The Haystack has the winners that you need 

By Bob Peters || August 1, 2024

Avoid getting poked by the needle 

The phrase, finding a needle in a haystack, connotates the near impossibility of finding someone or something.  When it comes to investing it may not be quite as improbable as finding a needle in a haystack but it’s close enough to justify shying away from thinking you can pick winners.  Don’t fret.  You will make steady progress towards financial security if you start early, invest in diversified equity funds, stay the course and avoid selling when there is a market decline. Just know that you will hear from friends, family, strangers, media and the vast majority of financial professionals how they pick winners.  They will show you their investment accumen by pointing to buying a winner.  They will underestimate the impact of luck and overestimate their investment prowess.  Avoid getting poked by the needle when reaching into the haystack.  There is a much better way to win the game. 

Picking a Winner is harder than it looks 

Picking a Winner is harder than it looks 

In the blog post, Improving Your Decision-Making Process Can Lead To A More Financially Secure Life, we discussed how incorporating probabilities into everyday decision making can increase desired outcomes.  Understanding that outcomes are influenced by both preparation and chance imposes a bit of humility on our decision-making prowess.  This backdrop is helpful as we look at some interesting research done by Professor Hendrik Bessembinder where he looked at the compound return of every common stock in the US since 1926.  Bessembinder’s research found some surprising outcomes: 

-The long-term return of the overall stock market has been dependent on a very small number of businesses that provided exceptionally high returns. 

-Just 86 stocks (.3% of the total number of businesses) have provided over half of the total stock market return over 90 years. 

-All wealth creation in the US stock market since 1926 has been attributable to 1,092 top performing stocks (4.2% of the total number of stocks).  With the remainder 96% of stocks, collectively, generating a return equal to a risk-free rate of one month US Treasury bills.  

-58% of all stocks during this period underperformed one month US Treasury bills. 

When you stop and reflect on the significance of these findings it overwhelmingly supports a low cost, diversified basket of stocks rather than actively looking to pick individual winners.  

10.26%… Why it’s hard to be satisfied with being average 

Attaining success in just about everything in life depends on a commitment of time and energy to increase knowledge and skills.  We get better at sports because we practice.  We get better grades because we study.  Our careers improve because we learn what our managers want, and we show commitment and competency to deliver results.  Our relationships with people improve as we work on social skills (listening, asking questions, showing interest, having empathy).  All these endeavors require action and a desire to improve.  As such we constantly make decisions.  We become wired to modify, adjust, increase, decrease, change.  An athlete may change coaches, the duration of practices, the drills used to improve skills.  A student may seek out a tutor or try different types of learning methods to improve understanding. 

I don’t believe any of us have been encouraged to do “average” when pursuing a goal that takes a level of above average commitment to achieve.  When it comes to investing, being average has some great advantages but because we are wired to be above average in so many other aspects of life it’s very hard to not seek out constant change.   The historical return of the S&P 500 from 1957 thru 2023 was 10.26%… being average is good when it comes to investing.

Let’s put it together

Now, let’s put it together.  Three things to review:

1) In the blog post, Part 2:  Pursuing Diversification, The Power of Staying Invested, Savings vs. Investing, The Importance of Matching, Duration, we referred to research performed by JP Morgan Asset Management that showed the folly of trying to time when to buy and sell.  Out of 7,300 days if you stayed fully invested you would have received a total return of 9.52%.  If you tried to time the market and missed the best 10 days, your return would have declined to 5.33%.  It gets worse.  If you missed the best 40 days, you would have experienced a loss of 1.51%.  You will be well served to understand that investing in the long term will result in periods of short-term losses.  Being diversified, not timing will likely give you average returns.  Average market returns have done pretty well in the long term.

2)  Professor Bessembinder’s research found a very small number of stocks generated outsized returns.  Only .3% of stocks (86 out of 26,000) generated over half of the total stock market returns over 90 years.  Picking such a small fraction of stocks is a low probability exercise.  If you try to buy and sell you run a high probability risk that you will do so at the wrong time and miss the full upside potential. 

3)  Historically, average S&P 500 returns (10.26% for years of 1957 through 2023) would have provided a long-term investor with a nice life after 40 years of compounding.  How nice?  Well, $10,000 invested for 40 years would grow to $497,415.  If that same investor were to save an additional $500/month for 40 years, the total at the end of the 40-year period would have grown to $3,347,800!

There is no guarantee that past returns will equal future returns but by starting early and getting the benefits of compounding you can increase your probability of enjoying a financially secure future. 

Life’s many accomplishments 

The vast majority of accomplishments in life will take hard work, persistence, moving past moments of failure and setbacks.  You will be well served to adjust, focus and employ above average effort if you seek above average results.  When it comes to long term investing, the pursuit of average returns by staying well diversified and not actively trying buy or sell individual stocks or time the market may be one of your best accomplishments. 

Stick with the haystack, no need to get poked by the needle!