Why Most Investors Lose at Stock Picking (Even the Pros)
I’ve met with many clients over the years who own individual stocks – some have been huge winners and others not so much. Sometimes it makes up a meaningful portion of their net worth, other times it’s a tiny fraction. I can understand the allure of stock picking.
Check out the return of $10,000 over the past 20 years (2005-2024) in the following stocks. Nvidia turns $10k into $7.5mm, Netflix into $5mm, and Apple into $2.5mm. The stock market index (S&P 500), just $71,000.
The payoffs of picking the right stocks and having the conviction to own them for a long time can have tremendous upside. The problem is that it is almost impossible to do that. A new paper from Morgan Stanley, Michael Mauboussin, and Dan Callahan dissects the data on picking stocks.
The biggest reason why stock picking is so hard is that very few stocks meaningfully drive the returns of the stock market. Just 2% of all stocks are responsible for 90% of the return since 1926 (Source: Morgan Stanley). If you happen to pick a stock in the 2%, you will vastly outperform the market. But if you don’t, you risk significantly underperforming the market – 60% of all stocks underperformed treasury bills. This is probably why even most professional money managers underperform the market.
If you do happen to pick a winning stock, you must have a ton of conviction. Over the past 40 years, the average max drawdown for the best 20 performing stocks was over 70%. Apple has had an 83% drawdown. Remember those stocks from earlier? Imagine you invested in them a long time ago, and it had grown to $1,000,000 by late 2018. You would have watched as that million got cut by $300k-$500k in a few months.
And it’s not enough to have conviction. You must be right. 40% of all stocks that have this catastrophic decline never recover, so it’s rational to ask yourself if your stock is part of that group when its stock price gets cut in half.
You probably get the point by now – you must be right AND have the conviction to pick good stocks. Both of those are incredibly hard to do.
I don’t have a problem with investors owning a few individual stocks. The reward of being right can be significant. But it should be sized appropriately (in my opinion, no more than 5-10% of assets for most investors), and you should know that the odds are stacked against you.
Happy Planning,
Alex
This blog post is not advice. Please read disclaimers.