Why Picking Stocks Can Be Disastrous for Your Nest Egg

More bad news for everyone who fancies themselves a stock picker.

A majority of individual stocks underperform one-month Treasury bills — which currently yield only 0.5 percent annually — according to new research out of Arizona State University.

For a paper released in draft form this month, ASU finance professor Hendrik Bessembinder worked with a database that contains all common stocks listed on the NYSE, Amex and NASDAQ exchanges from 1926 to 2015. His findings include:

• Looking at monthly return rates, only 47.7 percent of stocks beat one-month Treasury bills.
• Looking at returns over their entire lifetimes, only 42.1 percent of stocks beat one-month Treasury bills.

In addition, Bessembinder found that more than half of all stocks provide negative lifetime returns.

Bessembinder notes that this helps explain why active investment strategies, which tend to be more poorly diversified than passive strategies, generally underperform their passive counterparts.

Or, as financial columnist James Saft puts it in Reuters:

“… the main message of the study is the huge value of diversification. And diversification is cheaper than ever thanks to index funds and ETFs.”

Index funds: A better approach?

Index funds and exchange-traded funds, or ETFs, are examples of passive investments, meaning they’re generally managed by computers rather than humans.

We write about them often here. But before you can understand why everyone from Money Talks News founder Stacy Johnson to billionaire investor extraordinaire Warren Buffett sings their praises, you have to understand how index funds and ETFs work.

An index funds is a type of mutual fund — a pool of investments like stocks or bonds — that mimics the performance of a particular group of stocks or bonds. The Vanguard 500 Index Fund, for example, mimics the performance of Standard & Poor’s 500 stock index.

ETFs are investment funds traded on a stock exchange like stocks. Like index funds, they typically follow the performance of a particular index, like the S&P 500 or the Nasdaq-100.

As we report in “5 Simple Ways to Invest Your Retirement Savings,” many investors prefer index funds because they are a simple way to invest:

Index funds are cheaper to own than managed funds (managed by human experts, that is), but their track record is often at least as good.

A report in The New York Times cited a series of annual S&P Dow Jones studies that found “that over extended periods, the average actively managed fund lags the average index fund.” Some active managers do better than index funds, but it’s hard for most of them to maintain that edge over time, the report says.

To learn more about index funds and ETFs and what they can do for your retirement portfolio, also check out:

• “How to Get Started Investing When You Don’t Have Much Money“
• “Ask Stacy: How Do I Invest in the Stock Market?“
• “Ask Stacy: How Do I Invest in a Mutual Fund?“

Are you surprised by Bessembinder’s findings? Sound off below or on Facebook.