Many key tenets of money management are simple.
Good habits over time can build financial security. Picking individual stocks, however, is far from simple. It can reward concentrated risks or leave financial and emotional scars despite good intentions.
Sometimes the same stock can do both as it cycles in or out of favor. The range of outcomes for individual companies is vast. Research from Hendrik Bessembinder, a professor at Arizona State University, suggests that only 4 percent of all the stocks publicly traded on U.S. exchanges have accounted for all the market’s wealth creation. The other 96 percent collectively matched the return of Treasury bills, a proxy for cash.
The median stock in Bessembinder’s analysis, using data from 1926 through 2016, survived for seven and a half years. Many stocks went to zero, but enough had performance dramatically skewed to the upside to carry the overall stock market higher. The performance of a relatively small set of high-flying stocks has attracted more investors along the way, each hoping to buy the equivalent of a lottery winner.
If Bessembinder’s conclusion about past returns tells us anything about the future, roughly 120 of the 3,000 publicly traded U.S. stocks might be responsible for future gains. But which 120 will be worth owning? That is impossible to know.
You might feel like you have an edge in understanding or insight about a company or industry. If so, use it cautiously. Realize that the great majority of people who think they have an edge do not. You might think it would be easy to pick a stock like Microsoft, which has risen to new all-time highs this year. Microsoft reclaimed the title of most valuable company in the world (by stock market value) more than 20 years after it initially accomplished that feat. Since the beginning of 2010, Microsoft has returned 465 percent (including dividends, through May 28), more than double the S&P 500 Index.
But there were other stocks available with dramatically superior returns that likely never would have entered your radar at the beginning of 2010. Consider Domino’s. You’ve probably driven past one recently without thinking about it being a wealth creator. Since the beginning of 2010, its performance is seven times Microsoft’s. Domino’s gained over 3,200 percent.
Easier than picking Domino’s in 2010 would have been a seemingly safe choice like Exxon, the second largest company in the world at the time. The total return for the global oil giant since the beginning of 2010? Just 52 percent, most of which was due to dividends, not increasing price of the stock.
If given 10 guesses as to which company currently in the S&P 500 index had the top return over the past 20 years, it’s more likely that a kid on a skateboard in the 7-Eleven parking lot would guess correctly than your average investment analyst.
That stock with far-and-away the best 20-year total return is Monster Beverage, which changed its name from Hansen’s Natural in 2012, the same year it was added to the S&P 500. From 1985 until early 2005 it was a penny stock, trading for less than a dollar per share. Since then it has doubled many times over posting a nearly 80,000 percent return. It’s an absurd number that makes the S&P 500 return look comparatively like a flat line.
A well-timed individual stock purchase might make a big difference in your portfolio return, but the odds of finding the right needle in a stack of 3,000 needles is low. You should expect any breakthrough pick to be accompanied by others that turn out to be busts.
Another difficult-to-decipher factor in stock market investments is timing. If you were invested in U.S. stocks over the 10 years from March 2009 to March 2019, you might have experienced the wealth creation of a decade-long rally (albeit with many intermittent dips along the way). But unless you were invested the whole time, you likely didn’t come close to capturing all the gain that was available.
There were 2,517 trading days from the bottom of the Great Financial Crisis on March 9, 2009 through March 8, 2019. The S&P 500 (with dividends reinvested for total return, not just price change) gained 394 percent in that period. But here’s the mind-blowing part: All the S&P 500 gain came in just the 53 best trading days. The other 98 percent of the days that the stock market was open over the 10 years generated a combined return of essentially zero.
Bells do not ring to signal when to be in or out of any stock or even a broad market index fund. The simple way to capture the market’s return is own the whole market the whole time and not rely on finding only the winners.