The Illusion of Stock Picking Success

I’ve had a brokerage account for more than 25 years, which, for many reasons, I should never have opened in the first place. As I stated in Volume 2 of my book, it’s because I was investing without knowing why. Was it for emergency savings? Of course not. Was it for retirement? I never considered it as a retirement investment when I opened it, although that’s what it will be now that I’m in retirement. Anyway, I put money into the account over time, thinking I could pick good stocks and not do worse than the market. But of course, I didn’t always pick good stocks and have done worse than the market.

Today, the account is a hodgepodge of stocks and funds that I bought decades ago, as well as some acquired within the last few years. A few years ago, as I approached retirement, I determined the purpose of this account and executed numerous buy and sell transactions to adjust the individual investments, aiming to generate dividends that would supplement my other retirement income. I’ve sold off many of the poor performers at a loss in recent years, performing “tax-loss harvesting” as it’s called, to at least get a small $3,000 reduction in adjusted gross income on my tax form’s Schedule D. Any competent financial planner would scratch their head looking at the account and ask me the same question - what is the goal, or purpose of this account?

Now back to the title of this article - the illusion of stock picking success. When I open the account webpage today, I see the 30 or so investments, with more than a third showing gains of 100% or more. While these gains are impressive, without knowing when the investment was purchased, the gain numbers by themselves are meaningless. And, since I’ve sold off most poor performers, those losses aren’t visible on the account’s “positions” page anymore, so what’s left looks pretty good. Therefore, my stock (and fund) picking success is a bit of an illusion since individual gains and losses don’t tell the whole story.

Next, when I go look at the “performance” tab of the account, it shows me a comparison of my portfolio to the S&P 500, Dow Jones, or NASDAQ. While interesting, that comparison is irrelevant because I’m not trying to beat a stock index. I’ve oriented the portfolio to generate income. The current dividend yield of the S&P 500 index is only 1.1% while I’m getting 3.7% in income from my portfolio. The page shows my portfolio had an annualized return of 16.7%, while the S&P 500 index returned 22.9% over the past 2½ years. Is 16.7% with 3.7% of it as income a good performance? Compared to what?

And then, what about volatility? The brokerage account doesn’t calculate Beta, so I would have to do that on my own (which I haven’t for this account). [As a reminder, the Beta metric compares an investment’s volatility against the total market or a specific index.] However, I’ve taken steps to avoid owning any of the top, currently overvalued technology stocks, so my portfolio’s Beta metric is likely to be much less than the market's right now. Nevertheless, the brokerage webpage doesn’t provide that information either, and I haven’t taken the time to calculate it myself. If I want to be honest with myself, I’d calculate the Beta and decide if the lower portfolio volatility, combined with the 3.7% income, meets my needs.

I could also compare my portfolio to a similarly constructed mutual fund or ETF. I found that the Vanguard High Dividend Yield fund had about a 1% higher annualized return and averaged about 3.4% income. So, compared to that fund, which has a similar objective of generating high income, I performed about as well. But, again, illusion. I have 30 investments; the High Dividend Yield fund has 566. Thus, I have much more portfolio risk than just looking at a Beta metric would indicate because I’m much less diversified.

It’s easy to convince yourself of your great skill in picking winning stocks, but it can be an illusion unless you correctly compare it to other similarly constructed portfolios and do so over the long term. Those handful of stocks in my portfolio that show 100%+ gains are just an illusion because what matters is the entire portfolio performance over the long term. Without establishing the purpose and goal for the portfolio—and comparing it to others—you’ll never know how successful you really are.