This Stunning Statistic Will Make You Rethink Investing in Individual Stocks (Even The Winners)

Past performance does not guarantee future results.

Investors of all types, from retirement savers to day traders, have all come across this disclaimer at some point. But investors with individual stocks in their portfolios may want remind themselves of this axiom.

New research from Dimensional illustrates the inherent dangers of investing in single stocks as opposed to spreading your assets across a diversified portfolio. Using more than 70 years of historical data, Dimensional found that at any given time stocks with a history of outperforming the market are no more likely to continue to beat the market 10 years in the future than underperforming firms.

A financial advisor can help you build a diversified portfolio to meet your needs. Find a trusted fiduciary advisory today. 

Of the stocks that outperformed the market over 20-year stretches between 1947 and 2020, only 30.2% continued to do so over the next 10 years. Meanwhile, 30.3% of stocks that trailed the market during 20-year periods went on to outperform it in the next 10 years.

"In other words, winners have been no more likely than losers to beat the market in the future," Dimensional researcher Bryan Ting wrote in "Singled Out: Historical Performance of Individual Stocks."

The Problem With Owning Individual Stocks

As an investor, you may end up with large concentrations of single stocks in your portfolio. Perhaps you fell in love with a particular stock and ended up buying a plethora of shares. Maybe your employer compensates you by awarding you shares of company stock, which led to a portfolio that's underweighted elsewhere. Whatever the case may be, the Texas-based investment firm cautions against tying up too much of your wealth in single stocks.

"Familiarity with these stocks or a successful track record while holding them may discourage investors from diversifying. Unfortunately, this can lead to one of the most well-known cautionary tales in finance: tragic declines in wealth from losses in single securities," Ting and Crill wrote.

Ting and Crill found that the majority of firms don't even survive as publicly traded companies 20 years into the future. At any given point between 1927 and 2020, only 47.6% of stocks remained listed on public markets 20 years later, while 52.4% were delisted. It's important to note that delisting is not inherently a bad thing. In fact, a firm may delist as a result of a merger or simply decide to go private, creating a windfall for its investors. However, nearly a fifth of all companies that delist within 20 years from a given point in time do so because of deteriorating financial conditions.

Then comes the challenge of keeping pace with the market, let alone beating it. Dimensional determined that just under 35% of stocks outperform the market over rolling five-year periods. But that percentage drops as the time horizon extends. Under 29% of firms beat the market over 10-year periods, while only one out of five stocks survive and outperform the market over the following 20 years.

Identifying the stocks that will produce positive alpha in the long run (10 years or more) is particularly difficult considering past performance is hardly indicative of future success, as Dimensional's research suggests.

So what's an investor to do? The answer lies in diversification, according to the company.

"Even when accounting for capital gains taxes, transitioning from a concentrated portfolio to a broadly diversified one can deliver higher growth of wealth," Ting and Crill wrote. "The long-term benefits of diversification can outweigh the short-term costs associated with liquidating outsize positions."

How to Diversify Your Portfolio

If a heavily concentrated portfolio exposes an investor to undue risk, one that's broadly diversified across asset classes and industries should in theory reduce that risk.

The most common way to add diversification to an investment portfolio is to purchase shares in mutual funds and/or exchange-traded funds. These financial products pool money from investors and then invest in a variety of securities and assets. Some funds are extremely broad and look to mirror the economy as a whole, while others focus on particular asset classes, like dividend stocks, or sectors, like energy or health care.

For investors looking to take a more active role in the management of their portfolio, direct indexing may be an option to explore. Instead of buying a professionally managed fund that mimics an index, investors can directly purchase the individual stocks that comprise an index, reducing their tax burden while implementing a specialized investment strategy. Both Fidelity and Charles Schwab have rolled out new direct indexing services in recent months.

Lastly, working with a financial advisor may be the easiest way to build a diversified portfolio that aligns with your financial goals, risk tolerance and time horizon. Most advisors allocate client assets across a combination of mutual funds, ETFs, individual stocks and bonds, as well as alternative investments.

Bottom Line

Stock picking can be exciting and potentially lucrative, but research from Dimensional suggests investing in individual stocks for the long term isn't the best strategy. While a majority of stocks end up delisting within 20 years at any point in time, the stocks that have a 20-year history of outperforming the market are no more likely to thrive in the future than stocks that have trailed the market for 20 years. As a result, investors with wealth tied up in individual equities should consider diversifying their portfolios, even if it means incurring a tax bill.

Tips for Picking Mutual Funds

• If you're struggling to sort through the universe of mutual funds, consider working with a financial advisor.  Finding a qualified financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.

• Before selecting investments for your portfolio, determine what your asset allocation should be. SmartAsset's asset allocation calculator can help you set targets for how much your money should be invested in stocks, bonds and cash.

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