When markets are rising, it is often just a few stocks that contribute most of the gains. So wouldn't it be smart to focus your investments on these performance drivers? Here is why broad diversification offers better chances of success than trying to hit the bullseye with a carefully picked selection.
An astonishing 188 percent gain from the start of the year to the end of September: the share price performance of chipmaker Nvidia sounds like a fairy tale. At 150 percent, the gain for Meta, the parent company of Facebook, is barely less impressive. So far this year, both have been among the frontrunners in the US stock index, the S&P 500. Overall, large technology stocks were once again the driving forces whenever the markets moved higher.
Some may wonder whether this couldn't have been foreseen. Sure, the big tech stocks also included Meta (down 65 percent) and Nvidia (down 51 percent), which fell sharply in 2022. But somehow you get the feeling that it is very often the same names that top the performance rankings and dominate a stock index.
A handful of top stocks
The fact that a few stocks are the performance drivers in the markets is not just a feeling. US economist Hendrik Bessembinder took a closer look at the performance of US stocks between 1926 and 2019 in his study "Wealth Creation in the U.S. Public Stock Markets 1926 to 2019". One of his findings: of the 26,168 companies listed since 1926, 11,036 increased their shareholders' wealth. Yet just 83 companies accounted for half of the total wealth created in the US stock market over this period.
What is true for the American stock market also applies to the German one. The Flossbach von Storch Research Institute examined this for the CDAX. This index includes all domestic stocks in official trading on the Frankfurt Stock Exchange. From January 2003 to January 2023, just 12 of a total of 1,013 stocks accounted for around half of the value created.
Bullseyes are a matter of luck
So it is not unusual at all for a few stocks to stand out with their performance and contribute significantly to the average market return. "By definition, the above-average performers are not in the majority," explains Philipp Dobbert, Head of Asset Management at Quirin Privatbank and quirion. There will always be stocks whose performance leaves others far in the shade. But doesn't that argue for searching precisely for such stocks before you invest? "The idea seems obvious, but it is a fallacy," says Dobbert. "With luck, you might land a bullseye that is successful over the long term." But such hits cannot be reproduced systematically. If only because, as the various studies show, there are so many more relative losers than winners – a bet with unfavorable odds.
On top of that: which stocks will be among the winners in the future and then top the best-of lists in hindsight cannot be determined analytically in advance. "Even if in hindsight you feel you could have known it, you can only speculate about the future," Dobbert emphasizes. It is a mistake to believe that a stock's earnings prospects can be read reliably from its balance sheet, for example. Because it is not the balance sheet itself, but rather the expectations of future performance derived from it and from other factors, that ultimately drive prices.
"For some companies there are above-average expectations, and this influences share price performance accordingly," Dobbert notes. Sometimes the expectations are met and are then raised even higher. Some companies manage this over longer periods. But many do not. In any case, numerous former "stock market stars" have long since burned out. The market remains, but its participants are constantly changing: according to another, earlier study from 2018 by the aforementioned US economist Bessembinder, the average length of time companies were listed on the US market was just 7.5 years.
Better to go global
So finding the needle in the haystack with your own stock picking and landing a bullseye is not particularly likely. With very broad, global diversification, however, you can avoid missing out on the especially attractive market segments in your portfolio altogether. "With diversification, I increase the probability of investment success," Dobbert underscores. This applies both to the return side and to the risk side. Because individual stocks turning out to be a total loss happens not so rarely. By contrast, a broadly diversified portfolio "failing" over the long term is almost impossible. The broader the market and the investment, the more unlikely that becomes.
The asset class of stocks is geared toward growth – just like the global economy. This is no coincidence, but a systematic connection. quirion's investment strategy optimizes the balance between return opportunities and risks through the broadest possible diversification. The global ETF portfolio holds shares in around 8,000 stocks – including, incidentally, those of Nvidia and Meta. Depending on your personal risk profile and individual investment horizon, bonds are added to the portfolios. This further dampens price fluctuations.
On top of the more realistic return opportunities and the reduced risk of a particularly well diversified portfolio, a digital asset management service like quirion also offers the convenience of not having to worry about your investment yourself. Dobbert and his team take care of that on the basis of insights from capital market research. "A central insight of academic research is this: a globally diversified market portfolio is far superior to a targeted selection of individual securities in terms of the balance between expected opportunities and risks."
