As a financial advisor and investor, I’ve witnessed firsthand the profound impact of the stock market on everyday Americans. Prior to the Industrial Revolution, your average citizen didn’t enjoy the profits generated by companies beyond their salary. Since then, the stock market has democratized the world of investing, enabling virtually every American to purchase stock in publicly traded companies, spreading profits across a much larger segment of the population, and helping to create a robust middle class in the process. And nowhere is the stock market larger or more full of opportunity than the ones right here at home, the New York Stock Exchange and the Nasdaq.
Within these exchanges, you have thousands of stocks to choose from. And there lies the ultimate question – how can you possibly know which to pick, and should you pick them at all?
The Case For Stock Picking
Some of America’s most prominent investors have amassed incredible wealth through carefully analyzing and investing in individual stocks. Warren Buffett, Carl Icahn, and David Tepper are just a few examples of individuals who have demonstrated an exceptional ability to identify undervalued companies poised for enormous growth. Their success stories, along with those of numerous lesser-known investors, illustrate just how much money can be made by choosing the right stocks.
This phenomenon isn’t limited to individual investors, either. If we look at the recent history of the S&P 500, we’ll notice a specific trend: just a handful of stocks are responsible for the bulk of the index’s returns. The “Magnificent 7” – consisting of Apple, Amazon, Alphabet, Meta, Nvidia, Microsoft, and Tesla – has delivered remarkable returns over the last five years. What’s truly astonishing is that while these seven companies have soared, the remaining 493 stocks in the S&P 500 have actually been relatively flat.¹ To put this in perspective, if you had invested just $1,000 into each of the Magnificent 7 ten years ago, that $7,000 investment would have ballooned to an astounding $261,450 today.²
Perhaps even most surprisingly, this concentration of returns in a handful of stocks is decidedly NOT a modern anomaly. A groundbreaking 2018 study titled “Do stocks outperform Treasury bills?” revealed a startling fact: of the $32 trillion in wealth created in the U.S. stock market between 1926 and 2015, a mere 4% of listed companies were responsible for generating these returns.³ This leads to a vitally important question: if such a small percentage of stocks drive the majority of market gains, how can the average investor hope to consistently identify these winners?
The Case for Diversification
So why don’t we just spread the bulk of our funds across the Magnificent 7 and ride the wave of superior returns? Well, it’s not quite that simple; otherwise, we would all do it, right?
Let’s imagine you have $100,000 to invest today. How many companies should you buy? What are the chances that just one of them will make it big? And again, will you buy and sell at the right times to fully capture those gains? Maybe. But unfortunately, probably not. Or would you simply purchase equal portions of the Magnificent 7, which may have already reached their respective peaks, and hope for the best?
If we look at the main drivers of the U.S. stock market in the late 1990s and early 2000s, we’d see a very different set of companies compared to today’s leaders. Companies that were considered unstoppable giants then may not even exist today, while others that barely registered on investors’ radars have grown to dominate the market. Let’s just look at Enron. At its peak, it was number 6 in the Fortune 500 and was a major player in the energy, commodities, and services industries. But if all of your eggs were in the Enron basket in August of 2001, you were in for a terrible surprise.
In October of 2001, a shocking scandal broke that led to its downfall and the arrest of its founder, and in November of 2001, it dropped from the S&P 500 to be replaced by none other than Nvidia. It happened to Enron, it’s happened to several major corporations, and we never know when it will happen again or to whom.
The Case For Holistic Wealth Management
Instead of picking stocks, we should focus on factors that we have more control over, such as tax strategies to shield your earnings, choosing funds that have fair fee schedules, rebalancing to help buy low, sell high, and control your risk, and dollar-cost averaging to smooth out volatility over the long term. Combined with diversification and avoiding behaviors that lead to panic selling and the fear of missing out, we drastically improve our chances of growing a nest egg that will eventually snowball into a significant amount of wealth further down the road.
Let’s look at an index fund, for example. The S&P 500 averaged a 10.616% rate of return, including dividends, from June 1994 to June of 2024.⁴ So, an annual investment of $10,000 into SPY starting in 1994 would be worth $1,861,874.12 today, assuming we reinvest dividends. Yes, stocks come and go in the S&P 500, but you’re consistently catching the gains of the biggest winners in the S&P 500, and you don’t remain invested in the underperformers.
However, while investing in the S&P 500 is relatively simple and straightforward, a long-term financial plan that factors in taxes, insurance needs, financial goals, estate and legacy planning, retirement account contributions, social security, and philanthropic considerations isn’t – and that’s where a financial advisor’s advice can be invaluable. Plus, we shouldn’t just invest in the S&P 500; there’s a world of great mutual funds and ETFs out there that are likely more suited to your financial goals.
In Conclusion
Investing has never been more accessible. With platforms like Robinhood making it easier than ever to buy individual stocks or funds, it’s tempting to try your hand at picking the next big winner, especially when you see the enormous gains made by companies that dominate the headlines, such as Tesla and Nvidia. And you know what? That’s okay– as long as you don’t put your long-term savings at risk. If you want to allocate a small portion of your portfolio as ‘play money’ for individual stocks, go for it. It can be exciting and educational, and who knows, you might just pick a winner.
However, the backbone of your investment strategy should be built on stronger foundations. That’s where professional guidance can make all the difference. If you’re feeling overwhelmed by the complexities of building a truly comprehensive financial plan, or if you’re simply curious about how you could optimize your current strategy, don’t hesitate to reach out by clicking the button below.
