A Closer Look at Gambling
Last week I pointed out something you already know – the difference between gambling on things like meme stocks or cryptocurrencies and building an investment portfolio to sustain you throughout your retirement years.
Today I want to discuss a much more subtle form of gambling, something many of you are engaged in without knowing it, with an outcome that is almost certain to minimize your lifetime portfolio returns.
Today I want to talk about your affinity for owning individual stocks – no, not the speculative stocks of GameStop and AMC Entertainment. I am talking about the blue-chip companies of Merck, PepsiCo, Boeing, Costco, Starbucks, and the like.
Exhaustive research shows that a small subset of individual stocks will be the drivers of future stock market returns - and they are not the stocks you currently own. That’s where gambling enters the picture.
In 2018, Arizona State University professor Hendrik Bessembinder revealed that since 1927, almost the entire wealth creation from common stocks could be found in 4% of stocks. This means that 96% of stocks barely matched the return of T-Bills.
Following up on this analysis, research carried out by Dimensional Fund Advisors (DFA) looked at the best performing stocks of global stock markets for the period of 1994 to 2019. Excluding the top 10 percent of stocks with the highest returns, the cumulative return of global stocks dropped from 640 percent to 208 percent.*
How about the bluest of blue-chips? How about companies like Apple, Microsoft, Amazon, and Tesla that have driven the markets (and maybe your portfolio) to new heights in the past? Additional research by DFA shows those are the individual companies you REALLY want to avoid. As companies grow to become the largest publicly traded stocks, they generate impressive returns. For the 10-year period after becoming a “Top-10” stock, these companies collectively underperformed the market by -1.5%.
Two factors make up this interesting phenomenon. First, much of a company’s future growth is already built into today’s stock price, and second, these companies are so darned big that it is almost impossible for them to sustain growth rates of the past.
Why is it important to maximize portfolio returns throughout your lifetime? Simply because you are likely to live long past your “life expectancy,” according to The Wall Street Journal’s Josh Zumbrun, as presented in last weekend’s column titled “You Might Live Longer Than You Think. Your Finances Might Not."
The time to stop gambling with individual blue-chip stocks and start investing with your portfolio is now.
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