What Stock Picker’s Market?

Trading results for the past five years reveal an important lesson for investors and their advisors

What about just buying and holding a portfolio of individual blue chip stocks? Surely, this is the easiest and smartest way to outperform, isn’t it? What about just buying and holding a portfolio of individual blue chip stocks? Surely, this is the easiest and smartest way to outperform, isn’t it?

The term “stock picker’s market” really gets some investors going. It gives them the false hope that they can beat the broader stock market by carefully buying the right stocks. The end result is often misery.

Decades ago, William Sharpe warned, “Properly measured, the average actively managed dollar must underperform the average passively managed dollar.” Was he right?

Charlie Billelo at Pension Partners put it this way: “In a relentless up-trending market, investors become highly confident in their ability to pick stocks, naturally calling it a ‘stock picker’s market.’ After all, any stock they pick is going up and to the right. 

“We saw the most extreme example of this in 2013, which set a record in terms of breadth with 93% of stocks in the S&P 500 finishing positive on the year," he said. "Never mind the fact that a blindfolded monkey throwing darts was likely to pick a winning stock last year; most investors came out of 2013 believing they were the next Warren Buffett.”

What about just buying and holding a portfolio of individual blue chip stocks? Surely, this is the easiest and smartest way to outperform, isn’t it?

Putting this theory to test, I examined the five-year track record of all 30 stocks in the Dow Jones Industrial Average and here’s what I found: A pathetic 67% of Dow stocks (20 of them) have failed to beat their peer industry sector and the corresponding passive sector ETF (from April 28, 2009 to April 28, 2014).

The results were particularly heinous for stock pickers in the technology sector.  Every single Dow component in the tech arena, from Intel to Microsoft, lagged the Technology Sector SPDR ETF (XLK). Rather than trying to pick themselves to glory and riches, technology investors would’ve been better off with a passively managed tech fund.  

With the S&P 500 SPDR ETF (SPY) up over 100% in the same five-year span as my mini-study, most stock pickers, as my sample shows still lagged.

It’s one thing to underperform during a bad market, but significant underperformance when stocks are riding high is a mortal sin. Unfortunately, the investing public is good at it.

The average investor is a notoriously poor market timer and an equally bad stock picker. Most of them would be better off having just invested in diversified basket of stocks via an index fund or ETF.

For investors and the advisors who serve them, there are plenty of great ETFs to choose from when it comes to buying blue chips in a low-cost, tax-friendly way. Look no further than the Vanguard Mega Cap ETF (MGC), as one example.  

Even during a bull market, it’s never really a “stock picker’s market,” because the typical stock picker loses money versus the market.

In the end, most investors should avoid the temptation to hand pick stocks with anything other than play money. 

-- (Check out ETFs for Warren Buffett's Hot List on ThinkAdvisor.)

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