Following the stocks and shares that have experienced impressive returns can seem like fun and a way to make the most out of your investments.
Yet, a study indicates that following the crowd and investing in companies that are being hyped in the press or among investors could mean you miss out on growth opportunities from other sources.
Top stocks rarely perform well for two consecutive years
Research carried out by Schroders looked at the top 10 performing stocks on the US stock market each year.
Interestingly, in 12 of the past 18 years, not a single stock that was in the top 10 also made it into the top 10 in the following year. Of the other six years, in five of them, only a single company managed to maintain its strong position.
Even staying in the top 100 is rare – an average of 15 companies each year managed to be in the top 100 for two consecutive years. The odds of making it back onto the list in a couple of years are similarly low.
You might be surprised to learn that companies that performed well are more likely to be among the worst-performing stocks a year later.
The research noted that a similar trend can be seen in other markets. In the UK, 11 out of 18 years saw the average top 10 performers move to the bottom half of the performance distribution the next year.
So, if you’ve been hearing about how well a particular stock has been performing, automatically investing in it might not be the right thing to do. It could expose you to more investment volatility than is appropriate for you.
There’s also a risk that companies that are hyped might be overvalued.
The Magnificent Seven is a group of influential technology companies – Apple, Microsoft, Nvidia, Alphabet, Amazon, Meta Platforms, and Tesla – on the US stock market that has made impressive gains over the last year. However, Schroders found collectively they are twice as expensive as the rest of the market in terms of a multiple of the next 12 months of earnings.
Some companies will deliver these expectations, but others won’t, and identifying which ones will meet targets can be difficult.
3 investing lessons you can learn from the volatility of the top stocks
1. Don’t fall for hype
It can be tempting to invest in a company that’s experienced impressive growth recently. But the Schroders study highlights how these companies can experience a fall just as much as others, and perhaps more severely.
Chasing the “hot” stocks could result in higher costs and lower returns than if you opted for investments that were consistently delivering average returns.
That’s not to say you should avoid investing in popular stocks. Indeed, many investment funds will hold investments in the Magnificent Seven. What’s important is assessing if it’s the right option for you and focusing on long-term gains, rather than short-term rises.
2. Accept the investment market can be volatile
As the research highlights, volatility is part of investing.
As an investor, accepting this can be difficult – you understandably don’t want to see the value of your investments fall. Yet, for most investors, sticking to their long-term plan, even when markets dip, makes financial sense if you take a long-term view.
Historically, markets have delivered growth when you look at performance over a longer time frame, including after sharp drops like those experienced during the pandemic in 2020.
While returns cannot be guaranteed and past performance is not a reliable indicator of future performance, history suggests holding investments and waiting out volatility may be the right course of action for you.
Volatility is why it’s often recommended that you invest with a minimum time frame of five years. This provides time for the ups and downs of the market to smooth out and, hopefully, deliver investment returns.
3. Ensure your investments are diversified
If you invested in just one company that was in the top 10 performing stocks, the research suggests the value could fall within the next year. However, if you spread your investment across multiple stocks, you could reduce the risk of this happening.
Diversifying your investments means investing in a range of assets, sectors, and geographical locations. When one area of your investments experiences a drop, a rise in another could offset this.
This is how investment funds work. A fund would pool your money with that of other investors and then invest in a wide range of assets in line with the fund’s risk profile. So, if you want to diversify your investments, a fund could be a good solution for you.
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If you have any questions about how to invest in a way that’s appropriate for your goals and circumstances, we’re here to help.
We can offer ongoing support to ensure your investments continue to reflect your needs.
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