Nowadays, it is very tempting to “outsmart” the market and find those few stocks that appear to be bucking the trend. When this works—wow—we beat the market! However, when this does not work, facing losses is often the outcome.
Let’s go back a few years and compare two stocks. From 12/31/2019 to 12/31/2021, Netflix (NFLX) was one of the best-performing stocks in the S&P 500, increasing over 86% during these two years. Now let’s look at another stock, XOM (Exxon Mobil). During these same two years, from 12/31/2019 to 12/31/2021, XOM fell 12% while NFLX rose 86%, and the S&P 500 was up just over 47%.
Now let’s look at a different period, from 12/31/2021 to 06/30/2022. NFLX fell over 70%. So, in just six months, NFLX went from being one of the best-performing stocks in the S&P 500 to one of the worst. However, during the first six months of 2022, XOM was up 40%! In the first six months of 2022, NFLX underperformed XOM by 110%! (XOM rising 40% minus NFLX falling 70%). This is a significant difference and reminds us that outsmarting the market can be very tough. Nevertheless, it seemed like a good move, holding on to NFLX and assuming it would continue its rise. We refer to this as regression to the mean as NFLX quickly gave back its gains in just six months, whereas XOM has held up.
The lesson here is being a stock picker can be a challenging business. Imagine you are close to retirement or retired. Taking on these losses can seriously damage your portfolio. So rather than picking individual stocks, consider looking at broadly diversified funds, including no-load mutual funds and Exchange Traded Funds. Yes, many of these funds may hold NFLX and XOM. However, many diversified funds limit their exposure to a single stock, which helps avoid significant losses.
When assessing risk in your portfolio, broadly diversifying and avoiding over-concentrating on a single stock can help smooth out your returns and reduce volatility.