Mighty Bargain Hunter

Are stock-picking contests totally worthless?

July 16th, 2007 | by mbhunter |

Jonathan over at My Money Blog blasted CNBC’s Million Dollar Portfolio Challenge and other stock-picking contests.  He takes two main positions: that these contests are about luck rather than skill, and that there are always people trying to cheat the system.

So what?

First, if the contests are really about luck rather than skill, what does this say about stock-picking with real money in the real world?  It’s well-established that the majority of stock-pickers don’t beat the return of the broader indices.  So doesn’t this point just reinforce reality?  Folks who beat the market over a short period of time are just lucky anyway?

Secondly, people will cheat, even when there’s a whole lot less than $1,000,000 at stake.  People who cheat the system in real like sometimes go to prison.  Disqualification from the contest for being a cheater is neither unexpected nor divorced from real life.  (Watching filing disclosures from insiders to a company does give some traders an edge, though; reading and acting on this information is perfectly legal.)

OK, so let’s say that it is indeed stupid to try to pick stocks and the much smarter move is to invest for the long term.  Jonathan “ignore[s] short-term variations of the real stock market.”  This only really matters if he’s in stocks, which he appears to be heavily invested in at the moment.  Buying into the broad market via mutual funds is a good, low-cost way to come close to the return(s) of the market(s).  That’s fine.

The flip side of this is that he’s unlikely to do any better than these returns.   Stocks have been known to go down or stay steady for a long time.  The S&P 500 held steady for the 1970s, and it’s done a pretty good job of holding steady this decade so far, recovering to its starting point after losing about half of its value.  I don’t know, but I’d like to do better than that.  Seven years is a long time to be waiting for stocks to recover.  Even dollar-cost-averaging the whole time, it’s still a long time to wait for stocks to recover.

So how does one take steps to avoid the “sinking tide moors all ships” scenario of a falling broader market?  By not matching the broader market.  This is where individual stock picks come in.  This is where bonds and cash come in (which Jonathan has a little bit of).  This is where gold comes in.  And silver and other commodities.  Maybe Euros.  Possibly land in West Virginia.  I don’t know.  A collection of individual equities, currencies, whatever, with appropriate stop losses, should provide diversification in a way that investment in the broader indices can’t.

If this stock-picking contest gave some people the confidence they needed to get into the market, great.  (The winner probably won’t get into the market.)  They’ll start dealing with commissions and taxes, but hey, that’s real life.  If it convinced people that they’re not great stock-pickers, then it was a successful paper-trading exercise from their standpoint, so it should be worthwhile to those participants.  If I lost $500,000 in imaginary money in the eight weeks of the competition, the smart things for me to do would be (a) to figure out why and (b) watch to see if my portfolio would have recovered in a longer time frame.

Main point:  Stock-picking contests aren’t stupid.  And congratulations to the waitress in Ohio.  Whatever you did, it worked.  The market is always right, and the market thought you were the rightest.