Let's put it bluntly: for most people, investment selection is gambling, repackaged as entertainment.
That sounds harsh. The data says it is not an exaggeration. This is level 6 of the Wealth Principles pyramid, the most glamorous level and the one that matters least. It only makes sense once you have a mix that fits you and your own behavior under control.
Quick check. Of all US stocks listed since 1926, roughly what share created all of the stock market's wealth above cash?
50%? 25%? 10%? The answer is lower than most people guess.
The problem: every step needs another correct forecast
Picture a ladder of complexity. Each rung asks you to be right about one more thing:
- Index. Own the whole market, for example a broad index.
- Sectors. Hold more or less of a sector than the index does (tech vs utilities).
- Themes. Tilt within sectors: high debt, recent IPOs, management turnover.
- Individual stocks. Pick the companies you think will win.
- Speculation. Bet directly on what you think will rise the most, and when.
Climbing the ladder doesn't add risk. It multiplies it. If you are right 60% of the time at each step, which is generous, the chance of getting four steps right in a row is:
0.6 × 0.6 × 0.6 × 0.6 ≈ 13%
Even at 70% per step it is only about 24%. That is why the reward for stock picking would have to be enormous to justify the risk.
What it costs: even the professionals lose
These are not amateurs. They are fund managers with research teams and data terminals, working at level 6 full-time.
- SPIVA: in 2024, 65% of actively managed US large-cap funds trailed the S&P 500. Over 15 years, more than 90% did.
- Fama & French (2010): very few active US equity funds earned enough to cover their own costs. The overall group of active funds looks close to the market before fees and loses to it after.
The arithmetic nobody can escape
In 1991 Nobel laureate William Sharpe made the point in three pages. Every euro in the market is either actively or passively managed. Together they are the market. So:
- Before costs, the average active euro must earn the same as the average passive euro.
- After costs, the average active euro must earn less, because active management costs more.
No market conditions change this. It is addition and subtraction.
Why picking stocks is harder than it looks
Hendrik Bessembinder looked at every US stock in the CRSP database from 1926 to 2016, nearly 26,000 companies.
- Most individual stocks returned less over their lifetime than one-month Treasury bills, which are essentially cash.
- Just 4% of companies, about 1,100, accounted for all of the net wealth the stock market created above Treasury bills.
- Fewer than one third of 1%, about 90 companies, created more than half of it.
Returns are extremely skewed: a handful of huge winners and a long tail of losers. A broad index owns the winners automatically. A concentrated stock picker has to find them in advance, and most portfolios simply miss them.
The principle: start at the bottom rung
- Start with the index. It is the default that beats most professionals after costs.
- Climb only with proof. Move up a rung only if you can show, with a written record, that you beat the rung below.
- Keep speculation small and separate. If you want to pick, give it a fixed small budget that can never threaten the core.
You can be smart, or you can make money. Stock picking is an intellectual black hole: endlessly interesting and, for most people, endlessly expensive.
Your checklist
- Write down which rung of the ladder you are really on today.
- Compare your picks with a simple index over the same period, including fees.
- If you pick stocks, cap that part of your money at a fixed share.
- Keep a decision journal: why you bought, and what would prove you wrong.
- Review once a year, not every day.
Answer to the quick check
About 4%. Bessembinder found that roughly 1,100 of nearly 26,000 US stocks created all of the market's net wealth above Treasury bills between 1926 and 2016.
Sources
- S&P Dow Jones Indices. SPIVA U.S. Scorecard, Year-End 2024. Link
- Sharpe, W. F. (1991). The Arithmetic of Active Management. Financial Analysts Journal, 47(1), 7–9. Link
- Fama, E. F. & French, K. R. (2010). Luck versus Skill in the Cross-Section of Mutual Fund Returns. Journal of Finance, 65(5), 1915–1947. Link
- Bessembinder, H. (2018). Do Stocks Outperform Treasury Bills? Journal of Financial Economics, 129(3), 440–457. Link
Educational content, not financial or investment advice. Nothing here recommends buying or selling any specific security or fund. Investing carries the risk of loss.