More Evidence Of How Hard Stock-Picking Actually Is

Damon GonzalezInvesting, Markets Leave a Comment

A Reddit thread last week asked “If you could call yourself 10 years ago and speak for 1 minute, what would you say?”  One of the first things that came to mind was to tell myself to read every Larry Swedroe book ever written.  His evidence-based approach to investing is the basis today for how my firm manages money.

Swedroe’s biggest gift to investors is his ability to scour academic journals and break down complicated economic topics so that the layman can understand the findings.  One of his latest articles, Individual Stock Investing Increases Risk, is a prime example of why I think he is the best Financial Author alive.

While I already knew from research and personal experience how hard it is to invest in individual stocks, I was dumbfounded to learn just how hard it really is.  His article is a summation of peer-reviewed research that demonstrates how a tiny sliver of stocks make up most of the returns of the averages.  Larry explains that once you know how hard it is to pick individual stocks, the only explanation for why people still try is a “triumph of hope over wisdom.”  Here are some of the most interesting things I learned in the article:

“He noted that the 86 top-performing stocks, less than one-third of 1% of the total, collectively accounted for more than half of the wealth creation. And the 1,000 top-performing stocks, less than 4% of the total, accounted for all of the wealth creation. The other 96% of stocks just matched the return of riskless one-month Treasury bills!”

The S&P 500 had an annualized return of 18.2% during the boom of the 1990s, yet more than 20% of U.S. stocks in existence at the end of the decade lost money during the tech boom.

The Russell 3,000 Index had an annual return of 12.8% from 1983 to 2006, yet the median return was 5.1% and the average return was -1.1%.  A whopping 64% of the stocks in the index underperformed the index and 39% of the stocks lost money during the period.

“Diversification has been said to be the only free lunch in investing. Unfortunately, most investors fail to use the full buffet available to them. That is likely because they don’t recognize that poorly diversified portfolios are likely to underperform because they omit the relatively few stocks that generate large positive returns.”

“… they found that the stocks both men and women buy trail the market after they buy them, and the stocks they sell outperform after they are sold.”

I highly encourage you to read the full article here.


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