Make vs. Buy
Now, I know this is a blog advising about stocks and primarily focused on stock picking, and I am a huge proponent of stock picking, but every once in a while, it helps to step back and evaluate certain strategies or the goals behind the stock-picking effort.
So…Let’s talk “Make vs. Buy” today.
Now, you may have never heard this term before, so let me elaborate. In many companies, there is a constant evaluation of a concept known in business school, as comparative advantage. Companies are constantly deciding where their comparative advantage lies. Should they continue to make widgets A, B and C, or primarily focus on A & B, since C has far too much competition in the marketplace? I.e., does their comparative advantage only lie in widgets A & B?
Similarly, companies evaluate the make vs. buy decision when they look at outsourcing or insourcing…not just overseas, but to specialty companies. Every company outsources and if you think your company doesn’t, just look at how they handle their payroll, or who cooks their lunches during catered events. Some companies have taken this to new levels, outsourcing customer service centers, technology groups, or even entire manufacturing operations.
So, how does this apply to you, the stock picker? The make vs. buy question is critical to you! Do you continue stock picking (make) or do you just buy a few reliable mutual funds and let someone else, who has a clear comparative advantage manage your wealth for you (buy)? It’s a very important question. Stock picking is not simply about risk vs. reward…it’s also about time. If you are doing just as well as the leading mutual fund or just as well as the standard averages (S&P or Nasdaq), but you are investing 5 hours/week in this effort, is it worth the extra 250 hours you put in per year to get the same return???
It’s an evaluation which I am always struggling to gauge accurately. I mean, I love stock picking and over the short-term, there are times when I will out-perform the markets by 5-1, but I have never sat down and done a true evaluation over the long-term. And, this is something each of us NEEDs to do!
Now, you may say, “Well, Muizz – I outperform the averages by 10%! Year in and Year out!” Okay…well, how many hours are you putting in to generate this return? 8 hours per week? That’s 400 hours per year…Now, let’s say you’re investment pool is $50,000 (a nice sum!)…that means, you’ve found a way to generate an extra $5k per year (good for you!). Well, at 400 hours per year, you are making $12.50 per hour…so if this is about what you make per year, then congrats – you’ve found another vehicle to make more money. If, on the other hand, you’re making more than $12.50/hour in your profession (and based on your $50k investment pool, I’d say this is very likely)…then you basically have a comparative disadvantage in stock picking…and you should really consider the make vs. buy decision!
Muizz,
This is an excellent point and I feel many “at home” investors don’t take into account these costs because of the amount of hours someone spends on a daily basis. For example, on a typical week when I usually spend 8 hours per week researching my stock picks and the market overall, I might spend 1 hour on Monday (and that’s spread throughout the day), 2 hours on Tuesday, 2 hours on Wednesday, 2 hours on Thursday and 1 hour on Friday. For a typical investor, that’s not that much time over the whole week. But this is the same investor that spends $2.50 on a cup of coffee on a daily basis and doesn’t see the costs of that gnawing into his daily expense.