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Chart of the Week: Boulevard Of Broken Dreams – why I don’t pick stocks any more

Welcome to this week's 'Chart of the Week', where we share key insights to help keep you informed on what's happening in the markets.

2 MIN

A question I  get asked all the time is: "What stock should I buy?".

It's a fair  question – investing in a company you believe in can feel exciting. However,  one of my earliest and toughest lessons as an investor was just how badly  things can go when you get a single-stock investment wrong.

That's because  the risks are often underestimated. You're not just betting on a company –  you're betting on management, market trends, competitors, consumer behaviour,  regulation, taxes, interest rates, inflation, new technologies… the list goes  on. All of these factors can change rapidly and make yesterday's winners  tomorrow's relics.

What's  surprising to many is that I don't invest in individual stocks at all.  Instead, I invest in diversified, multi-asset portfolios. Why? Because  diversification is the closest thing investing has to a free lunch. It  spreads risk, boosts resilience and gives you a better chance of capturing  the rare winners without being sunk by the losers.

Of course,  there are expert professional portfolio managers with the experience and  resources to pick individual stocks. But for the rest of us, the case for  diversification is a strong one.

This week's  charts are from a study by Antti Petajisto, a US data scientist and portfolio  manager, and illustrate the risk associated with holding single stocks. They  show the distribution of returns for individual US stocks over one, five and  10 years. These are market-adjusted returns – the individual stock return  minus the return from the wider US equity market.

So, what the  charts show is the individual performance of around 3,000 single US stocks  compared to the overall return of the US equity market. The analysis looked  at data over almost a century between 1926 and 2022. 

Over one year, the outcomes are clustered – you might win or lose a bit. But as you stretch the horizon to five and 10 years, something fascinating (and terrifying) happens: the majority of stocks start to underperform significantly, and many go to zero. The tail risk grows, and the odds stack against you.

Imagine planting 3,000 seeds in a field. In the first week, they mostly look the same. But come back in 20 years, and you'll find that only a few have become sturdy oaks – the rest withered or never grew. That's how single-stock investing works. The longer you hold, the more the outcome depends on finding one of the rare long-term winners.

In fact, studies have shown that more than 50% of public companies eventually fail or get delisted – through bankruptcy, mergers or being outcompeted. Research indicates that corporate longevity is rare. One statistic that shocks people every time I mention it is that only 1% of UK companies listed in 1948 remained after 70 years, according to analysis by academics at the University of Cambridge.

Key takeaway

So, while stock picking might feel like a shortcut to wealth, more often, it's a detour. We all want to sprint toward our goals, but in investing – as in life more generally – it's often the slow and steady strategy that wins the race.

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This article is provided for general information purposes only and should not be construed as personal financial advice to invest in any fund or product. These are the investment manager’s views at the time of writing and should not be construed as investment advice. The opinions expressed are correct at time of writing and may be subject to change. Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds.