FOOL ON THE HILL
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Flying an airplane and picking stocks both require practice and temperament. Both are also risky. But while licenses and training are required to be a pilot, a brokerage account can be opened with little difficulty. While Whitney Tilson doesn't believe certification should be required before one can begin picking stocks, he does feel that investors would be well-served to act as if this is the case -- and consider hiring help if they're not up to the challenge.

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By Whitney Tilson
October 9, 2001

One of my readers sent me the following desperate email:

"My portfolio has declined 65%. My whole life savings is now down the tubes. I am really scared. I can't sleep at night. Please let us know your educated opinion on this BLOODBATH. Will there ever be a bottom?"

Stories like that one are all too common these days, and they break my heart. Driven by reasons from greed to naivet� and spanning everything in between, many people were drawn into the market at or near the top and have suffered devastating losses. Some of these people invested in mutual funds, but many got into trouble by buying former "blue-chip" stocks such as Priceline, Ariba, Exodus and the like, all of which have seen their market value evaporate -- or worse.

Beginning with "The Arrogance of Stock Picking" in January 2000, I've repeatedly pleaded with readers and cajoled my readers in numerous columns to stop picking stocks unless they had the "Three T's": time, training, and temperament. Most people don't have all three, and I believe those people would be better off investing in a broadly diversified index fund -- the QQQ Nasdaq 100 tracker doesn't count! -- and, perhaps, adding a few solid, value-oriented mutual funds.

It may sound arrogant to discourage people from doing what I do for a living, but consider the following analogy between picking stocks and piloting a plane, an activity many members of my family enjoy:

  • Both piloting a plane and stock picking can be enjoyable and exciting.
  • Both activities are extremely dangerous without the right skill set. Some people with inadequate skills or bad judgment die piloting. Similarly, some people with inadequate skills or bad judgment lose a lot of money picking stocks.
  • In both cases, by investing enough time, one can generally become proficient enough to undertake the activity safely.
  • However, many people -- perhaps not a majority, but certainly a large minority -- should not undertake either activity, regardless of how much training they have. People who are easily frightened shouldn't try piloting because if you panic, you can die. Similarly, those who are predisposed to follow the herd, or who lose their heads when a stock they own declines, shouldn't be picking stocks.
  • In both cases, there is no substitute for experience, so one is generally better off starting slowly in low-risk situations.
  • There's no shame in deciding you don't enjoy -- or don't have the time for -- either activity, and calling it quits.

There's one big difference between the two activities, however, that explains why so many people get into trouble picking stocks, while far fewer do so piloting: Anyone can open a brokerage account, while one must undertake lengthy, expensive training and pass a test before being allowed to fly. I'm certainly not advocating that similar certification be required before one can begin picking stocks, but investors would be well-served to act as if this is the case. 

In so many aspects of life, we face decisions about whether to do something ourselves or get a professional to do something for us: painting a house, teaching our children, drafting a will, unclogging a stopped-up pipe, setting a broken bone, installing a satellite dish, and so forth. For each of these activities, most of us could probably learn to do them adequately, yet we generally don't. We hire an expert instead. Why? Partly because we are too busy to do everything ourselves, but also because no matter how hard we tried, we probably wouldn't ever be as good as a professional. 

So why do so many people think differently about investing, and refuse to hire a professional -- a financial adviser or stock picker -- to help them? I can think of several reasons:

Financial advisors, as a group, have a dismal -- and, in my opinion, often well-deserved -- reputation, as this site has highlighted countless times. Painfully few mutual funds manage to beat their relevant indices, stockbrokers make money by encouraging heavy trading or investing in certain products pitched by their employers, and many financial advisors steer clients into lousy -- or at least high-fee -- mutual funds because they are compensated via a kickback (known as the "load"). 

But there are solutions to these problems, such as sticking to index funds or hiring a fee-only financial advisor. While everyone knows that to successfully set a broken bone requires training and experience, it's not as generally accepted that successfully picking stocks also requires lengthy training and experience. This danger is compounded by the fact that all of us know, or have read about, many completely unqualified people who have -- or at least claim to have -- made a lot of money picking stocks.

People consistently overestimate their abilities as stock pickers, often despite overwhelming evidence to the contrary. Given that 82% of people say they are in the top 30% of safe drivers, why should we expect people to assess their stock-picking prowess any more accurately? (For more on this topic, see "The Perils of Investor Overconfidence.")

Picking stocks is often a social activity: Millions of people belong to investment clubs or simply like to talk stocks with friends or at cocktail parties -- which is a fine diversion but can get investors into trouble if casual tips turn into capital allocation decisions.

It can also produce reactions inconsistent with the idea that effective investors should operate unemotionally. An article in the May 24th issue of the journal Neuron, the Associated Press reported, said a research team

"...used magnetic resonance imaging to map the brain responses of 12 men while they participated in a game of chance involving winning or losing money. They found that in the gambling experiment, blood flow to the brain changed in ways similar to that seen in other experiments during an infusion of cocaine in subjects addicted to that drug and to low doses of morphine in drug-free individuals. The changes varied in accordance with the amount of money involved, and a broadly distributed set of brain regions were involved in anticipating a win. The more money involved, the more excited the person became."

Conclusion
If you have the time, interest, and ability to manage your financial affairs and even pick stocks successfully without any assistance, then by all means, do so! But make sure you have accurately, honestly, and humbly assessed your capabilities, and don't hesitate to hire someone to help.

-- Whitney Tilson

Guest columnist Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a New York City-based money management firm. Mr. Tilson appreciates your feedback at Tilson@Tilsonfunds.com. To read his previous columns for The Motley Fool and other writings, visit http://www.tilsonfunds.com/