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The reason indexing works is that the stock market is largely "efficient."
That is, all the publicly available information (and maybe even, illegally,
a little of the inside information) has been factored into the price of
any given stock. Some people will be wrong for very much more sophisticated
reasons than others (an oil analyst may have stayed up all night crunching
numbers based on tanker bookings, yet misinterpreted how this data would
affect Exxon's stock), and some complete nincompoops may find that they're
right ("X is my lucky letter -- I love stocks with X's in them!"),
but it is very hard to tell whether a stock is likely to outperform or underperform
the market.
It may not be impossible to tell the bargains form the bozos, especially
with smaller, overlooked stocks, and especially when a market seems to have
gone to extremes of panic or euphoria. And it is certainly fun to try. But
it is very hard. (How well would you have done taking advantage of the panic
of 1917 to buy Russian stocks? Or taking advantage of Microsoft's wild 20-fold
increase to short it and watch it climb 20-fold again?)
Once you have hundreds of smart people trying really, really hard to decide
whether a stock should be bought or sold -- and thereby setting its price
through the convergence of supply and demand -- will you really get a much
more accurate or sensible price if you persuade thousands of others to chime
in with their opinions? No.
If literally everyone just blindly bought the S&P 500 index,
the market would of course become completely inefficient and astonishing
opportunities would emerge. Which is why we’ll never get that far.
There will always be a balance between people trying to beat the averages,
some succeeding, most failing, and those taking the boring, prudent, low-cost
course.
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