Baruch Young knew his grandfather had been a prosperous stock market investor during the 1980s and 90s. Zaide, being a blue chip investor (Blue chip is slang for “of the highest quality”), had spent just a few hours monthly selecting iconic American companies to invest in, such as Procter & Gamble, Johnson & Johnson, and Citibank. With enduring track records of growing their profits and paying hefty dividends, these companies were most likely to be reliable over the long term. Zaide would hold onto these stalwarts long term, collecting steady dividend checks.
Although he was now retired and largely out of the stock market, when asked, Mr. Young Sr. recommended to his grandchildren that they invest as he did in the past. But Baruch wasn’t so sure about his grandfather’s advice.
Should he research and buy a few solid “blue chip stocks” or invest his money into diversified mutual funds instead?
It’s a New World
While we should treasure the wisdom of our elders, they don’t always keep up with the world’s advances. Even if Zaide Young’s advice was accurate decades ago, today, almost all investors who try to pick stocks themselves are wasting their time and losing money. Much research has shown that it’s quite difficult for amateurs to build a secure stock portfolio by themselves, forget about one with outstanding performance. On the other hand, new technology and competition have vastly improved the mutual fund market, offering many options with excellent convenience and inexpensive diversification.
Dominated by Pros
If Baruch follows his grandfather’s outdated methods, he will likely have significantly lower returns while incurring higher risk. Unlike decades ago, when most stock traders were everyday people, today, investment management is dominated by sophisticated professionals. Trillions of dollars are deployed into stocks by thousands of hedge funds and institutional investors, each armed with highly trained teams, customized software, and complex trading algorithms. When buying a stock today, blue chip or otherwise, it’s probably being sold by one of these very savvy players. Therefore, picking up a specific stock at a bargain today is not just extraordinarily difficult but very unlikely after a few hours of research.
Obsolescence Risk
On top of being less lucrative, owning a mishmash portfolio of just a few stocks is riskier than ever. Technology changes cause entire industries and business models to become obsolete within just a few years. Companies like Woolworths, Pan Am, Eastman Kodak, Xerox, and MCI enjoyed decades of complete “blue chip” dominance of their markets, only to disappear abruptly, decimating their investors. Even powerful non-technology brands are vulnerable today.
Take Gillette (now owned by P&G) as an example. Founded in 1901, Gillette built its brand into a powerful 70% market share for razor blade shavers. This advantage allowed them to charge very high prices for what is essentially a sliver of metal. Recently, tiny internet “shave clubs” startups took away an astounding 20% of Gillette’s market share in just a few years, using clever social media strategies to spread the word with a minimal marketing budget. Regardless of how strong they seem, betting on just a few companies is a terrible idea in today’s ever-shifting world.
Tech Stocks: Today’s Blue Chips
It seems quaint today to think of airlines or shaver companies as no-brainer long-term investments. In most people’s minds, today’s Blue Chips are tech-driven companies like Microsoft, Apple, Amazon, Google, and Facebook. Their seemingly unstoppable growth and dominance over large segments of the economy leads many to believe that the smartest and safest investment approach is buying these behemoths for the long term. But the same concerns apply; the lack of diversification and technological evolution make relying on these High Flyers much riskier than the stocks’ recent, fantastic performance would indicate. Consider for a moment how ChatGPT may strike a death blow to Google’s search engine, the primary source of its revenue.
Mutual Funds Win
The good news is that innovation and competition have also made mutual fund investing better than ever. It’s now possible to invest as little as $1 into fantastic indexed mutual funds at almost no cost. These funds’ significant diversification removes the risk of occasional corporate bankruptcy causing significant harm to a portfolio.
Even with (and thanks to) this lower risk and minuscule fees, broadly diversified index funds consistently outperform the majority of professionally managed portfolios in their comparative categories. Vanguard’s flagship S&P 500 index fund has averaged over 11% from its inception in 1976 through the end of 2023, a stellar performance. There’s no rational reason for the vast majority of investors to look beyond a portfolio of solid index funds.
One Down on Wall Street
Many savvy investors, including David Swenson, manager of Yale University’s $25 Billion endowment fund, and Peter Lynch, award-winning former manager of the Fidelity Magellan Fund, are big fans of index mutual funds. Peter Lynch’s haskamah on index based investing is particularly noteworthy. Considered one of the world’s best stock investors, his books, written in the 1980s and 90s, influenced many to believe they could easily pick outstanding stock investments. Lynch deserves credit for admitting that, barring the few outliers, this is no longer true.
Too Smart for Your own Good
The fact is that investing in solid index funds means you will not make the tremendous returns that were available with hindsight by owning currently high-flying Blue Chips. But unless you’re a stock picking genius, you are far more likely to earn less money, not more, through picking single stocks. Being an oiberchacham can cost you lots of money.
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