By Gary Brooks, CFP®
Robust global stock market returns have been a cause of celebration for many investors. But if you own many individual stocks, it’s possible that your portfolio performance lagged that of broad indexes like the S&P 500.
The rising market tide does not lift all stocks equally. Roughly 55% of the stocks in the S&P 500 Index had 2017 returns that were less than the index.
If you owned the right stocks, you could have wildly outperformed the index. But owning even just a few of the out-of-favor positions could have made your 2017 returns underwhelming.
The S&P 500 gained 19.4% based solely on price appreciation in 2017. If you include dividends, the total return was 21.83%. However, dozens of individual U.S. stocks, including many companies considered industry leaders, had negative returns. Particularly if you emphasized energy and telecommunications stocks – likely for their higher dividends than the broad market – you may feel left out by the market’s rally.
Consider this sampling of widely-held stocks that posted negative returns in 2017:
| GE -42.2%
|Alaska Air -15.8%
Molson Coors -14.0%
Kraft Heinz -8.1%
Time Warner -3.6%
These stocks tell a very different story than if you held Boeing (+93%), Amazon (+56%), Apple (+48%) or others that were in favor in 2017.
Few stocks generate the majority of returns
In the 90+ years of recorded U.S. stock market history, about 4% of all publicly-traded companies have generated all the returns. That means thousands of stocks have been net negative contributors.
Of course, it is very difficult to simply pick the 4% and avoid those other drags on performance. Today, there are roughly 3,000 U.S. stocks with enough daily trading volume to invest in. If the 4% figure continues to hold, that means 120 stocks will contribute all the future gains. I know for sure that I cannot identify the right 120 stocks and avoid the other 2,880.
Surely, you couldn’t pick all the winners. But what are the odds you could at least pick 10 of them? There would be a small number of companies that would obviously be good buys, right? You could buy and hold. Collect dividends. Hold as prices appreciate over time, albeit, with unpredictable shifts in direction, sometimes swiftly and deeply in the opposite direction of the trend.
Picking individual stocks is extremely hard. Even when you happen to choose winners, you still must decide when you should sell some shares and capture gains or buy more shares at now-higher prices. There are psychological influences and expectations that frame your decision making and change over time as circumstances evolve and the broader landscape of market conditions and your personal needs change.
You also need to think about who you are up against in trying to consistently pick stocks that will do better than simply owning the market. If you can’t beat the broad market return, there is no reason to put in all the extra effort and take extra risk that goes uncompensated.
Remember there are two sides to every trade. When you are ready to buy or sell, the person or entity on the other side of the transaction is equally willing to do the opposite at the same price. You are competing against PhDs, Chartered Financial Analysts (CFAs), professional investors backed by tremendous computing power to run quantitative/algorithm driven strategies, industry insiders, government representatives who front-run policy changes and non-public information. You and I are not going to win that contest repeatedly.
Own the market
You are better off accepting that you will own some losers. The only way to capture all the good of the market is to accept that you’ll also own some of the bad (underperformers).
We believe the best you can do is to be broadly allocated, keep your costs low and tax efficiency high, and rebalance periodically to return the risk/return profile of your portfolio back to its original target that is aligned with your goals and your tolerance for market fluctuations.
If you must
If you are certain that your core long-term money is broadly diversified in a global portfolio, then owning individual stocks as a small percentage of your investments may be fine. It may be best to keep these positions in an account separate from your core investments so that you are reminded that with this separate money you are taking different risks, are comfortable with the wider variety of potential outcomes and don’t actually need this money to fund your retirement or other obligations.
Maybe you have an insight about a certain company or breakthrough innovation that you think creates a compelling investment. Perhaps you just have to feed the gambler’s appetite a little bit.
You may have held individual stocks for quite a while that have done well. Especially if they are held in a non-retirement account and would generate a significant capital gains tax if sold, it may be better to hold on to them.
If you’re like most people, those survivor stocks aren’t the only ones you invested in over time. Others were sold when they didn’t perform so well. As market history has demonstrated, for every 10 stocks you buy, three or four will perform very poorly, five or six will have market-like returns and one or two will be the ones you keep and anchor in your mind. ][
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