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Dec 5, 201901:39 PMOpen Mic

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Why picking stocks is likely a losing bet

(page 1 of 2)

Everyone loves to hear the story of someone who struck it rich by buying some unknown stock for pennies that later turns into a major player, like Apple or Amazon. It maybe gives us hope that one day we might strike it rich with the next great stock!

Unfortunately, recent studies indicate how difficult and unlikely that is for you. (Sorry!)

Dr. Hendrik Bessembinder, of Arizona State University, examined the returns of individual stocks from 1926–2016. Some of the study’s conclusions might surprise you:

  • All wealth creation in the U.S stock market from 1926–2016 above monthly U.S. Treasury bills (about $35 trillion) can be attributed to slightly more than 4 percent of stocks in the aggregate (1,092 top performing companies). This means that the performance of 96 percent of the stocks in the aggregate during that time period only matched Treasury bills.
  • Over half of the wealth creation can be attributed to 0.36 percent of stocks (90 top performing companies).
  • Five stocks accounted for a full 10 percent of wealth creation during that period: Microsoft, Apple, Exxon Mobil, IBM, and GE. (However, be sure to read this entire article to learn more about Apple and GE.)
  • 58 percent of all stocks performed worse than monthly U.S. Treasury bills.
  • More than half of all stocks suffered losses during their existence, with many of those going out of business.

This means most individual stocks were terrible investments.

The only reason the overall market performed well was because a small number of stocks generated enormous returns over a long period of time. Without the contributions of those stocks, average returns would have been very poor, well below the returns on U.S. monthly Treasury bills.

Vanguard came to similar conclusions in a recent study focusing on whether concentrating on a smaller number of stocks led to outperformance from 1987 through 2017 in the Russell 3000:

  • Approximately 47 percent of the stocks suffered negative returns;
  • Almost 30 percent lost more than half of their value; and
  • Approximately 7 percent of the stocks had a cumulative return of more than 1,000 percent.

Again, a few big winners and a lot of losers. “Rather than raise the outperformance odds, increasing concentration lowers them. The less diversified a portfolio, the less likely it is to hold the small percentage of stocks that account for most of the market’s long-term return,” the study concludes.

But, undoubtedly, some people will still believe they can outsmart the markets and pick the next big winner. After all, the studies do reinforce that a few big winners are where the riches are to be made.

It’s tempting to think that you, or some brilliant stock picker, can consistently pick the winners, but even professionals don’t do it very well.

The following table, from Standard and Poor’s SPIVA U.S. Scorecard, shows the percentage of actively managed U.S. stock funds that fail to outperform their respective index over various time periods, ending Dec. 31, 2018.

Interestingly, the longer the timeframe, the worse the relative performance.

For example, for all Large-Cap Funds, over the last five- and 15-year annualized periods, 82 percent and 91 percent of funds underperformed the S&P 500 Index, respectively. The results of these professionals are even worse with small companies.

If professionals can’t consistently outperform the market picking individual stocks, what are the odds that you or even an above average stockbroker will be able to do so?


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