[Important disclaimer: I am not a registered investment advisor. If you choose to try the experiment described below, which is shared with everyone for free, the risk is yours alone.]
Lots of people have jumped into the stock market lately, many of them with little experience. That isn’t stopping them, though; they’re creating Robinhood accounts and trading penny stocks at a blinding rate. I’m writing this to propose an experiment individuals can use to evaluate their own skills at picking stocks and mutual funds. This experiment does require some experience investing, but not much.
First, divide your investment capital into three parts of equal size. With the first part, buy either QQQ or SPY, or equal amounts of each. These are ETFs which track well-known stock indices: the technology-heavy NASDAQ 100 and the broader S&P 500, respectively. This chart shows how the S&P 500 has performed over the last five years.
This first third of the investment money is analogous to a control group; it is the standard by which we measure the performance of the other two-thirds.
The second third is to be invested in no-load, open-ended, actively-managed mutual funds. You should try to choose the best ones you can find. Two that I’ve bought shares of, myself, are TRBCX (a fund which invests mostly in large-capitalization blue-chip stocks), and WAMCX (a fund investing in small, rapidly-growing companies’ stocks).
The final third is made of stocks you pick and buy/hold/sell yourself, using whatever criteria you choose. If you run this experiment for six months (or longer), and this third is the largest at the end of this period, you have good evidence that your stock-picking methods work well, justifying continuing investing in this manner.
If, on the other hand, your hand-picked mutual funds do best, then the data supports the idea that you’re a good fund-picker, but should probably not invest in individual stocks.
Finally, what if SPY and/or QQQ do best? If that is the case, I wouldn’t try to beat the market with my own picks, but would simply invest in open-ended index funds, or ETFs.
I’m trying this experiment myself. So far, my hand-picked mutual funds are doing best. If the running of this experiment continues in this way, I’ll abandon the picking of individual stocks, in favor of mutual funds. Of course, it’s always possible to study and learn new things. If this running of the experiment yields the answer “funds,” there’s nothing stopping me from studying stock-picking some more, and then repeating the experiment to see if I get better results for the choosing of individual stocks. One could also abandon the experiment, but continue to invest in those particular stocks which did well.
There are some types of investment I haven’t mentioned here. Cash, money market funds, CDs, and bonds were not mentioned because interest rates are at historic lows, limiting the return one can get from such investments. As for derivatives, such as options or futures, those have not been included simply because I have no experience with derivatives. Traditional hedges against inflation, such as gold and silver, are not included because inflation is almost non-existent.
One last thing: Robinhood’s customers will have a hard time doing this experiment, for that company does not offer mutual funds. Schwab does, though; that’s the broker I use — and the one I recommend. You can find them online at http://www.schwab.com.