Stock Picking Experts vs. Coin Flippers: Who Wins?

by Jason Unger

At this point, if you still think there really are people who are experts at picking stocks, I’ve got a bridge to sell you in Brooklyn.

But I’m going to pile it on with even more irrefutable evidence that stock picking experts don’t exist, and if you’re paying someone to actively manage your investments, you’re losing out.

Enter: college students flipping coins.

As described by Index Funds Advisors:

In a study by Walter Good and Roy Hermansen, a hypothetical coin flipping experiment was compared to mutual fund manager performance. Three-hundred college students were asked to guess the outcome of 10 coin tosses. Their guesses were tabulated and charted. The performances of 300 mutual fund managers were then tabulated for 10 years (1987 to 1996) from Morningstar Principia.

So basically, here’s what happened:

  • 300 college students guessed whether heads or tails would come up in 10 coin flips
  • 300 mutual fund managers had their performance tracked over a 10 year period
  • the students’ correct guesses were charted against the number of years the managers were in the top 50% of all managers

And not surprisingly, here are the results:

They’re nearly identical.

So in this case, it’s a tie. And when the guy who’s managing your investments can’t beat a college kid guessing heads/tails, it’s not good news.

About the author: Jason is the author of Automatic Finances: 17 Days to Your Financial Freedom, a guide to automated money management. He started investing thanks to a free lunch, and after finding out how he was getting the short end of the stick, he sought out how to do it right. More »

{ 1 comment… read it below or add one }

Danny June 29, 2011 at 10:48 am

This may honestly be the dumbest study I have come accross on the internet. I am not saying there isn’t more to this, but the information presented is irrelevant. Did you notice that in both cases they created a bell curve?

You are tracking two things that have 50-50 odds against each other, and then making a correlation that doesn’t exist. If you take a random sample from any population, there is a 50-50 chance that any particular one of them is in the top 50% of performance. That’s just common sense. To then liken that to a coin toss as a negative is idiotic. You could do the same thing with professional athletes. In fact, let’s just do that.

Say we take a sample of 300 NHL hockey players, and construct a graph of how many of them selected at random to figure out how many years each of them has performed in the top 50% of the League in terms of points in each of the last 10 years, guess what we get? A freaking Bell curve that looks identical to this. So by that same leap of logic the 300 random college kids are as good at playing hockey as those 300 NHL hockey players right?

An actual useful study would be if we ran a computer simulation to follow the same fund mandates that a particular fund manager has (ie maintain a certain percentage of equities, not to invest too highly in certain areas, etc) and select funds that comply with this at random say 1000 times over. Then take the average performance of these randomly generated portfolios over the last 10 years, and compare it to the fund managers. If the fund manager’s ROI isn’t better than the average random portfolio’s ROI then we can say that fund manager is clearly not anything of a stock picking expert. That would be a worthwhile study.

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