Ask Colin

While the concepts of diversification and efficient frontier appear to make modern portfolio theory (MPT) the "obvious choice" for investing, it appears to me that one would need an unlimited time horizon in order to assure its superior outcome. MPT seems to suggest that no one can consistently pick "winners". Do you feel that this is true, or do you think that "stock picking" can beat this system?

I have contemplated this issue over many years, as have many others. I do not think that there is a single right answer to the problem. Let me explain why.

I have learned from reading and observation that there seem to be many ways to make money in the markets. It is difficult to get hard facts to compare one with the other. Nevertheless, I wonder whether such a comparison would prove anything, because for any method there seem to be a few who have made it work very well and many who have failed, ostensibly with the same method.

It seems to me that the main factor may be the actual person involved. Good investors seem to develop or gravitate towards a method that suits their personality, attitudes and beliefs. I have just read again and reviewed for a magazine Philip Fisher's book Common Stocks and Uncommon Profits.In the Wiley edition that I read there is also two other of his writings that were partly autobiographical. These make clear to me that he chose the route he took to profits based very much on his attitudes and beliefs, though his experience also reinforced them as he went along.

I have also recently read again Charles D Ellis' brilliant book Winning the Losers Game, which I have also reviewed for the same magazine. He, of course, believes that all attempts at stock picking are probably futile and that by the time there was statistical evidence that one manager had superior ability, his career would be over. I think Warren Buffett, John Templeton, Philip Fisher and Peter Lynch, among a few others, may be a challenge to this view, but he may be right statistically, even with them. However, they and their clients/shareholders got fairly rich on a statistical blip!

I really doubt that we will ever resolve the question of whether stock picking is superior or not, However, I think there is an insight that is important. Most people accept that it is difficult to beat the index. Then they see one of these investment greats seem to do it by stock picking. Clearly it can be done. However, the problem is that they make the incorrect assumption that because a few can do it, or were lucky enough to do it, then so can anybody. I think this is false. These are exceptional people. Most people are not exceptional. For most of them, the odds are better in other ways.

That brings us back to the question of what we do if we are not comfortable with the alternatives. If we still hanker to try the stock picking route. My thought here is that we should try it with some of your money. If it works, put more into it and keep doing that as we prove that we have what it takes. However, if we fail to beat the market, most of our funds will get a market return.