I guarantee you I could pick 10 stocks that would outperform the market, each year, for the next 10 years. How?
The Dow Jones Industrial Average, or the S&P 500, or Nasdaq, are stock indexes. A stock index is a broad collection of stocks. The S&P is literally just a group of 500 stocks. So, when someone talks about “the market”, they are usually referring to one of these indexes. If “the market” goes up 5%, what they really mean is the S&P, that group of stocks, went up 5% on average.
So, since the index is an average, if you randomly picked half the stocks out of that basket, you’d have a 50% chance of beating “the market”.
Now, say there are 1000 financial advisers in the world. In any given year, 500 of them, simply by sheer luck, should beat the market. Fine. But how about these guys that beat the market for five or ten years in a row? Well, out of those 500 who beat the market the first year, 250 of those will also beat the market in year two. 125 will beat the market in year three. 62 will beat the market in year 4. 31 will beat the market for five years in a row, simply by chance. This means that simply by dumb luck, 3% of all fund managers should beat the market for 5 years in a row.
But, this statistics game is a powerful selling tool. Lets pretend you’re a fund manager or a pundit looking to sell your stock picking advice. You decide to send out 100,000 emails touting your next big stock purchase. You’re smart though, so you’re not putting all of your eggs in one basket. You write one email to 10,000 people touting Stock 1. You write another email to the 10,000 people touting Stock 2, and so on. Even if only one of your picks is right, you’ve now demonstrated to 10,000 people how good you are.
Now, you send a follow-up email, telling those 10,000 people how good you are, and asking them to jump on board. You say you understand if they’re skeptical, so you offer another stock pick. Again, you divide up your emails in the same way as above, touting a different pick to each group. Even if only one of your picks does well, you’ve now got 1000 or 2000 people who have seen you pick 2 stocks in a row for them. You could do this a few more times and still have hundreds of people who now swear you’re the next Warren Buffet. All the while, you haven’t done anything but guess and play the numbers game.
So, ya, I could pick 10 stocks that would outperform the market, each year, for the next 10 years. I’d just have to start with a big enough audience.
