Don’t let this investment bias lead you astray

And yet, because of recency bias, this is how many individuals invest. Disciplined investors do the opposite: they rebalance to maintain a well-thought-out allocation to risky assets.

With their spectacular recent performance, I thought it a good idea to review the historical performance of the 10 largest stocks. Before we do that, let’s take a quick look at how the composition of the top 10 stocks changes over time.

The largest US stocks by market capitalization are:

At the start of 2024, the top 10 US stocks were Apple (AAPL), Microsoft (MSFT), Alphabet (GOOGL), Amazon.com (AMZN), Nvidia (NVDA), Meta Platforms (META), Tesla (TSLA) , Berkshire Hathaway ( BRK.B ), Eli Lilly ( LLY ) and Visa ( V ). There has been a large turnover (40%) since the start of 2023, with Nvidia, Meta, Tesla and Eli Lilly joining the list, while UnitedHealth ( UNH ), Johnson & Johnson ( JNJ ), Exxon Mobil ( XOM ) and JPMorgan Chase (JPM) left. Such rotation is quite common.

For example, 10 years earlier in early 2014, only Apple, Microsoft and Berkshire Hathaway were in the top 10. If we go back 30 years to early 1994, none of the top 10 in 2024 made it. to stay there the whole time. The top 10 then were Exxon Mobil, Coca-Cola (KO), Walmart (WMT), Raytheon (RTN), Merck (MRK), Procter & Gamble (PG), GE (GE), PepsiCo (PEP), IBM (IBM). ), and Johnson & Johnson.

With an emphasis on recency bias, our analysis of the performance of the largest stocks will examine returns over the three, five and 10-year periods before and after the stock joined the top 10 list. The data covers the period 1926-2023 and includes stocks from the CRSP database.

The Highflyers return to Earth

In the 10 years before it became one of the 10 largest US stocks, it returned 11.8% per year. In the five years before doing so, they returned 20% annually. And in the three years before doing so, they returned a spectacular 27.2% annually. The combination of recency bias and fear of missing out, or FOMO, may cause investors to overweight these companies. What investors subject to these biases probably fail to understand is that spectacular performance is often fueled not just by earnings growth, but also—and often largely—by multiple expansion. Multiple expansion lowers the cost of capital for companies, which lowers the expected return for investors. So how did these high flyers perform in the periods after they became a top-10 stock?

In the three years since entering the list of the 10 largest companies by market capitalization, these stocks have returned only 0.5% per year. In the five years after doing so, they did even worse – losing 0.9% a year. And in the 10 years after doing so, they performed even worse, losing 1.5% a year. In other words, after their spectacular performance allowed them to become one of the 10 largest stocks, over the following three-, five-, and 10-year periods, these former highflyers underperformed one-month Treasuries overall without risk.

Recommendations for investors

Because investors can only buy tomorrow’s returns, not yesterday’s, one of the keys to successful investing is avoiding recency bias and FOMO, which can cause investors to abandon even well-thought-out plans.

Larry Swedroe is head of financial and economic research for Buckingham Wealth Partners and is a Morningstar contributor. He is the author or co-author of 18 books on investing, including his most recent, Enrich Your Future: The Keys to Successful Investing.