Equities hot streak poses stock picking dilemma Stock picking is back. This year's rally has finally made it safe to bet that a company's prospects are better than investors suspect, rather than trying to guess whether today is a day to embrace risk or run from it. The value half of the S&P 500, a rough indication of the views of discerning stock pickers, is up 8.9 per cent so far this year, ahead of the broad index. On Wall Street Moreover, correlations between stocks after a year in which several markets danced together have started to fall. This reflects the natural optimism of a new year. Investors have the freedom to take risks that they would not have dared contemplate as they tried to end 2011 without losing (more) money. Indeed, Larry Fink, chief executive of BlackRock, the world's largest asset manager, has even advised investors to put all of their money into stocks, as he contemplates a robust long-term outlook. But before diving back into the game with enthusiasm, reconsider whether it makes sense to play at all. There are very good reasons why index fund provider Vanguard picked up the most new mandates from pension funds of any asset manager last year, according to Mandatewire. Notice that the most highly paid stock pickers have not kept up. Long/short equity hedge funds, paid to decide how much to invest and when as well as picking stocks to buy and sell, stayed cautious in January. They are up only 3.4 per cent so far on average this year, according to hedge fund research, less than half as much as the US market. Picking money managers is just as hard as picking stocks. Consider two managers who both fared badly after betting on financial stocks last year: Bruce Berkowitz of the Fairholme mutual funds and hedge fund manager John Paulson. Do you go with the former, who has stuck to his guns and ridden the new year rally for banks, or the latter, who dumped his shares of Citigroup and Bank of America in the fourth quarter? Investors essentially have two options. Like a gambler granted a new line of credit, they can return to the table, place their bets and see how their run of luck goes this time round. It is, after all, fun to pick stocks. At a conference for value investors, held at the Columbia University Business School in New York this month, the mood was optimistic, with the emphasis on swapping ideas for misunderstood companies to buy. Investors told each other that a hot streak does not rule out further gains, particularly when it comes to the stock of the day - Apple. Or, savers can back the house, knowing that over time corporate America will continue to expand. This does not mean just buying a stock fund. For nine years in a row, there has been a very simple way to beat the hedge fund industry average: a portfolio held 60 per cent in an S&P500 index fund, and 40 per cent in the Vanguard total bond market index fund. The trick is that by resetting the portfolio back to 60-40 each year, the passive investor forces himself to sell stocks when they are high, and buy them when they are low. Since 2003 the simple passive portfolio would have made you an average 6.8 per cent a year, handsomely beating the 2.5 per cent made by the average hedge fund investor, and bang in line with how pension funds tend to assume their investments will perform. So much for the claim that traditional asset classes have failed to produce the returns needed to fund retirement, and that paying for alternative investments is the only solution. Saving money on fees starts to add up as well. Optimistically assume that this simple investment strategy will average a 7 per cent return for the next 20 years. And, instead of paying a handful of basis points to the index fund, imagine you were to pay a 2 per cent management fee each year to an expert stock picker. A thousand dollars invested today would be worth $3,900 in 2032, but that pot would shrink by a quarter back to $2,700 after the fund manager was paid. It's not just because stock picking is fun that so many money managers will offer to do it for you.