Picking stocks is statistically likely to underperform the market

It always seems like the majority of investors who pick individual stocks will underperform couch potato investors who simply invest in a diversified ETF. At first glance, this was unintuitive to me. Surely just throwing darts on a board would lead to a 50% win/loss rate when comparing performance of the chosen stock to the market, it’s just basic statistics. However, a closer analysis to historical asset performance demonstrates why this is.

Just like “whales” in free-to-play microtransaction-filled mobile games, a majority of the earnings come from a small subset of stocks. As per PensionCraft and ValueWalk, 64% of stocks underperformed the market. While 36% outperformed the market, only 6.1% significantly outperformed (500%+ increase) the market. Looking at the total return on ETFs, 75% of stocks had a return of 0, whereas the remaining 25% made up the entire return.

What this tells us is that statistically choosing individual stocks is more likely to underperform the market. For every TSLA, MSFT, MRNA etc that have made the overall return of ETFs that hold them look positive, there are dozens of stocks that are stagnating or otherwise underperforming the overall market. If you’re going to insist on picking individual stocks, you must have strong convictions that this asset is, for whatever reason, one of the lucky 36%. Even then, your criteria may need to be more strict than just “barely outperform the market” when you factor in the required time investment to analyze stocks.

Of course, it’s no fun to just say “well, statistically we’re likely to lose, no point in trying.” If it is possible to find the “whale” stocks with some degree of accuracy, the returns prove worth it. In a future post, I’ll investigate creating a classifier that looks to identify which stocks that have not yet broken out will be the new 500%+ winners.

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