Episode 107: The Myth of the Stock-Picker’s Market

Transcript

Hello and welcome to the Balanced Wealth podcast. My name is Jarrett Topel. Today I wanted to talk about an idea, or a phrase, I’ve been hearing mentioned a lot lately. And perhaps you have too.

Maybe on CNBC, or from your neighbor, or from that one insufferable friend who now thinks she’s a genius because she happened to buy Nvidia stock in 2020. And that phrase is, “This is a stock-picker’s market.” So today we’re going to talk about what that phrase actually means, why it sounds so convincing, and what the long-term evidence really shows.

When people say “stock-picker’s market,” what they’re really saying is this: Markets feel messy right now. Some stocks are doing great. Some are doing terribly. Surely this must be the moment in time when skilled stock picking professionals finally earn their keep. It sounds reasonable. It sounds sexy. It sounds exciting. After all, if everything isn’t just rising together, surely someone smart can zig while everyone else zags, avoid the losers, pick the winners, and justify those high fees.

It is a great story. Now, before we get to the evidence, let’s acknowledge something important. We want this to be true. The idea that there are experts who can consistently outsmart the market is comforting. It suggests control, skill, and mastery.

It also supports an entire industry. If the message were instead “markets are unpredictable and low costs matter more than brilliance,” that wouldn’t make for very exciting commercials. No one wants to hear, “Good news, we’re average, but we’re cheap.”

Now, let’s move from the marketing department to the statistics department. Researchers have studied decades of performance comparing actively managed funds to simple, low-cost index funds. S&P Dow Jones Indices publishes something called the SPIVA Scorecard, which has tracked active manager performance for more than twenty years. And what they consistently find is that roughly 85% to 90% of actively managed U.S. large-cap funds fail to beat their benchmark over long periods once fees are accounted for.

Not just one lucky year. Not just one star manager. They’ve studied this across time, across categories, and most importantly, after fees. And what they consistently find is that over long periods of time, most active managers simply don’t beat their passive benchmarks.

Now, this is where people often push back. They say, “Sure, indexing works when markets are calm. But now things are volatile. Now the dispersion of returns between different stocks and funds is high. Now skill matters.” That theory has been tested too.

Research from firms like AQR Capital Management and follow-up SPIVA studies show that even during periods when the gap between winning and losing stocks widens, active managers as a group still fail to outperform consistently.

Just because stocks move differently does not mean managers suddenly develop superpowers. In fact, volatile markets often make things even worse. When markets become chaotic, active managers tend to trade more. Costs rise. Mistakes compound. And timing becomes even harder and more dangerous.

Decades of behavioral finance research by Professor Brad Barber of the University of California, Davis and Professor Terrance Odean of the University of California, Berkeley show that investors who trade more frequently tend to earn meaningfully lower returns, largely because overconfidence and mistimed decisions increase during uncertain markets.

Chaos does not automatically equal opportunity. Sometimes chaos is just chaos.

And here is another uncomfortable truth. Even the active managers who outperform their benchmarks for a while rarely keep doing so in the long run.

Morningstar and SPIVA persistence studies show that fewer than one quarter of top-performing funds remain top performers just five years later, results that are not much better than random chance.

A fund or manager that beats the market in one period is not meaningfully more likely to beat it again in the next. So when you see headlines like “Top-Performing Funds of Last Year,” you are often looking at a list of funds that may have already used up their luck.

So, does this mean all active investing is bad? No. Some active managers do add value, especially in smaller, less efficient, or less heavily traded niches of the market. However, for most long-term investors saving for retirement, education, or financial independence, using larger and more traditional asset classes, the odds strongly favor low-cost, broadly diversified indexing.

So, why does the phrase “Stock Picker’s Market” refuse to go away? Three reasons:

It makes us feel smart.

Hope sells better than humility.

It gives us a sense of control at precisely the moment markets feel uncontrollable.

It is easier to believe we just have not hired the right expert yet than to accept that markets are messy and often humbling.

So here is the bottom line. When you hear “this is a stock-picker’s market,” translate it in your head to: “Markets are uncertain, and certainty is being marketed.” Long-term success still most often comes from discipline, diversification, low costs, and sticking to a plan when emotions are screaming at you to do something dramatic and different.

Because, in reality, the real danger is not the phrase “stock-picker’s market.” The real danger is believing that the normal rules of investing no longer apply. That somehow the basic principles of discipline, diversification, and humility have stopped working.

As legendary investor Sir John Templeton warned decades ago, the four most dangerous words in investing are: “This time is different.”