This week, I explain the second half of the story: How to choose the best shares to buy and hold.

THE BEST SHARES

Every day, you can find at least one newspaper report offering advice on the best stocks and funds to buy.

They all say the key to good stock selection is research, research, research.

After that, do some more research.

Typical is a weekly series by Business Times and Citibank.

It does a good job of explaining the conventional wisdom: Find good shares by calculating ratios, check out brokers' reports and talk to the management.

The series advises you to keep abreast of whats going on with any company you are interested in, preferably through a reputable news source.

Who could argue against such solid advice?

Who would claim that your best bet is to simply buy shares randomly?

RANDOM WORKS BEST

Here is my advice for stock selection: Your best bet is to simply buy shares randomly.

What! Everyone knows that hard work and careful choice beats no work and random selection. What if you chose a marriage partner this way? You could end up with a mad killer.

* True, it defies intuition. But academic studies show that when it comes to picking stocks, random selection work best.

This amazing result goes by the name efficient market theory or random walk theory.

It is well-known in academia and every business school student knows the random walk theory.

The average investor, however, has never heard of it. Brokers and fund managers would prefer we do not hear about it, since it makes their expensive stock picking obsolete.

* There are 3 levels of random walk tests: Weak, semi-strong and strong form tests.

* Weak form tests ask the question: Is it possible to make better than average returns using past price information?

This method of stock picking is called technical analysis and there are hundreds of studies to see if it works.

With few exceptions - called anomalies - all fail.

* Semi-strong form tests ask the question: Is it possible to make better than average returns by using ALL publicly available information?

If you read EVERY news story about a company, surely that would help.

Big surprise. It doesn't.

Even a company's latest earnings and its annual report won't help you.

Why? Because by the time you hear the news, the stock price has already moved. You would have missed the boat.

* Strong form tests ask the question: Is it possible to make better than average returns by using ALL publicly available information PLUS superior ability to analyse information?

Wow. If this doesn't put the odds in your favour, nothing will.

Sorry. The market turns out to be strong form efficient. Even with complete information and investment pros analysing it, returns are no better than if you buy stocks randomly.

The most famous strong form tests look at unit trusts and funds where highly paid stock analysts pick the stocks. Before costs, the average return for these funds is the same as the overall stock market. After costs, their performance is worse.

IMPLICATIONS

Managed funds employ high-priced experts to select stocks that will beat the market.

The only problem is that it can't be done. Studies show that investing pros do not beat the market.

Your best bet is to keep it simple: Construct your own portfolio of at least 15 randomly selected shares OR buy and hold an inexpensive index fund.

An index fund buys ALL the shares in a market index such as the Straits Times Index (STI) or the S&P 500 index in the US.

The problem is we have over 600 unit trusts and funds in Singapore and nearly all are the high-cost managed funds.

Only a handful are index funds.

* An index fund that I like is the STI exchange traded fund. You buy it through a broker. Its trading symbol is STTF.

Its expense ratio is just 0.3 per cent per year vs. 2.2 per cent for the average unit trust in Singapore, and it has few hidden expenses.

Next week: There is one more investing myth to debunk: that you can get rich by selecting the best fund manager.

Can it really be done? How to do it? I will tell you next week.

Monkey versus expert

YOU may have heard the story that a monkey hitting computer keys at random will eventually produce a great novel.

Did you know that the same monkey selecting stocks randomly will ALWAYS produce average returns that beat the experts?

* How can?

There are two reasons for this incredible result.

First, experts cost a fortune while the monkey is paid peanuts.

Second, the monkey picks stocks randomly then holds them, while managed funds trade continuously in a futile effort to find the best stocks.

This increases the taxes and brokerage commissions for managed funds.

These costs are invisible to you since funds decline to report them.

But they take a big bite out of your returns.