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The age-old debate between passive investing and active management has long focused on whether individual investors can outperform the market, particularly benchmarks like the S&P 500.
However, with the right strategy and a disciplined approach, managing your own portfolio of about 20 carefully selected stocks can potentially outperform not just the S&P 500 but also the returns offered by managed funds.
The recent data suggests a compelling case for DIY (Do-It-Yourself) investing over relying on Independent Financial Advisers (IFAs) who typically spread investments across multiple funds with hundreds of stocks.
The Current Landscape: A Surge in Outperforming Stocks
The chart indicates a significant increase in the number of S&P 500 stocks outperforming the index in recent quarters, reaching a peak of 296 in the third quarter of 2024. This surge highlights that an increasing number of stocks are capable of delivering superior returns compared to the broader index, suggesting fertile ground for astute stock-picking. This environment favours a DIY investor who is willing to invest time in research and portfolio management.
Why a Smaller, Focused Portfolio Outperforms
1. Concentration of Capital: By managing your own portfolio of around 20 stocks, you can concentrate your capital into your best ideas. This concentration allows you to benefit more significantly from the appreciation of those stocks. In contrast, when funds hold hundreds of stocks, the impact of any single stock's performance is diluted, making it difficult for the overall fund to outperform the index significantly.
2. Personalised Strategy: DIY investors have the flexibility to craft a personalized investment strategy that aligns with their specific risk tolerance, investment horizon, and market outlook. This could include focusing on sectors or themes that are poised for growth or avoiding areas with expected underperformance. Managed funds, on the other hand, often follow broader mandates, limiting their flexibility to capitalize on specific opportunities.
3. Lower Costs: DIY investing typically incurs lower fees compared to the management fees and other costs associated with mutual funds or ETFs. Over time, these cost savings can significantly boost net returns. Additionally, funds managed by IFAs often involve multiple layers of fees – both from the IFA and the fund itself – which can erode returns.
4. Active Management Risks: While IFAs might claim to provide value through diversification across multiple funds, this often leads to over-diversification, reducing the chances of achieving alpha. When funds are spread across 100 stocks in 4-5 different funds, the performance of the best stocks can be easily offset by underperformers, leading to mediocre returns.
The Advantage of Stock-Picking in a High-Performing Market
The current market environment, as highlighted in the chart, shows a high proportion of stocks outperforming the S&P 500 index. This suggests that with careful selection, a DIY investor has a reasonable chance to pick stocks that can beat the index. In contrast, fund managers are often bound by the need to adhere to specific benchmarks and diversification rules, which can prevent them from capitalising on the best opportunities.
Moreover, the data implies that the trend of outperformance among a larger number of stocks is gaining momentum. This can be a boon for individual investors who are selective and strategic in their stock choices, enabling them to outperform broader funds that are spread too thin across the market.
Conclusion: DIY Investing Empowers Better Returns
The evidence suggests that, especially in a market where a significant number of stocks are outperforming, a well-managed, concentrated portfolio of 20 stocks can deliver better returns than a diversified fund strategy managed by an IFA. The benefits of lower costs, personalised strategy, and the ability to concentrate on high-conviction ideas make DIY investing a compelling approach for those looking to beat the S&P 500.
The key to success in DIY investing lies in disciplined research, understanding market trends, and being willing to take calculated risks. In the current market environment, where nearly 300 S&P 500 stocks are outperforming the index, there is ample opportunity for individual investors to pick winners and achieve superior returns compared to the often diluted performance of managed funds.
Investing is an art as much as it is a science, and with the right tools and mindset, DIY investors can indeed outpace the market and the professionals.
Alpesh Patel OBE
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Disclaimer: The content provided on this blog is for informational purposes only and does not constitute financial advice. The opinions expressed here are the author's own and do not reflect the views of any associated companies. Investing in financial markets involves risk, including the potential loss of your invested capital. Past performance is not indicative of future results.
You should not invest money that you cannot afford to lose. Mentions of specific securities, investment strategies, or financial products do not constitute an endorsement or recommendation. The author may hold positions in the securities discussed, but these should not be viewed as personalised investment advice.
Readers are encouraged to conduct their own research and seek professional advice before acting on any information provided in this blog. The author is not responsible for any investment decisions made based on the content of this blog.