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Moving Beyond Sound-Bite Investing Wisdom

The following questions — and others of a similar nature — are some of the most common in my email inbox:

  • Does buying an S&P 500 fund count as stock picking, given that there’s a committee of people choosing which stocks are included in the index?
  • Does overweighting U.S. stocks (or value stocks, or REITs, or whatever) count as active investing?
  • Does rebalancing count as market timing?
  • Does basing my spending rate in retirement on market valuations (and/or interest rates) count as market timing?
  • Does Social Security count as a bond?

Typically, the person is asking the question because they’ve latched on to a sound bite-style piece of investing wisdom (e.g., stock picking is bad, market timing is bad, passive investing is better than active investing, your bond allocation should be equal to your age, etc.) and they’re trying to figure out how to apply it.

Sound bites are helpful when you’re first getting started investing, because they allow you to put a decent plan into place without being completely overwhelmed with information. But as you might imagine, they tend to be oversimplifications. And, eventually, rather than trying to base every decision on such simplified advice, you’re better off taking the time to understand the reasoning behind the sound bite, so you can make critical decisions on your own.

For example, why do we often say that stock picking is bad? The answer:

  • It results in less-diversified portfolios,
  • It often results in higher costs (i.e., brokerage commissions and sometimes taxes) as the investor rapidly buys and sells various stocks, and
  • There’s quite a bit of research showing that it’s unlikely that you’ll consistently pick above-average stocks anyway.

Once you understand that, you don’t have to ask whether something counts as stock picking. You can simply determine for yourself whether the activity in question has the same drawbacks — because, ultimately, that’s what you really care about.

So for example, if you’re considering using an S&P 500 index fund in your 401(k), rather than wondering whether or not that would count as stock picking, you can instead try to directly address the important questions:

  • Would using that fund allow you to be sufficiently diversified? (And, is there a way to be better diversified?)
  • Would using that fund result in high costs? (And, is there a way to achieve lower costs?)
  • Is there any reason to think that the stocks included in the index (and therefore the fund) are in some way systematically chosen to be poor performers?

In summary, when it comes to investing, when you find yourself asking, “Does _____ count as _____?” there’s a good chance you’re asking the wrong question.

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