Apple stock has been an incredibly profitable investment. Stories about winners like Apple encourage many investors to seek the next Apple. The issue is that identifying the next big winner ahead of time is not a consistently profitable investment strategy. In fact, the majority of professional investors who attempt that strategy underperform a simple indexed portfolio. Those that do outperform do not do so consistently.
If investors miss the next big winner, however, their long-term returns suffer compared to the market average because of the winner’s impact on the overall market performance. Quite a conundrum isn’t it?
This graph shows that a few outperforming stocks may account for a disproportionately large share of the US market’s return in a given year. (Click on the graph for a larger view.)
From 1926 to 2009, the US stock market, as measured by the CRSP 1-10 Index, provided a 9.6% compound average annual return. If the top-performing decile (top 10%) of stocks were excluded each year, the market’s return would drop to 6.2% annualized. Excluding the top quartile of performers each year (top 25%) would reduce the market’s average annual return to a negative 0.6%. So you see, there isn’t much room for error.
How have successful long term investors dealt with this issue?
Since it is impossible to reliably identify winners before the fact, the most prudent approach is to maintain broad diversification and consistent exposure within a particular asset class. This improves the likelihood that a portfolio will capture outperformance—wherever it may occur.
Disclosures: This blog is intended to provide general information only and should not be construed as an offer of specifically tailored individualized advice. Please contact Independence Advisors, your accountant and/or attorney for advice appropriate to your specific situation.
Investing in any security, including mutual funds and ETFs, involves a risk of loss of both income and principal.
This blog may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe”, “estimate”, “anticipate”, “may”, “will”, “should”, and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can gove no assurance that such expectations will prove to be correct.