Before choosing individual stocks, it helps to be honest about the alternative. For a few basis points a year, an index fund gives you the whole market. Every stock you pick is a bet that you can do better than that, after costs, taxes and the hours you spend.
An index tracks a defined basket of stocks, such as the 500 large US companies in the S&P 500. Index funds and ETFs hold that basket for you. Because most professional fund managers fail to beat their index over long periods, the index is the bar any stock-picking process has to clear.
What to look at
- The S&P 500 is weighted by market cap: the largest companies move it most.
- An ETF trades on an exchange like a stock; a mutual fund is priced once a day. Both can track an index.
- Expense ratio is the yearly fee. Broad index funds often charge under 0.10%.
- Compare every pick with the index over the same period. A stock up 12% in a year the index rose 25% was a losing decision.
- Many investors keep a core in index funds and a smaller satellite portfolio of individual stocks they research.
The shape of it
Excess return = Your return − Benchmark return
An example
You bought five stocks that returned 9% on average over two years. The S&P 500 returned 24% over the same two years. Your process cost you 15 percentage points compared with doing nothing clever at all.
Where people go wrong
Judging picks without a benchmark makes almost any process look good in a rising market. Write down the index level on the day you buy, so you can compare honestly later.
This is not an argument against picking stocks. It is an argument for picking them deliberately, measuring the results, and sizing the effort to the evidence that it is working.