Enrich Your Future 15: Individual Stocks Are Riskier Than You Believe
In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. In this series, they discuss Chapter 15: Individual Stocks Are Riskier Than Investors Believe.LEARNING: Don’t invest in individual stocks. Instead, diversify your portfolio to reduce your risk. “Diversification has been said to be the only free lunch in investing. Unfortunately, most investors fail to use the full buffet available.”Larry Swedroe In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. The book is a collection of stories that Larry has developed over 30 years as the head of financial and economic research at Buckingham Wealth Partners to help investors. You can learn more about Larry’s Worst Investment Ever story on Ep645: Beware of Idiosyncratic Risks.Larry deeply understands the world of academic research and investing, especially risk. Today, Andrew and Larry discuss Chapter 15: Individual Stocks Are Riskier Than Investors Believe.Chapter 15: Individual Stocks Are Riskier Than Investors BelieveIn this chapter, Larry reveals the stark reality of investing in individual stocks, highlighting the significant risks involved. His aim is to help investors understand the potential pitfalls of this high-stakes game and why they should avoid it.Given the apparent benefits of diversification, it’s baffling why investors don’t hold highly diversified portfolios. According to Larry, one reason is that most investors likely don’t understand how risky individual stocks are compared to owning a broad selection of hundreds or thousands of stocks.Evidence that individual stocks are very riskyLarry notes that the stock market has returned roughly 10% per year over the last 100 years, and the standard deviation on an annual basis of a portfolio of a broad market of stocks has been about 20%. He observes that most people don’t understand that the average individual stock has a standard deviation of more than twice that.In another study from 1983 to 2006 that covered the top 3,000 stocks, the stock market returned almost 13% per annum, but the median return was just 5.1%, nearly 8% below the market’s return. The mean annualized return was -1.1%. This means that if you randomly pick one stock, the odds would say you’re more likely to get -1.1%. However, if you own hundreds or thousands of stocks, the odds are in your favor, and you’ll get very close to that mean return.Larry shares another stark example of the riskiness of individual stocks. Despite the 1990s being one of the greatest bull markets of all time, with the Russell 3000 providing an annualized return of 17.7% and a cumulative return of almost 410%, 22% of the 2,397 U.S. stocks in existence throughout the decade had negative absolute returns. This means they underperformed by at least 410%. Over the decade, inflation was a cumulative 33.5%, meaning they lost at least 33.5% in real terms.In another study by Hendrik Bessembinder of all common stocks listed on the NYSE, Amex, and NASDAQ exchanges from 1926 through 2015 and