Why Index Investing Statistically Provides Better Returns Then Individual Stock Picking

In this video, Matt discusses the risks of stock picking, particularly influenced by trends like those seen on TikTok, and compares it with the statistical success of index investing over the long term. Using the Russell 3000 index as an example, he explains that a diversified asset allocation through index funds is statistically more likely to yield favorable outcomes. He highlights that a significant portion of individual stocks underperform or even lose money over time, making it challenging for investors to beat the index. Matt advocates for index investing as a safer, more reliable approach for long-term financial success, emphasizing the importance of focusing on proven strategies rather than fleeting trends.

Video Transcript

With all of the attention out there in social media, news, et cetera, TikTok stock picking is something that we see more common than not with individual investors. And a lot of individual companies can provide massive returns. But statistically, trying to pick those companies not only from the get go, but then how long you hold on to those. If you just look at the probabilities and statistics, it’s very hard to have financial success long term doing this. And I wanted today just talk about some general data over the last couple of decades to back this up. So, on the screen here, we have the Russell 3000 index. Now, the Russell 3000 index represents the majority of publicly traded companies in the US. This represents the Russell 1000, which would be large cap, and the Russell 2000, which would be small and mid caps and blended together. So a $10,000 investment we see here from 1987 through 2023 would have grown to over 3000%. So right about 2021, over $400,000. And then with the drop that happened in 2022, still 350 ish. So the interesting data here is the black line shows the journey. So you went up and down and up and down and up. But the companies internally, 34%. So about a third of these companies that you were invested in outperformed the index itself. 27% of the companies underperformed, and 39% of the companies actually lost money over that time period. So if you add up the underperformance and the companies that lost money, we’re now looking at 66%. So two thirds of the companies you could have invested in did either lost you money or did under the index. So you had a one third chance of actually beating the index. Now, there’s professionals that do this, and there’s statistically, if you look at a mutual fund that tries to compete over the index, about half of them can do that over one year periods. But if you look at the funds that have outperformed the index over 25 year periods, it’s less than 5% in the US. And this data really shows the why behind that. Companies change quickly, technology changes quickly, and having a diversified asset allocated index is not only the safest way to go statistically, and the probabilities are just stacked in your favor if you focus index investing. So how do you index invest? There’s many index funds available, and there’s also a strategy called direct indexing, where not only can you get the tracking error very close to what an index would provide, but you can actually take advantage of these 39% companies that went down and get the tax benefits of them going down versus just having 39% of the companies being losers inside the portfolio, not having anything to do about it. Very interesting and statistically probabilities to have a life by design. Very important to pay attention to this stuff and not just the fad that’s happening that week or that year close.

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