It doesn’t take many stocks to converge toward market behavior
Random stocks can act very similar to the overall market
It’s hard to beat the market. One thing that makes it hard is that, even if you make your own portfolio of just a few stocks, they can quickly start acting like the overall market.
To measure this, I created portfolios with one to thirty randomly selected stocks from the S&P 500 that have available data going back to 2010. For each grouping of one to thirty holdings, I created 2,500 random portfolios. I then measured the correlation of every portfolio to the S&P 500 and took the average of all those correlations for each portfolio holding size:
With a portfolio of just a handful of stocks, you get behavior that quickly converges to that of the overall market. Even when you consider the portfolios out of the 2,500 simulations that are the most and least correlated, you still see the same behavior:
Essentially, if you want to do something totally different than what the overall market is doing, you can only hold a small number of stocks. Unfortunately, you then take on a significant amount of idiosyncratic risk (e.g. one heavily allocated holding has a significant drop or goes bankrupt).
The good news is, although portfolios of increasing holdings have high correlation with the overall market, you can still find outperformance. In a simple example, while Apple tends to go up or down when the market goes up or down and, therefore, has high market correlation, you definitely would’ve gotten more return holding Apple from 2010 to 2020 than holding the S&P 500. So, picking good stuff still matters, even if a collection of good stuff inevitably ends up correlated to the overall market trend.
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