Tech Stocks Are the Highest Performers – Should You Get In? | Erik Averill, Brandon Averill | AWM Insights #22
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Episode Notes
Most economic news continues to point to things not looking great – including a 2nd quarter contraction of US GDP by an annual rate of 32.9%. However, the stock market still seems to have some positive moves. What’s behind the majority of the returns in the public stock market? Tech companies like Apple, Microsoft, and Google. In fact, the disparity in the S&P 500 is from the 5 largest companies, which have accounted for all the growth, but the remaining 495 have been producing negative returns.
Does that mean now is the time to invest in these companies? In this episode, Brandon & Erik discuss this and more including:
What is contributing to the majority of returns in the US stock market?
If the 5 biggest companies are driving all growth in the S&P 500, why even consider investing in the other 495 companies – let alone international options?
What are the risks of investing in individual equities if I’m trying to grow wealth in a long-term, risk-adjusted way?
Is there ever a situation where you might recommend taking concentrated risk?
Where would an investor have the best change of growing wealth through concentrated investments?
+ Read the Transcript
Erik Averill (00:00):
Hey everyone. Welcome back to another episode of AWM Insights, where we cover all things investing. Brandon, want to jump straight into the conversation today around the concentration of risk. We have seen markets continue to surprise investors with the positive returns, in the midst of just continued negative information right around COVID, globally of what's going on. Congress doesn't really seem to be able to get on the same page about a potential stimulus package. And we actually got information last Thursday that the US economy contracted 32.9% in the second quarter.
Erik Averill (00:40):
So it's just this crazy time where all of the economic news got points to things are not great. Markets continue to stabilize and increase. And it's really being led by only a few specific companies. Can you shed light on what is really contributing to the majority of the returns in the public stock market?
Brandon Averill (01:03):
Yeah, Eric, I think it's, again, back to the tales of the haves and the have nots, unfortunately. What we've seen is quite a disparity on what's causing the S&P 500, so the largest 500 companies in the US, to have a positive return this year. And what we're seeing, there was a recent study by FactSet and then Goldman Sachs, and it showed that the five largest companies have actually accounted for all the growth in the index this year, while the remaining 495 companies have actually produced negative returns.
Brandon Averill (01:35):
So as we look at this, it's pretty fascinating. You certainly just can't take the high level information. You have to peel back the onion a little bit to see what's really contributing to those returns. And it looks like it's down to five large companies that are producing it.
Erik Averill (01:50):
So, leading the witness with the question here, why not just invest in those five companies and why even not only worry about the other 495 in the United States large growth sector, but international? Like why would I even think about investing anywhere except for these five FAANG stocks?
Brandon Averill (02:10):
Yeah, it's a great question, Eric. And obviously I set you up for that easy layup there. You know, really, it all comes down to predicting the future. If you believe you've got some special power, some crystal ball, and you could have picked the timeframe, which companies over which period that you could have isolated these, then all the power to you. I think any rational person that looks at the evidence and the data knows that that's not possible. You could get lucky maybe once or twice, but to consistently call that prediction, I think is kind of foolhardy. And we've seen that time and time again with the studies.
Brandon Averill (02:48):
So, I think the interesting part here is what if you were guessing on some other stocks and you were predicting some other stocks to produce those returns, what happens? I mean, you would be significantly impacted to the downside. So yes, while if you got lucky and hit those five stocks for home runs, over a long period of time, it doesn't produce a very consistent or positive investment experience.
Erik Averill (03:14):
I think one thing you hit on there that just is a good reminder, it also matters what timeframe you're looking at. So sure enough, 2020, these FAANG stocks have been on a blitzkrieg, right? And we would all have loved to have been on that rocket ship of a ride. But I think we're not even a year removed where we saw Facebook drop close to 30% within weeks because of Congressional hearing. And so can you talk a little bit about just not even using a specific case study, but why not individual equities if we're trying to really grow longterm wealth in a risk adjusted way?
Brandon Averill (03:56):
Yeah, Eric. I mean, I think, even singling out individual companies is difficult because you can still create a diversified approach. However, just kind of isolating those individual companies, there are so many risks at play, right? So I think a great example of this is what's going on right now in the private markets, you've got President Trump trying to shut down TikTok. Three weeks ago, four weeks ago, I think if we would have asked any investor if they'd like to be in the parent company ByteDance that owns TikTok, they would have said yes. But very quickly, they're potentially looking at all their gains being eroded because of some regulatory risk.
Brandon Averill (04:31):
To the same effect, we're seeing all these tech companies, like you had mentioned, are testifying in front of Congress right now, being questioned. There's a lot of regulatory risk here that maybe people don't realize. So I think just when you look at it, having that diversified approach is really kind of bringing you back to having the most consistent, positive investment experience over time. So I think that concentration risk for most people is just far, far too great when you're trying to realize growth in your portfolio that's going to support you later in life.
Erik Averill (05:05):
One of the things I think is important to talk about, like you said, is we're really suggesting the importance of a globally diversified portfolio for your public portfolio, and what we would call kind of your core capital. This is really, if your goal is to grow your wealth longterm, and one of the most consistent ways based off of historical evidence. Can you talk about when concentration does make sense? If you're going to concentrate, should we be doing it in the public markets, in the private markets? I mean, where does concentration make sense for an investor?
Brandon Averill (05:42):
Yeah. So our opinion on this is concentration makes sense when you've achieved core capital, when you've achieved a certain set of money that gives you that safety moat to support your current lifestyle and the lifestyle that you desire for your family and potentially for generations ahead, depending on your goals. But once you achieve that number, then certainly if you want to take some concentration risk, then looking to the private markets is where we believe you can actually add value. We know that information is efficient in the public markets. To gain an edge is probably not possible, certainly for most people. So really turning to the private markets is where you can grow your wealth exponentially.
Brandon Averill (06:27):
Now, I will say it comes with certainly a ton of risk. That you're accepting the fact that you're concentrating your investment in one company or a handful of companies, and those very well could go out of business and you would lose all your capital in that case. But you're also looking at potentially excess return. So looking at, hey, if I put a dollar at risk, is the upside 10X or a 100X, maybe even. But, you got to be willing to accept the downside there that potentially could go to zero. So it's a different game, but in our opinion, if you're going to go for that game, that's where you should be applying.
Erik Averill (07:04):
Brandon, that's super helpful. And I think just reminding our audience, right, and everybody listening first, thank you for tuning in once again. But really the goal of this podcast is to help you capture the returns that you deserve and use it in what is the evidence-based research out there. And so it's not necessarily we're sitting there saying that concentration never makes sense. It's just more of, are you sitting down with your certified private wealth advisor? Do you have a customized plan that really understands what is your goal? What are you trying to accomplish within a specific set of time and resources?
Erik Averill (07:40):
And so, so much of when we're talking about the downside of this concentrated risk, it's in that publicly traded portfolio. And so as Brandon had mentioned, it's not just the risk of one specific stock, but we see the same thing happen if you tried to concentrate in a specific sector or a specific country. A lot of times we see home bias of if you live in the United States, you only hold companies in the United States. And just the research that we love to bring up is this isn't our opinion, this is so much backed by what we've seen, is that it shows there is no reliable way to predict the top performers, that we know that broad diversification is the only way that can really reduce the unnecessary risk that you can diversify.
Erik Averill (08:27):
Brandon always talks about diversification is the only free lunch in investing. And just to put some meat on that conversation is, the compound average annual returns, if you are globally diversified, from 1994 to 2018 was 7.2%. So, fantastic returns. The curious thing is if you exclude only the top 10% of performers, those returns dropped down to 2.9%. And then if you happen to accidentally exclude the top 25%, the return actually goes from a positive 7.2 to a negative 5.1%.
Erik Averill (09:06):
And so realistically, what we're saying here is you have so much more risk of destroying your ability to grow your wealth by accidentally missing out on the companies that are going to perform best next year or the year after. And we know there's no reliable way to predict those. And so we appreciate your guys's attention. Hopefully this has been helpful for you. Of course, you can find all of the show notes over at awminsights.com. We'd love to hear from you as well on anything you'd like for us to cover in the future. And until then, stay humble, stay hungry, and always be a pro.
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