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Stock markets, over time, have historically shown to produce strong investment growth. In the USA, for instance, the S&P 500 index has risen from 264.53 in January 1928 to 3,714.24 in January 2021. Its average annual return, therefore, has been about 8%–11% since inception.
Yet throughout that time, there have been many “bumps in the road” including the 1930s Great Depression, the OPEC oil price shock, the Dot.com bubble, the 2008-9 Financial Crisis and, more recently, COVID-19. In these periods, stock markets as a whole took a big hit – hurting investors in the short term (although markets went on to recover, as the S&P 500 shows). Yet in these periods, certain companies continued to perform well and even keep growing.
In 2020, for instance, many “big tech” businesses (e.g. Facebook & Microsoft) actually benefited from the pandemic as more people worked from home, increasing social media use and using video conferencing services (e.g. MS Teams). The fact that it is possible to find “winners” like these in the midst of a stock market crash can, therefore, make it tempting for certain investors to engage in “stock picking”. This is a form of market timing – where you attempt to buy stock in particular companies which you expect to rise in value, and avoid those which you anticipate will fall. Yet does this approach really work?
The allure and shortcomings of stock-picking
Stock picking does have an appeal to many people. It can be exciting to think of ourselves as experienced, “in-the-know” investors who have exclusive insight into what will happen next in the stock markets. Picking individual companies gives us something exciting to talk about during a dinner party, gives false confidence that we can navigate short-term losses and can create an illusion of control over a portfolio. Yet the evidence for stock-picking is not good.
First of all, it is incredibly difficult even for experienced investors to consistently “pick winners” – in both good and bad markets. An interesting resource to remind of this is the SPIVA Scorecard, which shows 77.97% of large-cap fund managers failing to beat the S&P 500 (its benchmark) over a five-year period. If the “experts” cannot do it, what makes those with a passing interest in investing think they can do better?
Secondly, nobody can predict the future. Cast your memory back to January 2020. At the time, almost all investment managers were looking ahead positively at the equity landscape after a near 11-year global bull run. Barely two months later, COVID-19 had spread across the western world and a huge crash occurred. Who could have foreseen that? Few people did. The same can occur with individual companies. All might appear well on the surface with strong revenue, profits and overall balance sheets. Yet who is to say there isn’t a scandal waiting to erupt, or a damaging dispute between members of the board? Concentrating wealth in specific businesses, therefore, can be a risky bet.
Here at WMM, we firmly believe that the evidence shows that “buying the market” and spending time in it largely surpasses – in the long term – the results you could realistically hope to achieve by trying to pick individual stocks. Of course, this means following the market down during hard times. Yet over many years (e.g. ten, twenty or more) this approach has shown to be effective in growing wealth – especially for retirement. The key here is to determine your goals and your risk appetite, as well as your investment horizon. From there, an asset allocation can be determined which suits you. In these respects, a financial planner can be immensely helpful – assisting with crafting your long term strategy and keeping your plan on track.
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