It’s been said that diversification is only for folks who don’t know the future….
Well I’m going to go out on a limb and say that is pretty much all of us.
But don’t we all daydream of picking the next company that becomes a big market winner like an Amazon, or Apple, or Facebook, etc. That could set us up for life. Isn’t that why many people use financial planners and stockbrokers, to obtain their stock picking wisdom or their new hot tip? How many people do you know where that strategy has worked out fabulously?
How many people do you know that are always satisfied with their financial person because he or she does so well selecting these great performing stocks? Well, if picking those big winners is the goal, I would say most people are rarely satisfied by the results.
I was reading portions of a 2019 Investment Research Retreat presentation relating to a 2018 study entitled “Do Stocks Outperform Treasury Bills” by Hendrik Bessembinder 1. His findings may prove to be a shock to many. From a large database of all the common stocks since 1926, roughly four of every seven stocks had lower lifetime buy-and-hold returns than one-month Treasury bills.
Also, the researchers could attribute almost the entire net gain in the market since 1936 to just 4% of the individual stocks. Said another way, altogether, the other 96% only equaled the gains of T-bills, meaning only one of every 25 stocks historically has proven to be a long-term winner.
Back to the next Amazon. We all want to identify that one in 25, but obviously the odds are not in our favor. That means the odds of professional money managers finding that next Amazon are not so attractive either. All their hot tips don’t prove to have such a good chance of being a big winner.
Are you willing to bet your financial future on trying to select, or having your financial person trying to select, those 4% stocks? And then how long do you have to hold that stock before you recognize it as one of the big winners. Remember, they don’t always go straight up.
Maybe there is an alternative strategy for finding stock winners. It may not be as glamorous, but maybe more effective.
Rather than searching for the next Amazon like searching for a needle in a haystack, why not take advantage of the entire market and search for the companies that have historically paid the owners year after year, and have the numbers to continue doing so in the foreseeable future. Again, not as glamorous as big market gains, but effective in making sure you are paid again and again for holding the investment.
Now back to diversification. You could buy a portion of every stock available in order to
capture those 4% companies, but you need to understand that in this case, this wide
diversification to capture those big winners won’t make you a hero. Along with the best
performers, you will be owning your share of the worst performers.
On second thought, maybe I’m not going to be able to pick the next Amazon…..
1 Do Stocks Outperform Treasury Bills? Evidence and Implications Hendrik (Hank) Bessembinder, Arizona State University, April 8, 2019