Throughout history, there always seems to be a new grouping of stocks receiving a fancy name after performing well. When hearing headlines about stocks like this, a common question that arises is: why not just buy those select stocks? Here at Greenspring, we believe in utilizing pooled investment vehicles like mutual funds or ETFs, where you still get exposure to popular stocks but are much more diversified and face less risk.
If you followed the market throughout 2023, you probably heard of the group of stocks that have been deemed the Magnificent 7. These stocks include Google, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla. With all the hype surrounding these stocks for 2023, you might have thought they were the top 7 performing stocks in the market. While these stocks may have been the primary drivers of market returns due to their unique combination of large size and strong returns for the year, this chart shows that many other stocks also did well, and in some cases, even better.
Investors who had allocations to these stocks surely benefited from their strong run in 2023, but how did they rank just one year prior in 2022? It’s a much different story, as they all ranked in the bottom 25% of all stocks in the S&P 500 Index.
The whipsaw for these stocks has continued into 2024, as some of their returns have pulled back significantly, leading some to rename the Magnificent 7 as the Fabulous 4. All of this underscores the importance of diversifying your exposure and not putting all of your eggs in one basket. Attempting to time not only when a stock’s big run will start is incredibly difficult, but it is equally challenging to predict when that run will end.
When examining a single stock, despite its past strong performance, there is no guarantee that its future performance will follow a similar trajectory. By analyzing nearly 100 years of data, we observe that as companies grow into some of the largest stocks, the returns that propel them there can be impressive. However, sustaining this performance over time, after they reach a certain size relative to the market, has proven to be incredibly challenging. These companies eventually tend to perform in line with the market or will even underperform it in many cases.
Lastly, picking individual stocks to perform well can be incredibly challenging, even in a strong year for the market. In 2023, the US stock market experienced significant growth, with an increase of approximately 26%. Given this substantial growth for the overall market, one might assume that most stocks in the US would have yielded positive returns as well. However, the reality shown in the chart below presents a different scenario. Despite the overall market’s considerable upturn, 43% of US stocks actually lost money for the year. In contrast, only 1% of all mutual funds and ETFs in the US experienced losses over the same period.
While investing in a handful of individual stocks may offer the potential for higher returns, it also exposes your portfolio to more significant potential losses and an increased risk of losing money. Here at Greenspring, we advocate for a long-term approach to investing by utilizing mutual funds and ETFs, ensuring that your portfolio is well diversified across many stocks and bonds representing different asset classes, sectors, and countries. Historically, this approach has proven to be a more predictable and successful investment strategy than attempting to speculate on which handful of stocks will perform well next.
