Why stock-picking is a dangerous game

Buying and holding the wrong stocks can get ugly in the long run.

Because stocks usually go up, buying stocks and refusing to sell even during pockets of volatility pays off long-term.

However, by “stocks”, it’s usually a safer bet to be parked in an index fund that tracks a resilient benchmark like the S&P 500, unless an investor is picking the right individual stocks.

CLSA’s Damian Kestel published some research in a recent note to clients that illustrates how most of the market’s returns can be attributed to only a few stocks.

The research looked at lifetime returns on stocks that have traded since 1983, including delisted names. It limited the scope to stocks that would have been in the top 3,000 by market cap at some point — or listed on the Russell 3000 index — and ended up with just over 8,000 stocks.

It found that while 61% of all the stocks earned a positive return in that period, just one in five stocks gave outsized total returns of 300% or more.

But looking at the distribution of each stock’s compounded annual return, the average was -1.06%, while the median was 5.1%.

Sorted from the least profitable to the most profitable total returns from 1983 till 2007, only 2,000 stocks, or about 25%, made up all of the basket’s gains. And so, an investor that picked only from the other 75% of stocks would have had a total gain of 0% in that period.

“In other words, a minority of stocks are responsible for the majority of the market’s gains,” Kestel wrote.

NOW WATCH: The truth about those crazy calendar trends stock market gurus always talk about

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.