You're going to mess up throughout your investing career; there's no way around it. Famous investor Peter Lynch once said that you're doing well if you can get six out of 10 stock picks right.
In other words, success means slightly outpacing a coin flip! The reality of investing is that it's really hard. Sometimes you make a mistake, and sometimes an investment fails for reasons you couldn't possibly see coming.
So why would anyone invest in individual stocks if the odds are so much against you, and how do you succeed in the market? Roll up your sleeves because you'll never "unsee" what I'm about to walk through with you.
Your winners matter more than your losers
Six out of 10 stocks -- how can you be successful getting nearly as much wrong as you get right? People have a big misconception that the losers and winners have the same impact on their investment returns.
Suppose you buy a stock and the company goes bankrupt. The most you can lose is the money you originally invested, a 100% loss. But a stock can appreciate way beyond 100%, meaning a single winner can make up for multiple losers.
Imagine you buy and hold 10 stocks for a decade. Of those, nine out of 10 stocks go to zero. However, your 10th stock goes up 1,000% over that time. Having 90% of your stock picks go to zero would be disastrous, yet you would still make money by the end of the decade because that one winner overcame all of the losers.
The odds of picking the "big one"
Keeping this in mind, an investor's goal may be to find these winners, but how common are these exceptional stocks? Vanguard studied all stocks that were part of the Russell 3000 Index from 1987 to 2017. Roughly 47% of all stocks, nearly half, were "losers," generating negative total returns over their lifetime. In fact, the total return of the median stock was just 7%!
Meanwhile, about 7% of the stocks generated 1,000% or more in total returns. In other words, the index was a wasteland of bad stocks, with a small group of exceptional stocks generating most of the returns for the stock market index.
More swings at the plate create more hits
I've seen many investors speak of diversifying their investments as a defensive strategy, with the idea that great investment returns come from concentrating a portfolio around a select few of the investor's best ideas. But mathematically, the odds of mediocre performance could increase because they're taking fewer "bites of the apple" to find those genuinely life-changing investments.
No matter how smart you are or how much research you do, investing will always have a little bit of luck involved. Too many things can go wrong -- deceitful management, fraud, emerging competition, recessions, etc. Many of these are virtually impossible to predict.
But rather than a defensive tool, a diversified portfolio helps you achieve more upside. It increases the amount of "swings at the plate," giving you better odds of hitting a home run. Remember, it only takes a few big winners to build a lifetime of wealth.