The Pitfalls of Playing the Stock Market: Why Index Funds Win Every Time
Updated May 11, 2023
My mini-retirement had finally given me the time to really learn more about investing, and after taking many months to soak up as much knowledge as I could…it all led me to the conclusion that low-cost index investing is the simplest and easiest way to earn better than average returns.
Yes, I am a Boglehead!
So after firing my advisor, I put together a financial plan, and have tried to stick to it as best as I can.
I’ve worked quite hard to manage capital gains from the transfer, sell out of expensive mutual funds, and manage an out of control portfolio of 80+ stocks.
Then I made a bad decision.
False Logic and FOMO
Already owning 80 stocks that I wasn’t going to be able to sell out of anytime soon, I figured “I should pick some stocks that I believe in” to supplement my personal mutual fund:
I created a small play portfolio consisting of growth stocks that I believed in and wanted to invest in for the long run.
So against all Boglehead advice, I took about 1.5% of my total portfolio and invested in these stocks.
My intentions were pure. I really believed that I would own them for at least 5 years, come hell or high water.
My logic was backasswards. I was chasing a sunk cost. My sunk cost in this was the 80+ stocks that I already owned and couldn’t sell off.
I thought that I could help round out my portfolio.
I thought that I should at least get to choose some growth stocks that I would be stuck with for the long run.
I was wrong. I could feel it in my gut. I just didn’t listen.
Finally, I Trusted My Gut.
A few months into this experiment during a minor market correction, I wanted to look and see if there were any expensive mutual funds that I could sell off and “save” on capital gains tax.
Then I noticed that most of my “play portfolio” stocks that I added earlier in the year had all taken a beating.
I considered if I should sell some to take losses. I already had sold a few in the months prior to take some short-term losses and allow me to sell more of my 80+ stocks that I didn’t want.
But I needed to listen to my gut.
I had to think long and hard about it, but the answer was yes.
False logic. FOMO. Sunk cost fallacy. Whatever, you want to call it, I was using it.
We could cue in a comment from Warren Buffet, Mark Cuban, Charles Schwab, Jack Bogle, etc. They all say that the average investor should invest in Low-Cost Index Funds. Every. Single. One.
Why would you screw it up?
Maybe I did end up choosing the right horses…But maybe not. Why was I bothering with something that is a tried and true method? Set it and forget it.
Ben Carlson, shows how simplicity beats complexity in real-life in “How the Bogle Model Beats the Yale Model” – he compares “The Bogel Model” of passive index investing with “The Yale Model” of actively managed endowment funds.
The results speak volumes:
This has nothing to do with active vs. passive investing. This is all about simple vs. complex, operationally efficient investment programs vs. operationally inefficient investment programs and high-probability portfolios vs. low-probability portfolios. Investing is hard enough as it is before introducing a complex, inefficient, low-probability investment style.
That’s why the simple, efficient, high-probability Bogle Model wins.How the Bogle Model Beats the Yale Model – A Wealth of Common Sense
If endowment funds can’t beat index funds in the long run, then there is no way in hell that I will be able to.
So why was I thinking that I could beat the stock market?
And for what? More stress, more decision fatigue. More trying to figure out when to sell, when to buy? What to buy? It’s all effin stressful.
Making one decision that led to more decisions
I wrote a while back about 10 ways to overcome decision fatigue. I should heed my own advice.
Holding individual stocks was not only likely going to be non-impactful on my total returns, but it was causing a heck of a lot of decisions that needed to be made.
In fact, taking over my investment portfolio itself has caused my decision load to go way way up in the short term.
My decision to start a play portfolio, in hindsight led to more decisions in the future.
Holding an individual stock is much different than holding an index.
You have to sell an individual stock at some point.
The shelf life of a company is not as long as the shelf life of the index.
So my one decision to buy individual stocks, created an infinite potential of decisions needing to be made in the future.
It’s not worth it!
Would You Rather Bet on a Player, a Team, or a League?
I feel confident in my decision to ditch my play portfolio.
I’ll not only sleep better at night, but I’ll likely have better returns in the long run anyway.
As Warren Buffett said to Jack Bogle in 2006:
This whole thing made me think about betting.
When you are investing in individual stocks, you are making actual bets. It is a gamble. No doubt about it.
Betting on Players
In the case of individual stocks, you are betting on the player.
Some players have great careers.
They may be hall of famers.
They may earn all of the accolades from Rookie of the Year to Most Valuable Player, to Defensive Player of the Year, All-Star teams, etc.
And this is the same for compares or individual stocks.
They may have a great run of 5, 10, or 20 years.
Once in a blue moon perhaps they’ll go 100 years, but eventually, it will come to an end.
Do you want to bet on something that has an expiration date?
Betting on Teams
So maybe it is more sensible to bet on a team?
Teams aren’t reliant on one player.
Even the Chicago Bulls’ dynasties primarily powered by Michael Jordan, were team efforts:
- Scottie Pippen
- Dennis Rodman
- Toni Kukoc
- Horace Grant
- AND Michael Jordan
So sure, you can bet on a team and they may create a dynasty and win for years…BUT all dynasties eventually come to an end and teams then have to go through a rebuilding phase.
As you can see, there is nearly no rhyme or reason for which sector will win in a given year.
And even if a sector does perform year after year, all dynasties come to an end.
You can’t be on teams either.
Betting on The League
Finally, there are the leagues.
Someone is going to win a championship every year in every league, rain or shine.
Not even the pandemic could stop that from happening!
The popularity of each league continues to grow, year after year, even despite more things for people to watch and do.
And as the popularity of each league grows, so does the average franchise value:
Clearly, betting on the league is going to get you the most consistent bang for your buck.
Year, after year, popularity and value increase.
Leagues, as you may have noticed, are like Low-Cost Total Market Index Funds.
It doesn’t matter what team wins every year.
It doesn’t matter who is MVP of the league.
It just doesn’t matter. You still win!
Clearly, the only bet to make is to bet on the league.
Thank You Common Sense
Thankfully, I came to the realization pretty early into my investing career that I need to simplify my portfolio, not make it more complex.
I want to invest in the league and NOT bet on the players.
I want to utilize the common sense imparted on me by Jack Bogle, and invest in low-cost index funds.
I trusted my gut. And it feels good.
It doesn’t matter to me what happens with certain stocks now.
It only matters how the market is performing over the course of decades.
We’ve had a few up and down years, but I know in the long run the market is only going to go up.
That is why every time I even think about betting on sports, I am going to take that money and invest it in $VTI instead.
Gambling of any kind is no get-rich-quick scheme. And play portfolios aren’t get-rich-quick schemes either.