors” are actually traders (e.g. investing in an actively managed mutual funds where the fund manager trades/gambles on your behalf). But true investing–researching, indentifying, and owning for the long term shares in great businesses–has always worked and continues to work today.

For me, Bogle’s greatest flaw is his prejudice that most investors are too stupid to be able to identify a great, consistently profitable business and to be able to purchase shares when those shares are reasonably priced.

[Reply]

2 scrilla gorilla June 19, 2009 at 7:05 pm

For those people who do basically no research before investing, then yes, it basically is like gambling, because it’s all random.

For those who have done some research, are following a thesis, etc., then they are definitely placing a “bet” but only because they believe they have a clear edge. They may end up being wrong (due to chance, stupidity, or both), but the outcome is not random. Not gambling.

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