Why Investors Can Get Crushed Owning Stocks

How many times have you heard someone say "stocks should return 10%"? I've heard this many times from colleagues, financial advisors, and even at cocktail parties. The fact is, this is just plain wrong! Individual stocks have a huge range of returns.

Investors who buy-and-hold individual stocks are at great risk of losing money. The chart below from a research paper by Blackstar Funds shows why. More than two-thirds of all stocks underperformed the index (red bars on the left). On the other hand, just over 6% of all stocks dramatically outperformed the index (blue bar on the far right) and it is axiomatic that these outperforming stocks spent many weeks on the all-time high list.

Confusion arises because the mythical 10% number (or 8, 9, 11, 12%) is calculated from the long-term return for stock-market indexes like the Dow Jones Industrial Average or the S&P 500. But beware: index funds are very different from individual stocks. Indexes are weighted so stocks with rising prices (and market capitalization) gain more weight in the index, while stocks with falling prices get less weight. Indexes have a built-in trend following system, individual stocks do not.

The Blackstar study reports that on an annualized basis, the average return for individual stocks was negative (-1.06%; that is not a typo!) This will be a shock to many individuals who are only familiar with the '10%' number. It is also why investors who don't have a strategy will get crushed owning individual stocks.

A grim picture for owning individual stocks:

• Most individual stocks have negative annualized total returns
• Most individual stocks do worse than an index

But the fact that most of the market's gains come from a small number of stocks can be a good thing. Why? Because traders can simplify. Focus on the best performing stocks. This is why I pay close attention to my all-time high stock screener.

Mathematically it makes perfect sense. Stocks that generate thousands of percent returns will typically hit new highs hundreds of times, usually over the course of many years. - Cole Wilcox and Eric Crittenden (Blackstar Funds)

Related Posts:

• Screen for All-Time Highs: US All-Time Highs Last Week
• Understand Why They Outperform: Explaining why all-time highs outperform
• Learn from Previous Trades: Trend-trading Potash Corp 2006-2008
• Plan Your Stop-Loss: On Setting Stops
• Stick To The Plan: Outcomes of a trade