NerdWallet's Smart Money Podcast - Learn How Random Investments Can Outperform Managed Funds

Episode Date: May 29, 2024

Learn why randomly choosing individual stocks can beat expert investing strategies — and what that means for your portfolio. Can random stock picks outperform Wall Street professionals? What kind of portfolio returns can low-cost index investing drive? Hosts Sean Pyles and Anna Helhoski delve into the astonishing results of a dart-throwing experiment by Wall Street Journal columnist Spencer Jakab and his team, which pitted random stock selections against high-profile hedge fund picks. The hosts explore this intriguing setup and its outcomes, offering actionable insights into the power of simple, low-cost index funds and ETFs over expensive investment managers. Their insights are intended to offer a better understanding of the practicality of low-cost index funds, the importance of maintaining a diversified portfolio, and the pitfalls of frequent market adjustments. Then, Sean and Anna delve into the latest financial headlines, including findings from the Federal Reserve's Economic Well-Being of US Households report for 2023, April’s drop in home sales, and Google Flights adding Southwest Airlines fares to its search results. In their conversation, the Nerds discuss: index funds, investment strategies, stock market, ETFs, dart-throwing experiment, investing tips, low-cost investing, financial wellbeing, active vs. passive investing, hedge funds, portfolio diversification, The Wall Street Journal, stock picks, investment success, random stock selection, economic well-being, smarter investing, outperforming the pros, investment managers, A Random Walk Down Wall Street by Burton Malkiel, stock listings, mutual funds, stock performance, financial journalists, retirement savings, financial stress, household income, emergency expenses, high mortgage rates, affordable housing, home sales, previously owned homes, Google Flights, Southwest Airlines, travel expenses, airfare comparison, financial education, money management, financial planning, investment portfolio, stock market analysis, market adjustments, investment risks, and diversification benefits. To send the Nerds your money questions, call or text the Nerd hotline at 901-730-6373 or email [e-mail]. Like what you hear? Please leave us a review and tell a friend.

Welcome to NerdWallet's Smart Money Podcast. I'm Sean Piles. And I'm Anna Helhosky. And this is our weekly money news roundup, where we break down the latest in the world of finance to help you be smarter with your money. We'll go deep into a single topic and then leave you with the latest money headlines. Today, we're talking about another proof point for very basic investing. Yes, we're hearing from a Wall Street Journal columnist about an experiment that makes the case for using simple investments like index funds, ETFs, and the like, instead of pricey

investment managers. In fact, you could just throw a dart. Oh, so we're going to a bar? No. These darts don't have a bullseye. They're random. So let's hear from Spencer Jacob. He's a heard-on-the-street columnist for The Journal. Spencer Jacob, welcome to Smart Money. Thanks for having me. So you and some fellow columnists decided to repeat an experiment you first did back in 2018, where you threw darts at a wall of stock tickers from your newspaper pages and invest in the companies hit by those darts. So first, I'd like you to describe that scene

for us from this latest round. Bring us into the dart room. Sure. Well, we all write for the Wall Street Journal. And like many newspapers and even the Wall Street Journal, the complete US stock listings are no longer available. It used to be, you know, back in the day, every newspaper would list hundreds and hundreds of stocks every single day. Barron's Magazine, our sister publication, luckily does. So we took several pages of it, stuck it up on a wall in a conference room here at the Wall Street Journal, used the same darts that we purchased back in 2018, and then threw away. Basically, we had a basket of pieces of paper. We had to pick it up, and it either said

long or short, meaning that we either were buying or selling the stocks. Shorting is when you bet on a price declining. So we had 10 longs and two shorts. And that was meant to mimic and to be done on the same day as the Soan Conference, which is a conference that people pay thousands of dollars to attend before charity to hear the best and brightest minds in hedge funds reveal their stock picks to the audience. So you throw the darts and then what? Are you using actual money to invest in the companies that you hit the darts with? And if so, how much? No, unfortunately, we did not because for the second time, our performance was excellent. We're

not allowed to, unfortunately, invest in individual stocks as columnists at the Wall Street Journal. And it would have been pretty nail-biting. The performance overall was quite good. So no, it was a virtual portfolio. There was no anxiety. I mean, we just were afraid of looking dumb, but there was no money on the line. And the hedge fund managers do, it's not their own money, although I guess it's some of their own money, but they have their clients' money on the line. So I would point out that it's two very different things. You can say that can say that, like, I can go on Twitter or X, whatever, right now and say, I like XYZ stock, and I don't really have skin or a lot of skin in the game. And that's one criticism of journalists acting as pundits. If you're at a hedge fund or investing your own retirement savings,

there's a bit of anxiety there. The decision is much more difficult to buy and to sell. But in this case, we actually didn't make a decision either. I mean, it was literally random. And the point of it was to show that a random process can beat the pros. So do all of you columnists, quote, invest because you're not actually investing, but in those companies, or does everybody take one and just follow it? No, I think we lost track of whose darts landed on what. We just basically took turns so that it was as random as possible.

And then if it fell on the floor, we threw again. But yeah, as long as it hits something. And we hit some very odd things. I mean, there are a lot of stocks that are really obscure, things that we had never heard of. There are a couple of companies that were near bankruptcy. So you just go with what you land on. Quote unquote, penny stocks are listed there. But anything besides that, anything that would make it into those several pages of with very tiny print stock

listings that Barron's carries every week. So, all right, before we get to the results, this experiment is an echo of a famous book on investing, Burton Malkiel's A Random Walk Down Wall Street. Now, for listeners who may not have read it, can you give us the CliffsNotes version as it relates to your dark game? Sure. Burton Malkiel went on, well, I guess he was a professor at the time. He's now a professor emeritus of economics at Princeton University.

But he wrote a very, very influential book. It's been reissued many times. It's a bestseller. It was really a revelation at the time, where he basically, he made a very, very influential book. It's been reissued many times. It's a bestseller. It was really a revelation at the time where he basically made a very strong case that ordinary people could understand for index investing. This was in the early 1970s when he wrote it. Index investing is something that we're all familiar with now. Probably most people listening to this, if you have investments in the stock market, some or maybe all of your money is invested in index funds, which are basically, you know, you have this group of stocks that represent not all the market, but much of the market. You invest in them proportionally. There's

no decision being made. They're very cheap. They adjust automatically. There's no judgment in them. You're just basically trying to own something as close to the stock market or the bond market as possible. But that was a radical idea at the time, And at the time that he wrote it, fund managers charged a lot of money to manage mutual funds and stockbrokers charged a lot of money to tell you what to buy and what to sell and when to do it. Wall Street was a pretty expensive place to leave your savings. And index funds have made it much more democratic and much cheaper. But the idea has always had a lot of resistance. And part of it is that the industry didn't like it. And part of it is that psychologically, people are like, how can you tell me all these smart

people I read about in the newspaper and I see on TV who say they did this and they did that and they bought Apple when it was really cheap? Don't I want to give those guys my money and have them do better than just average, just owning the market? And the fact is, and there've been thousands of studies really showing this, that in most cases, they cannot beat the market. And the reason is that they cost something. So if you look at all of the US mutual funds in any given year, they mostly do not beat the market. If you look at hedge funds, which are a bit different, they mostly do not beat a simple index fund because they have costs.

And investing in an index carries no costs. So Malkiel had talked about monkeys beating the pros, right? So here, instead of monkeys, we have you and your colleagues tossing darts at a wall of ticker symbols. Yes, the insurance to get a monkey into the office was a little steep. So that would have been really fun. But, you know, we're journalists, we get paid peanuts. So it was close enough.

The idea is just that it'd be random. I mean, he was making a throwaway comment. But yeah, we've made it as random as possible and as similar as possible to what the sewn picks were going to be. We made our picks a day before. Sometimes the hedge fund managers at the sewn conference will going to be. We made our picks a day before. Sometimes the hedge fund managers at the sewn conference will, instead of saying, I think this stock is going to go up, they'll say, I think this stock is going to go down. They didn't in this particular year,

but that's why we made some of our picks shorts. So we wanted it to be, you know, we don't want people to say like, well, you didn't, you know, it wasn't really that similar to what the hedge fund managers did. So can you give us a sense of what kind of companies these were? Did the darts hit any down industrials or were they less well-known? They were mostly less well-known. I mean, think about it. There are probably three and a half thousand stocks listed in the United States, not including things that are over the counter in the pink sheets. And so the odds of hitting a household name were not very high. Like I think we hit Coca-Cola FEMSA, which is a Mexican bottler of Coca-Cola.

So that was a company that we had heard of. We hit some companies we had never, ever heard of, despite there being seven financial journalists in the room while we were doing this. There were two that I knew were pretty close to bankruptcy. One didn't go bankrupt, but wound up being delisted and lost 97% of its value. One wound up turning things around and rising, I think, 117%. It's called NGL Partners. Oh, and there was a third one that was in trouble. And unfortunately, it was one of our shorts. It was Western Alliance Bancorp. Remember last year, there was a bit of trouble with regional banks,

and they had really sold off. And this is one of the ones we had written about it. So that's one we were pretty familiar with. And it did really well, but it hurt our results because our bet was a negative bet on it. And the kind of the upshot of all this, you know, aside from demonstrating once again that random picks can do just as well, if not much better than a bunch of experts, which we did in spades again this time, is that our results were really, really lopsided. So unless you have a fairly large group of stocks in your portfolio, you can really be blindsided by bad results. And in our case, we had one very good result that really kind of bailed us out. The rest of the results were sort of mixed. And there was one company that thank goodness we landed on. I mean, I guess it would have been fine. It's like we would have

lost money. There's no actual money on the line, but I think it would have made it a less interesting article because the overall portfolio rose by more than 80%. Wow. Yeah. So is it fair to extrapolate your performance with these 12 DART stocks out to the broader market? At a certain point, it would be, yeah. I think if you were to pick enough stocks at random, your performance, there's academic evidence to show not only would it most years be pretty similar to the market, but more years than not, it would be slightly superior. And then now you're getting to kind of wonky ground in terms of finance, but there's some evidence that, for example, most people listening to this

have something like a target date fund, or you own a standard and poor's 500 index fund, which is a fine thing to own. But this year, especially, there's a lot of angst over that, because the performance of those stock indexes is really concentrated in a handful of names, like things like Apple and Microsoft and Nvidia. And they're really all technology companies too. And so you're benefiting from a very narrow group of stocks that's advancing. Whereas if you owned lots of stocks at random and they weren't weighted so that most of your money or much of your money was in these large capitalization stocks, mainly in one business, then you might actually have a smoother experience.

Well, we here at Smart Money are big advocates of keeping investing very simple with index funds and ETFs and the like. It seems to me like that's a sound bet based on your darts doing better than professional investment managers. Would you agree that's a sound bet based on your darts doing better than professional investment managers. Would you agree that's one of the lessons here? Absolutely. Think about it. You know, these are people who they did it for charity, but people paid thousands of dollars to hear their advice.

And some of their picks were good and some of their picks were not good at all. But over any longer period of time, and whether you look at these hedge fund managers or you look at the recommendations of analysts on Wall Street, or you look at these hedge fund managers, or you look at the recommendations of analysts on Wall Street, or you look at actively managed mutual funds that cost money, they all struggle to be just a simple index fund in the long run. Of course, there always are going to be some that stand out, but it's very difficult to prove skill. I mean, let's say that, for example, for example, Ana, like, you know, instead of admitting that we just threw darts and got randomly lucky, that we said, oh, yeah,

these are our picks. We thought really carefully about them. People would be like, you know, clamoring to give us money, right? But it was literally just dumb luck that both times that we've done it, we beat the pros by a very substantial margin, by the way. We beat them by 48 percentage points this time and 22 percentage points last time, which is a very wide margin. So, I mean, we won't always beat them and we definitely won't always beat them by so much, but it absolutely in the long run will really behoove you to stick to low cost index funds and also not to tinker with them too much because that's a form of active investing. If you read a scary headline in our paper or some other paper or saw something about a war or conflict or fears of a

recession or some talking head said, this is the time to get out of stocks, they may or may not be right in that particular instance. But even just tinkering with the allocation that you have is not too smart. And most people are invested in things, target date funds through their retirement programs, which automatically rebalance between safer and riskier assets. So it's sort of diversifying your portfolio on autopilot, rather than leaving it to your whims. All right. Spencer Jacob is a herd on the street columnist for the Wall Street Journal and Airsats DART champion. And we hope that DART game earned you a beer, Spencer. Thanks so much for joining us today. Hey, thanks for having me. Up next, a few money headlines from the last few days.

Ana, there's a lot of talk these days about how Americans are feeling about the economy. After all, we've got an election coming up in a few months. Oh, right. I heard something about that. Well, the Federal Reserve is out with its annual Economic Well-Being of the U.S. Households Report for 2023. And at its essence, we're in about the same shape as 2022. So not a lot of progress, not a lot of regression. We've still got higher prices than people want, but the job market is still strong. Yeah, so this survey happened last October.

And it asks American households about everything from income and employment to housing and retirement. Basically, how are we feeling about our overall financial situations? 72% of adults reported either doing okay or living comfortably financially. That compares to 73% in 2022. Right, but it's still down from 78% in 2021 in the aftermath of the pandemic. And 65% said higher prices had made their financial situation worse. This is inflation rearing its ugly head. Rattling off a few more numbers here.

63% said they have enough cash to cover a $400 emergency expense. And 48% said they had money left over after paying monthly expenses. Both of those figures were similar to or the same as in 2022. Lower income Americans reported higher rates of financial stress, including not having enough to eat and skipping medical care because it was too expensive, with 17% saying they weren't able to pay their monthly bills in full. Ana, one aggravating factor for a lot of Americans when they're looking at their financial situation is that they can't imagine how they're going to afford to buy a house. Right. Factor in high mortgage rates and a lack of affordable housing, and you've got a recipe for frustration.

Those are likely factors in a drop in home sales last month. The National Association of Realtors says sales of previously owned homes fell 1.9 percent in April, down from March, which also saw a drop in the previous month. This figure measures sales and prices of existing single-family homes, including condos and co-ops, but not new construction. And prices rose for the homes that did sell, up 5.7% from a year ago April to an average of $407,600. That's the highest price ever for the month of April. Oof, good luck out there if you're on the hunt. Sean, I don't know how often you fly Southwest Airlines, but if you do, you'll have a new place to search for its airfares. Google Flights is now displaying

Southwest's fares along with all the other major airlines. This has been a bugaboo for travelers for years. Google Flights is an easy-to-use flight aggregator, but Southwest wasn't part of it. You'd have to go over to Southwest's website to do comparison shopping. It's very hashtag first-world problems, but for some folks, it did get annoying, myself included. Well, be annoyed no more, travelers, or at least not about this. When you head to Google Flights and other aggregators, you'll now see Southwest fares. That means you'll also be able to track price drops if you've got Google Flights set up to track your itinerary. And it could also help you get money back if the price changes on your flight after you've booked it. Southwest has very easy change and cancellation policies. And now if the price drops and you've got that flight set up for tracking, you can get an alert and change your booking to the lower price. And that's it for this week's money news. We always welcome your money questions and comments.

Turn to the nerds and call or text your questions to 901-730-6373. That's 901-730-NERD. Or email us a voice memo at podcast at nerdwallet.com. And remember, you can follow the show on your favorite podcast app, including Spotify, Apple Podcasts, and iHeartRadio to automatically download new episodes. Today's episode was produced by Tess Figlin and edited by Rick Vanderkneife. Sarah Brink mixed our audio. Here's our brief disclaimer. We are not financial or investment advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances.

And with that said, until next time, turn to the nerds.