So, You Think You Can Pick Stocks……
Being financial advisors, we are often asked why we eschew individual stocks and consistently recommend mutual funds and exchange traded funds (ETF’s) for our client portfolios. In particular, some clients want us to load up on the current “high flyers” such as Apple (AAPL), Amazon (AMZN) and Facebook (FB). Besides being counter to our belief in the importance of constructing well diversified portfolios (rather than highly focused individual stock holdings), our most common response is that picking individual securities is exceedingly difficult. It’s our belief that despite the fact that one can occasionally “hit a home run” with an individual stock, the odds of long-term success are rather low.
The stock market is very efficient in establishing the fair price for the common shares of a corporation and outperforming the broad market indexes is quite a challenge. How much of a challenge? Hendrik Bessembinder, in a soon to be published article in the Journal of Financial Economics illustrates just how formidable it is. Bessembinder points out that between 1926 and 2015, just 30 individual stocks (out of the thousands available) were responsible for 31.2% of the total stock market wealth creation. Further, Bessembinder notes that the majority of individual stocks fail to beat even the one-month Treasury bill. Over the same period from 1926-2015, only 47.7% of individual stocks had monthly returns that exceeded one-month T-bills. In a separate analysis, Longboard Asset Management found that 39% of individual U.S. stocks had a negative return over the period 1983-2006.
Even the professionals have a tough time picking the stocks that will outperform. According to the S&P Dow Jones Indices’ 2017 SPIVA U.S. Scorecard, 86.7% of all domestic stock mutual funds underperformed their relevant benchmark over the trailing five-year period. So, we’ll stick with our recommendations for clients to invest in low cost index funds and index-based ETF’s. While we know that we’ll never outperform the markets, we’ll still obtain the lion’s share of the markets’ return each and every year. And, in the process, we’ll outperform the majority of the individual stock pickers and active mutual fund managers!!
