Do you consider yourself a member in good standing of the community of amateur stock pickers? If so, you best be a truly exceptional one because if you’re not, the road ahead of you is going to be unpleasant. Maybe you’ve already learned this, or maybe you’re still in denial. Either way, you’re eventually going to get “Plimptoned”.
Getting Plimptoned
George Plimpton was an American journalist, writer, and occasional amateur sportsman. He is widely known for his sports writing. He was also famous for “participatory journalism” which included competing in professional sporting events, and then writing about his experiences.
He climbed into the ring to spar with Sugar Ray Robinson, pitched in a Major League baseball game, performed a comedy act at Caesars Palace in Las Vegas, and played quarterback for the Detroit Lions in a regular season game. He recorded these experiences from the point of view of an amateur trying to compete (or perhaps simply survive) in a battle against professionals.
You can imagine the outcomes of these events. It was only the kindness of the professionals that saved Plimpton from being maimed or killed in the process of making his point – that amateurs have no business trying to compete against professionals. It’s not that the pros have superior skills. It’s that they have skills that are several orders of magnitude better than amateurs.
Getting Plimptoned in the Stock Market
And so it is in the realm of stock picking. First let’s define our terms so we’ll be on the same page. In the community of stock pickers, a professional is someone whose livelihood depends on how skilled she is, how profitable her trading decisions are, and how successfully she is able to avoid blowing herself up in the market.
She spends most of her waking hours thinking about her investments, doing research, crunching numbers, and working her Rolodex (her network of industry contacts), looking for clues about new developments that might be on the horizon.
She has a Bloomberg terminal, a state-of-the-art computer network, access to the best minds in the research community, a staff of young Ivy League math and science wizards to take care of the grunt work, and enough capital to weather just about any storm that blows through the market.
And there are thousands of professional stock pickers just like her, who are competing for the finite amount of Alpha that’s available in the marketplace. Do you think you can compete with her and her peers? You could spend hundreds of hours developing an investment strategy, and who knows? You might even find one that works.
But, as George Plimpton learned, no amount of hard work and preparation that he did to prepare for his events was enough to make him truly competitive in the Big Leagues.
Yes, you CAN beat the odds
Maybe you were your high school valedictorian, got a perfect score on your SAT’s, and graduated Cum Laude from the University Of Chicago Booth School Of Business. You still will not be able to keep up with the Wall Street analysts with their PhDs in math, statistics, physics, behavioral psychology, and computer science.
But here is a glimmer of hope for you. George Plimpton was handicapped by a woefully inadequate combination of size, strength, coordination, training, and conditioning. But amateur stock pickers don’t need any of those attributes to compete in the stock market. As lopsided as the playing field may be, it’s not as lopsided as a contest between amateur and professional athletes.
It is absolutely possible for an amateur to compete, and even outperform professional stock pickers in today’s market. This is due to several factors, not least the efficiency of the market itself. With all of these highly skilled analysts, traders, and portfolio managers competing for a finite amount of Alpha (excess return above the market return), the difference between the average performance of the top quartile and the bottom quartile of the professionals is only 2.8%.
The Amateur’s Edge
The implication of this narrow difference in professional performance is significant. For one thing, it shows how difficult it is to capture Alpha – even for a professional with a large staff and a generous research budget. To understand this phenomenon, consider the incentive structure in the business. Portfolio managers are well-compensated for outperforming their peers, but they are severely penalized for underperformance. That makes them reluctant to “stick their necks out” by straying too far from their designated benchmark.
A large cap fund will try to stay close to the performance of the S&P 500 index, for example. To boost performance, the manager will tilt her allocations in favor of stocks that she thinks will outperform, and underweight those she thinks will lag. But she won’t stray too far from the S&P 500 weightings.
There is little incentive for a professional manager to try and “shoot for the moon” by making straying too far from the benchmark she is trying to beat. The punishment for guessing wrong is a drastic cut in bonus pay, or even an outright firing. For most managers, it just isn’t worth the risk.
This dynamic opens up a lane of opportunity for the amateur investor. She is not bound by the conventions of the industry, so she is free to create any degree of tilt, take any amount of risk, and pursue any stock picking strategy that she likes, without worrying about what the boss might say. She IS the boss.
Don’t Miss Part 2 of A Little Tough Love for Stock Pickers
In the next installment on this topic, I’ll dig into the details of what it takes for an amateur to beat the market, and even beat the pros, as a stock picker. It’s not easy, but neither is it impossible.