New York Times Your Money columnist Ron Lieber wrote an interesting article Picking Stocks After Facebook. He had someone look up the best performing stocks since 1982 in the Wilshire 5000 Index, which is basically everything except very tiny ones.
It turns out that most of the best performing stocks are largely unknown (to me anyway). Here are the top 10:
- Home Depot
- Kansas City Southern
- Apco Oil & Gas
- Eaton Vance
- Precision Castparts
- Raven Industries
- TJX Companies
Even today, I only heard of Home Depot, Eaton Vance, Gap, and TJX Companies. That’s 4 out of 10. Back in 1982? Probably none. Would I have picked these 10 if I were investing in 1982? Of course not. From this, the article concludes that you are better off investing in index funds than picking stocks.
While I don’t disagree with the conclusion — I invest in index funds, not individual stocks — there’s also a logical flaw in the argument.
The argument goes like this:
(A) If you were able to pick the top 10 stocks, you would beat the index.
(B) You could not have picked the top 10 stocks because you didn’t even know about those companies.
(C) Therefore picking stocks will not beat the index. Invest in index funds instead.
I had to look it up. The flaw is called denying the antecedent:
If P, then Q.
Therefore, not Q.
Picking the top 10 stocks isn’t the only way to beat the index. Therefore the inability to pick the top 10 stocks doesn’t prove that picking stocks is an inferior strategy. We need other evidence.
Does this mean picking stocks is a better strategy than investing in index funds? Of course not. It would be another fallacy if we reach that conclusion. One piece of evidence not proving it poor doesn’t mean it’s better.
It’s also very similar to the stats about missing the 10 best days in the stock market:
(A) If you missed the 10 best days, your performance would suffer greatly.
(B) It’s impossible to tell which days will be the 10 best days.
(C) Therefore you should stay in the market at all times.
This is equivalent to
Staying in the market at all times will make sure you won’t miss the 10 best days.
Market timing means you are not staying in the market at all times.
Therefore market timing will lead to poor performance relative to the market.
We see "denying the antecedent" again. Not that market timing is a great strategy, just the "missing the 10 best days" argument doesn’t prove it’s a bad one.