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The Agony and the Ecstasy

I started investing just after the dot com bust, right through the commodity boom. I was buying individual stocks and names, mining companies I had never heard of, IPOs at 20 cent issue prices, the major banks, and whatever else was hot at the time. I was in my early 20's. I made a few dollars and felt like a genius. But when it all came crumbling down, I lost hundreds of thousands of dollars. It was an expensive exercise, yet it was the most valuable lesson I ever learnt. One that would not only set me up personally, but also my career and philosophy in wealth management.

Stock picking is really hard. Some of the best in the business will concede this to you. Most stocks not only underperform the market, but they actually underperform US Treasury bills too - about 60% actually.

Here are more facts for you:

  • In a J.P. Morgan study using a universe of Russell 3000 companies since 1980, the return on the median stock since its inception vs. an investment in the Russell 3000 Index was -54%. 

  • Approximately 40% of stocks suffered a permanent decline of more than 70% from their peak values.

  • Two-thirds of all stocks underperformed the Russell 3000 Index.

  • For 40% of all stocks, their absolute returns were negative.

Only a small number of stocks contribute to the vast majority of wealth creation. In the chart below, we can see that 3 stocks contributed to 10% of total wealth creation over the long-term. As you follow the chart, you can see 11 stocks contribute 20% of total wealth creation, 72 stocks contribute to 50%, and a total of 966 stocks contribute to 100% of total wealth creation over the long-term. You might think 966 stocks is a large number, but when you consider the total number of stocks is 28,114, you'll soon realise that only 3.4% of stocks contribute to 100% of total gains.

Here are the best performing stocks (in the S&P 500) over the last 30 years. If you did not own each of these stocks your performance is going to be shot. And here lies the problem - trying to pick the winners at the right time with the odds I have just outlined above.

Over the last 30 years, the S&P 500 has returned 1,900%, or 10.5% pa - and you did not have to pick up one research report.

If you think this concept of diversification only applies to public market, think again. The chart below shows that investing in a single private equity or single private credit fund is like picking a single stock: you could pick the best performer and the payoff is huge. However, the odds are you're going to pick the worst performer, in which case, you are missing out on the potential of higher returns of other managers in the asset class.

Source: Blackstone

Irrespective of which market you invest, diversification remains key. One may argue that manager diversification is more important in private markets to ensure price discovery.

The agony or the ecstacy - you decide.


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