- Over the past 90 years, the majority of individual stocks (58%) have failed to outperform one-month Treasury bills.
- Maintaining a well-diversified portfolio of low-cost investments will substantially increase your odds of building a secure financial future—something individual stock pickers can’t claim.
Investors in General Electric (GE) stock aren’t happy right now. This week the company cut its dividend by 50 percent. This decision added insult to injury because GE’s stock has dropped more than 40 percent over the last year. But, these results are more common than you might realize.
The purpose of this post is not to explain why GE’s stock is dropping so severely. Instead, it’s to urge you to use GE’s short-term stock woes as a cautionary tale to make you a smarter long-term investor. You see, investments in individual stocks can produce big winners at times, but also big losers.
Your brother-in-law or your friend at the club love to brag about the big winners they’ve had in the stock market. They rarely crow about their losers. Unfortunately, those winners become overrepresented in our minds. That’s a problem because it is very hard, if not impossible, to predict reliably which stocks will be winners and which will be losers.
This uncertainty is compounded by another challenge–the “Profit Concentration Issue.” The concentration issue was examined in recent research by Hendrik Bessembinder, a finance professor at Arizona State University.
Bessembinder’s study contained very important findings for investors in the stock market:
- Since 1926, just 4 percent of the stocks in the S&P 500 have accounted for virtually all of the wealth made by investors during that time.
- Three in five individual stocks (58%) since 1926 have failed to outperform one-month Treasury bills over their lifetime.
- The most common single result for an individual stock since 1926 has been a return of nearly negative 100 percent — almost a total loss.
Read those findings again and let them sink in.
The profit concentration issue means that investors have very little chance of picking long-term winners consistently. In fact, the odds are heavily stacked against them. Despite these results, some investors will continue to try to pick individual stocks for the same reason that folks play the lottery—they think they can win BIG despite the overwhelming odds against them.
I wish them luck.
The good news is that investors can increase their chances of having above average returns (returns better than the average investor) by broadly diversifying their portfolios in low-cost investments and by maintaining their portfolio’s allocation in a disciplined manner. This pragmatic investing strategy will rarely give you bragging rights at the club or Holiday dinner table. But, over the long run, you will probably be much better off financially than your golfing buddy or brother in law, the stock pickers.