Should You Pick Stocks at Random?

Board and darts on dark blue background

Should you pick stocks at random? Doing so is the same as guessing, but is there any advantage? Do professionals who pick stocks for a living have any advantage over just picking randomly? Can a professional beat an index fund? Here is a look at the concept of random stock picking.

Random Stock Picking

Random stock picking is just as it states. It implies that you would pull stock picks out of the air as opposed to researching before buying.

An interesting study from a few years ago concluded that picking at random was more productive and profitable than choosing stocks via researching them. So, what was the catch? This strategy only seemed to benefit new and inexperienced investors. The premise was that new investors didn’t understand diversification or risk. They tended to pick stocks in the same industry, or at least they made picks in sectors and industries that moved in unison. In this scenario, picking at random would often result in better diversification and risk management.

A Case for Picking at Random

I was surprised how many articles were out there that advocated for picking stocks at random, or at least showing that random picking was no better than a portfolio picked by experts who did research before carefully selecting stocks.

I guess this shouldn’t really be a surprise after all, since I’ve been hearing for years that most people can’t beat an index fund. If you are a fan of Jack Boglethen you are familiar with this concept.

One particular study said that a fund manager would have better results flipping coins than managing a portfolio of stocks. Basically, a blindfolded monkey throwing darts at a wall would perform just as well as a fund manager.

Orlando won a stock picking contest in 2012. He went toe to toe with three financial advisors and a group of students from The John Warner School in England. Orlando’s portfolio grew to $8,900 after the one-year contest, while the investors’ team’s portfolio only grew by $8,300. The catch? Orlando was a cat. He achieved stock picking by throwing his toy mouse at a grid of numbers. Each number represented a company.

This article dives into the human phycology of the markets and how most people suffer from overconfidence. In a 1965 paper, University of Chicago Economics professor Eugene Fama concluded that the markets are reasonably efficient and that stock prices move randomly.

His research suggested that it was impossible for someone to beat the market over a long period of time. Stock pickers who have done so is the result of luck and not brilliance. His observations would lead one to believe that investing in index funds would produce better results.

A study in 2014 from JP Morgan looked at all publicly traded companies dating back to 1980. 40% of the 13,000 stocks in the study declined in value by more than 70% from their peak value and never recovered.

A Case for Researching Your Stock Picks

Not all opinions point to throwing a dart at a wall. There are some compelling arguments for researching your stock picks before buying.

In this blog post it is argued that picking at random is no different than gambling. You should at least have some understanding of what you are investing in. If you truly want to not have to do any work before investing, then you should stick to index funds.

Even our friend Orlando wasn’t picking completely random stocks. He was choosing from a preselected group of stocks. He didn’t have access to the entire market. This could be a strategy to employ. Screen a group of stocks, then randomly select X number of them.

There are a few people who have consistently beaten the market long-term, but there aren’t many. Do they possess some genius that others don’t, or are they extremely lucky?