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Most of the research I've read seems to indictate that no more than 20% of the people who buy individual stocks beat the S&P500. Imagine my surprise when I read this from Dr. Bernstein's "Efficient Frontier" web site.

The 15 Stock Diversification Myth

In order to investigate this problem, I looked at the stocks constituting the S&P 500 as of 11/30/99, and formed 98 random equally-weighted 15-stock portfolios for the 12/89-11/99 10-year holding period. Below is a histogram of the annualized portfolio returns:

[see link above to view plot]

The "market return" (all 500 stocks held in equal proportion) was 24.15%. This is considerably higher than the 18.94% return of the actual S&P for two reasons: First, the S&P is a cap-weighted, not an equal-weighted, portfolio. Second, and much more important, many of the stocks in the S&P on 11/30/99 were not in the index at the beginning of the period. The recently-added stocks obviously had much higher returns than the companies they replaced, upwardly biasing the entire series of returns. Nonetheless, these flaws in the methodology do not change the basic conclusion; the TWD of these 15-stock portfolios is staggering—three-quarters of them failed to beat "the market." (Had the study been done with the S&P stocks extant on 12/1/99, it seems certain that the positive kurtoskewness of the present sample would have been replaced with a significant negative kurtoskewness—a much more important descriptor of risk. If anybody wants to give me a survivorship-bias-free S&P database for the past 10 years, my modem and mailbox are in fine working order.) Even so, the scatter of returns was quite high, with more than a few portfolios underperforming "the market" by 5%-10% per annum.


Actually, Bernstein's plot doesn't show that "three-quarters of them failed to beat "the market"". Only 29 out of the 98 portfolios he examined failed to equal or beat the 18.94% annualized return for the S&P500 for the 10-year period. Fully 70% of the 15-stock portfolios beat the S&P500 10-year return of 18.94% per annum.

Of course, Bernstein picked his 15 stock portfolios at random while most investors think long and hard about what stocks to buy.

Perhaps "too much thinking" leads to underperformance.

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