Few investment approaches seem simpler and more intuitive than buying and holding a handful of large, successful companies. By the time they've established themselves, the thinking goes, these businesses have strong competitive positions in their industry, solid earnings, and a bright and stable future. All this is true, with only one problem: the market knows these facts as well and has marked up their prices accordingly. And high current prices typically lead to lower future returns (and vice versa).
Consider the top 10 stocks in the market at the turn of the century: GE, Exxon Mobil, Pfizer, Citigroup, Cisco, Walmart, Microsoft, AIG, Merk, and Intel. How would you have done if you bought all of them in equal amounts?
The red line (Portfolio 2) illustrates the growth of this portfolio starting with $1M on January 1, 2000. At a +3.3% annual return, dividends included, the blue-chip portfolio only grew to $1.7M, barely outpacing inflation. For comparison, the blue line (Portfolio 1) illustrates the returns of a globally diversified stock portfolio that emphasizes higher returning smaller and more value-oriented stocks. Instead of holding 10 stocks it owns over 10,000. The differences are remarkable -- Portfolio 1 compounded at +8.8% per year and $1M grew to over $4.4M.
But maybe the blue-chip portfolio was saddled by a few bad stocks? Let's look at each company individually, listed in order of their relative size in 2000, each time comparing it to the more diversified portfolio (always "Portfolio 1").
Here's GE, which has actually lost -1.2% per year:
Exxon Mobil was the best performing stock of the bunch, at one point reaching the top spot in the market, and returning +6.3% per year since 2000. But even this was still 2.5% per year lower than the diversified stock portfolio:
Here's Pfizer, which returned +3.7% per year since 2000:
Citigroup, or what's left of it after a -7.8% annual loss:
Here's Cisco, which lost -1.8% per year:
Walmart is still doing well as a company, so this result surprised me -- it's only gained +2.5% per year since 2000:
Microsoft has had a nice run lately, and founder Bill Gates is the richest man in the world. But MSFT investors haven't gotten rich since 2000, the stock has only returned +3.7% per year:
I have to put AIG up here because it was the 8th largest stock in the market in 2000. It's worth a fraction of that today after a -15.0% annual loss since 2000:
Merk was the second pharmaceutical company to crack the top 10, but it had similar returns to Pfizer -- only +3.6% per year:
And finally, Intel, which gained only +1.3% per year:
All 10 individual stocks underperformed the more diversified portfolio, and it wasn't even close. What's more, none of the individual stocks were safer (when measured by volatility of returns) than the diversified portfolio that included riskier small-cap and value companies.
So yes, buying a handful of large-cap, blue-chip US stocks might seem simple, safe, and intuitive, it's just not likely to be very profitable.
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Past performance is not a guarantee of future results. Index and mutual fund performance