There is an interesting article on Slate by Henry Blodget entitled, “Stop Picking Stocks—Immediately! Why the world’s greatest stock picker stopped picking stocks, and why you should, too.”
Blodget points out that the market has become much more efficient in the internet era. He contends that stock pickers have the deck stacked against them, and that they would do much better if they bought low-cost index funds and let it go at that.
In support of this thesis, Blodget quotes Benjamin Graham, from a 1976 article in the Journal of Finance:
“I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when [the bible of fundamental stock analysis, Graham and Dodd’s Security Analysis] was first published; but the situation has changed. I doubt whether such extensive efforts will generate sufficiently superior selections to justify their cost.”
Blodget adds that Graham had come to favor a simpler stragegy of screening stocks using simple valuation and fundamental criteria and incorporating them into diversified portfolios.
There is certainly some truth in this. The average small investor can not expect to beat the market, but he or she can easily equal market returns through passive investment in index funds.
But that still leaves the question of which index fund this hypothetical passive investor should choose, and whether additional investments should be made in bond funds, international index funds, and so on. The possibilities are mind-boggling! Stock-picking is replaced by fund-picking. Also, unless he sticks to one index fund, the passive investor must make continuous decisions about sector weighting, reinvestment and rebalancing which can have a profound impact on the bottom line. But the goal of matching the market’s return will still be hard to achieve for various reasons, including investment expenses and transaction fees, and there is no hope of beating the market.
If I were starting out today I would definitely begin with a foundation of carefully chosen low-cost index funds and accumulate shares through dollar cost averaging. But I think that if someone has the time, educational background, and aptitude, and is willing to work hard, it is still possible to supplement the index funds with individual stocks which will provide superior results, boosting overall returns and providing satisfaction which can not be achieved through passive investing.