Why Performing Below The Benchmark Is Irrelevant

Let’s look at the data on individual stock returns of S&P 500 members to contextualize what we are up against when it comes to picking stocks. Of course, individuals should set their own expectations. You should aim to have enough money to achieve your life goals while taking an acceptable risk. If someone has invested well enough to send their kids to college, no one would complain to them that they underperformed the benchmark by a few basis points. No one can complain anyway because it is their money. Comparing stocks to the S&P 500 is simply the best way to gauge returns, but it’s not the ‘end all be all’ for individual investors.

In the past 25 years, there have been about 1,000 stocks in the S&P 500 because companies have been added and subtracted. This passive index is actively managed based on specific criteria. In the spectrum of passive versus active, this is relatively passive, but it’s not completely so. The chart shows about 29% of stocks had a loss on a total return basis. Even losing a small amount is terrible because there is a massive opportunity cost over 25 years. Even a CD would have been much better.

The median return is 66% which means half delivered less returns. The average return is 359%. 80% of stocks did worse than average which makes picking winners quite difficult. Of course, the odds differ if you are willing to invest in stocks outside of the index (which you should be willing to do). The good news is most of your stocks don’t need to outperform as long as you have a few really great winners like the index does. There are quite a few that have delivered over 20X returns.

The key is to avoid diversifying away from your huge winners. Let them go. That’s easier said than done. You need deep conviction to hold stock after it has doubled. Cyclical stocks double all the time, but they aren’t the big winners. You should be more inclined to sell cyclicals when people start to think they are secular winners. People are easily fooled. They are also fooled in the reverse as we are seeing now. Investors believe energy will never come back. Narratives are backward-looking.

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