I enjoy talking stocks, and whenever you hang around on the finance parts of the internet, you’ll inevitably run into the following sentiment:

Why are you even buying individual stocks? You should just buy a broad-market ETF. You’ll never beat the market so ETFs are the best and most reliable way to grow your money.

Bogleheads et al

I’ve written about the Efficient Market Hypothesis before and about the difficulties of stock picking. I understand and to an extent agree with the arguments that people in general cannot beat the market reliably over any significant length of time. Any good runs are transitory, purely luck based, and eventually fall back to earth (see $ARKK 2016-2021 and then 2021-today). But that isn’t the primary value most stick pickers are going for, they’re going for potential return not expected return.

When you buy a broad market ETF, what is your expected return? Well the ETF tracks the whole market and the market goes up 5-10% every year, so that’s the return you can expect. Some years you’re down 20% (like 2021), some years you’re up 30% (like 2019), but on average you get a 5-10% yearly return that will slowly grow your money. Slowly is the key word: investing in the stock market probably won’t make you rich, for the average American it won’t even make you a millionaire over the course of your entirely life, but it will give you a small leg up in the long run with very little risk to yourself.

So what’s the expected return for stock picking instead? Well, definitely less than 5-10%. The efficient market hypothesis and significant amounts of experimental data show that stock pickers broadly lose to the market over any significant timescale. They might be up 100% one year but are equally likely to lose it all the next. But the key here is that the expected return is not everyone’s return. The expected return is just the average of everyone’s return, and while on average people lose to the market there are always a lucky few that beat the market and some of them win big. There is at least one person out there who went all in on Tesla stock in 2013, sold in 2021 when Musk started acting weird, and made a truly life changing amount of money, and everyone who stock picks hopes to be like that person. Is it likely? Of course not, but it’s possible and that’s what keeps people going.

This may sound illogical to a bogglehead, and they may scoff and say the stock picker is no different that the casino gambler, but let’s try another example. What is the expected return of starting a small restaurant? Well, it takes a lot of capital investment to start a restaurant and 80% of them fail within the first 5 years of operation, so it’s safe to say that the expected return of a restaurants is actually negative. On average a person starting a restaurant will end up losing money, so are an restauranteurs as illogical as stock pickers? I’d argue no, the expected return isn’t as important to them as the potential return. A restaurant is an opportunity to make a life-changing amount of money, and while it’s clearly very uncommon, it happens often enough to continue enticing people to try it. The bogglehead could just as easily state that it’s more efficient for restauranteurs to not open up restaurants at all and they should instead invest in broad market ETFs, but if no one ever took risks like that then we’d never have new businesses at all.

Big gains require big risk, and I’d argue being content with your lot and investing like a bogglehead is no more “logical” than going all in on smart but high-risk plays, it’s simply a questions of values.