By: Julio Cacho, PhD & Juan Carlos Herrera
Many of today’s investors are familiar with the high-achieving FAANG stocks. For the majority of investors, it’d be a big mistake to ignore the FAANG stocks just because lots of people invest in them. These stocks - comprised of Facebook, Amazon, Apple, Netflix, and Google – are the driving force behind the current S&P 500 gains.
A recent paper by Hendrik Bessembinder of Arizona State University agrees with this assertion. His research indicates that most stock market returns in America are from a small fraction of shares. For example, his research found that five stocks - Apple, ExxonMobil, Microsoft, GE, and IBM - accounted for 10% of all created shareholder wealth from 1926 to 2016.
The top 50 stocks accounted for 40% of the total market returns during that same time period. Consequently, that means the vast majority of stocks returned very little during that period. In fact, over 50% of the stocks listed in America in the past 90 years were actually worse investments than Treasury Bills.
Furthermore, different research concluded that most stock returns are made on just a couple of trading days. Therefore, it is important to not be out of the market on those days, and to not omit key stocks from your portfolio.
In the late 1960’s there were 50 popular stocks, aptly named the “Nifty Fifty”. It would have required skillful timing and some luck to know which of those crashed during the 1970’s bear market and which stocks flourished. This also helps explain how active stock management, which is usually not diversified, can underperform relative to long-term expectations.
However, it would not be wise to interpret the above information as a suggestion to only invest in FAANG. We don’t know who tomorrow’s winners will be, even if we know who today’s winners are.
Instead, it would be better to diversify your portfolio extremely well. You will be affected if a FAANG stock crash occurs, but you will be able to withstand it with a diverse portfolio. Diversify widely across both domestic and international markets. Diversify the assets you have. Diversify the stocks you invest in. Include bonds and cash in your diverse portfolio. Investing in the FAANG stocks is a good idea, but diversifying your portfolio will protect you in the event of a FAANG stock crash.
For more please read this article from The Economist.