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No. of Recommendations: 6
Thanks for the compliment, Less Traveled.

I have been around MF for many years (and was a volunteer in the AOL days). The MF philosophy is that it is possible for ordinary people, with real lives/jobs/families, to pick stocks instead of using mutual funds. However, with the exception of the RB portfolio, all of other portfolios that have appeared in MF have underperformed the market, some disastrously (including RM and Running with the Market). And the RB performance is somewhat distorted by buying AOL (who was MF's original partner) way back in 94 - that stock pick alone (I believe, I haven't crunched the numbers) accounts for much of the portfolio outperformance.

If it is not possible for the MF's (who are doing this full-time) to pick stocks that beat the market, how can we expect to do so?

Caveat: I love investing, and do have about half my portfolio in individual stocks. I believe that there *are* stock picking strategies that work, but that RM is not one of of them.

Here is my philosophy:
1) The market is more or less efficient - that means that for the most part, stocks are priced so that they reflect the prospects and risks of the company, and, on the average, one stock will return, over time, the same as another. Stocks with good prospects and low risk are expensive - priced high enough so that their returns will be average. Stocks with bad prospects and/or high risk will be cheap, priced low enough so that their returns are average.
2) Any successful market-beating strategy must exploit some inefficiency, and I insist that I be able to explain to myself why that inefficiency exists and whether it is likely to persist before I try it.
3) ANY stock-picking strategy has higher turnover than an index fund, which creates a substantial tax drag (except retirement accounts). So it is very difficult to outperform index funds, due to their tax-efficiency.

The problem with RM is it picks well-known growth stocks with good prospects and low risk, which will be expensive. Even with a valuation criterion (which will help it), if 8 of 10 stocks meet the criterion, and 2 of 10 blow-up (and lose 3/4 of value), the returns will be little or no better than the market (that would give a 10.5% return if 8 double in 5 years, and the other 2 lose 75%).

RB is much more likely to work, if you can identify companies with unique products or niches before anyone else - AOL, Iomega are great examples. It needs a sell discipline that allows it to sell stocks when they are dramatically overvalued and then, later, when they are mature and their pricing is efficient (e.g. AOL now). It can work because you are buying stocks based on beliefs about future prospects that are not reflected in the market price. If you are right, the stock increases dramatically - and the big winners (10-20x) more than make up for the losers.

I believe value strategies work - buying stocks that are currently very much out of favor, where fear has driven down their prices irrationally. There is substantial academic evidence for these strategies, and for the underlying psychological mistake (projecting recent past too far into the future). It is unfortunate that MF has never had a value portfolio.

I also believe momentum strategies work, though I do not use them myself. They work because when a company's prospects improve, there is a lot of skepticism at first, so that it takes a while (and a number of quarters of doing better than expected) before expectations and market price reflect the new reality. This accounts for the promise of many of the strategies explored here on the Mechanical Investing board.

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