There are a lot of bad things you can do in the stock market. Freaking out during a selloff. Getting too greedy during a rally. Buying a penny stock without limit orders. Forgetting to set a stop-loss on a volatile stock.
All bad things.
But the single worst mistake you can make in markets is betting that things will stay the same.
I know. That probably goes against everything your Finance 101 class taught you, right?
Traditional thinking in the markets is that, in order to avoid risk, you buy large-cap companies with stable businesses, tons of cash, boatloads of earnings, a low-volatility stock, and preferably, a fat dividend — because those businesses are going to keep growing no matter what, and will always keep your hard-earned money safe.
Invest in the incumbents, so they say.
A Different Approach to the Stock Market
But the reality is that investing in the incumbents is an awful investment strategy.
Just look at a list of the biggest companies in the world back in 2001 and compare it to a list of the biggest companies in the world today. There aren’t too many similarities.
The 2001 list includes General Electric (NYSE:GE), Cisco (NASDAQ:CSCO), Exxon (NYSE:XOM), and Pfizer (NYSE:PFE) at the top. None of those companies crack the top 10 today. In fact, of the 10 largest companies in the world back in 2001, only one of them (Microsoft) remains in the top 10 today.
I’m not cherry picking examples here.
Let’s say you made a portfolio of the 10 largest stocks by market cap every single year. That is, your 2001 portfolio would be the 10 stocks listed on the left above. Your 2002 portfolio would be the 10 biggest stocks by market cap in 2002. Your 2003 portfolio would be the same for 2003. So on and so forth all the way to 2009.
Guess what? Each one of those portfolios would’ve dramatically underperformed over the past 20 years.
Had you invested an equal amount into each of the 10 largest companies in the market in 2001, you would’ve been up 122% by the end of 2020 — a nice return, until you consider that the S&P index rose 228% over that same time frame, meaning you would’ve made 106% more had you just bought the whole market!
Same with the 2003, 2004, 2005, 2006, 2007, 2008, and 2009 portfolios. Had you bought the 10 largest stocks in the market in any one of those years, you would’ve underperformed the S&P 500 every single time into 2020.
And the difference is not negligible.
The average return of these large-cap portfolios into the end of 2020? About 96%.
The average return for the S&P 500? 240%.
In other words, by buying the biggest stocks in the market, you’d be underwater relative to just buying the entire market by a jaw-dropping 144%.
Get the point?
To succeed in the stock market, you have to forget your Finance 101 class. You have to forget what’s big today. Capitalism is defined by creative destruction. Nothing lasts forever in an economy where we are all incentivized to always go bigger, do better, and be stronger.
And that, in simple terms, is the game folks. Betting on today’s giants is a losing bet. Betting that they’ll get replaced… now that’s the winning bet.
Finding Tomorrow’s Winners
This is the winning bet we make in Innovation Investor, our flagship investment research advisory that is hyperfocused on investing in the technology startups that are destined to be tomorrow’s giants — not today’s giants.
We forget the present. We focus on the future.
Listen, good money can be made by investing in the present. But the big money — the type of gains that made folks “Teslanaires” and crypto millionaires — can only be made by investing in the future.
So, if that’s what you want to do in the stock market, then consider joining us by clicking here.
On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article.