A simple way of achieving maximum returns
How important is stock selection to overall
investment performance? Consider that if, in May, 2003, you had invested equal
numbers of dollars in each of the components of the S&P 500 Index via the Rydex
Equal-Weight Fund
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RSP |
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money. If you had purchased the S&P 500 Index outright
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have been only 36%.
Of course, had you avoided large capitalization
stocks altogether and simply purchased the Russell 2000 small cap stocks
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on that date, your return would have been about 74%–more than double the S&P
500 Index performance.
But take a look at the chart below, and you’ll
see a group of stocks that, since 2003, have actually continued a pattern of
underperformance that began in 2000. The red line is the S&P 500 Index
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The blue line is the ratio between the growth stocks in the S&P 500 Index
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IVW |
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and the value stocks in the S&P 500 Index
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IVE |
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S&P 500 Index has been in a bull market, growth stocks within the S&P have
underperformed value components of that index. Had you purchased the growth
stocks in the S&P 500 Index at the start of May, 2003, your return to date would
have been about 22%. Your return on the value stocks would have been about 53%.
Here’s a simple litmus test. Ask a
typical individual investor to jot down as many stocks and their symbols as he
or she can. The odds are good that you’ll get a laundry list of issues that
have been market underperformers: the large cap growth stocks from the NASDAQ
and NYSE. The odds are also good that you’ll get fewer names from the
lower-weighted S&P 500 Index stocks, the S&P 500 value stocks, and especially
from the Russell 2000. The more familiar the company–on average–the worse it
has performed. Which is a way of saying that research into unfamiliar issues
has paid off.
Oh yes, notice that all of the
stocks we’ve considered are from U.S. markets. Had you invested in Japan
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your return would have been 101% since May, 2003. German stocks
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EWG |
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returned 99%. And emerging markets
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EEM |
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returned 153%.
If it’s familiar, it’s
underperformed. It’s not a happy thought when you look at the concentration of
stocks in most people’s mutual funds.
Brett N. Steenbarger, Ph.D. is Associate Clinical
Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical
University in Syracuse, NY and author of
The Psychology of Trading (Wiley, 2003). As Director of Trader
Development for Kingstree Trading, LLC in Chicago, he has mentored numerous
professional traders and coordinated a training program for traders. An active
trader of the stock indexes, Brett utilizes statistically-based pattern
recognition for intraday trading. Brett does not offer commercial services to
traders, but maintains an archive of articles and a trading blog at
www.brettsteenbarger.com and a
blog of market analytics at
www.traderfeed.blogspot.com. His book, Enhancing Trader Performance,
is due for publication this fall (Wiley).