In a recent Marketwatch article, columnist Philip Van Doorn pointed out the amazing triple-digit returns of the ten best Nasdaq (QQQ) stocks of the year. You can see them all in the following chart:

COMPANY TICKER CLOSING PRICE – Sept. 9 TOTAL RETURN YTD TOTAL RETURN – 3 YEARS TOTAL RETURN – 5 YEARS
BioFuel Energy Corp. BIOF $10.83 533% 95% -28%
SinoCoking Coal & Coke Chemical Industries Inc. SCOK $7.09 511% 79% -36%
InterMune Inc. ITMN $73.50 399% 182% 372%
Pacific Ethanol Inc. PEIX $22.86 349% 296% -59%
Cellular Biomedicine Group Inc. CBMG $22.27 337% 197% 960%
Intercept Pharmaceuticals Inc. ICPT $283.09 315% N/A N/A
RadNet Inc. RDNT $6.81 308% 148% 226%
Achillion Pharmaceuticals Inc. ACHN $12.38 273% 113% 731%
Identiv Inc. INVE $19.66 241% 13% -23%
Plug Power Inc. PLUG $5.27 240% 208% -26%
Total returns assume dividends are reinvested. Source: FactSet

Two things immediately stick out about this chart. Firstly, 4 of these stocks are biotech names (biotech has risen by about 20% for 2014, as can be seen with IBB). Three are alternative energy stocks, while only three remaining are in more established and less volatile sectors—although one of those (SCOK), is a Chinese coal company whose accounting may not be held to the same standard as American stocks. In other words, this selection of stocks is high-risk, volatile, and undiversified.

Even more distressing is the fact that there is a massive selection bias going on here. For instance, ICPT is up after shooting up like a rocket in early 2014 on news that one of its liver disease drugs had passed independent analysis. Other pharma stocks who haven’t been so lucky have not seen such massive gains, while others that have received FDA approvals (like MNKD) are up a much more modest amount for the year. Also, it’s important to remember that some of these stocks are actually down from their YTD highs. ICPT touched $497 in March, and is down 40% since then.

Charts like this get the gambler’s heart pumping because it shows a group of massive winners and dangles the thought of big gains in front of traders’ eyes. While those multiple-baggers exist in the market and can be purchased at a discount by savvy investors who do their due diligence—for instance, a biotech-focused fund with scientist analysts on staff could bet on ICPT before it popped in January. But that involves specialist analysis, meticulous research, and a broad view of the market.

In other words, capturing these multi-baggers involves hard work.

Other stocks on this list are in severe financial distress if they aren’t at least showing signs of financial uncertainty. PLUG has reported a loss for every quarter since its IPO, with TTM EPS of -1.05. Revenue growth is extremely uneven, with traders valuing the stock on orders instead of cash received. Stockholders are paying over 20x sales. In other words, the bet on this stock is highly speculative and forward-looking, depending much more on the supposed new paradigm that the stock heralds and not on any actual fundamental financial reasoning.

Investing in something like PLUG is more accurately described as a gamble that electric cars in China will explode in demand, and PLUG will be able to sustain its first-mover advantage as the market surges.

When we look at the performance of QQQ for 2014, a rather interesting story emerges that’s quite different from a focus on the high-risk stocks above. The index is up about 13% YTD, well above the S&P 500’s 8% performance or the Dow Jones’s 2.9%. It’s also a much better performer than small caps (IWM), which are roughly flat for 2014. QQQ has been driven forward by many strong tech performers, such as Apple (AAPL, up 24% YTD), Facebook (FB, up 42% YTD), and Gilead (GILD, up 42% YTD). These stocks have shown a much lower beta and much shallower corrections, particularly in March and April when the tech industry corrected severely, and when stocks like ICPT lost almost half of their peak value.

The lesson of this comparison is not to avoid multi-baggers and speculative bets, but rather to understand how survivorship bias can encourage the gambler’s instinct, which needs to be tempered by portfolio diversification. Confidence in biotech, technology, and emerging industries is good, and can encourage investors to place speculative bets on stocks before their run up. But such a bet needs to be done with a careful exit strategy and a clear model of exactly how much the stock is worth to the investor; otherwise bets on big winners like ICPT and PLUG can get away from investors who see enormous gains quickly erased as the market changes its mood. Likewise, a way to hedge against this risk while maintaining conviction in the sector is to diversify a portfolio with more value-driven names that are still in a strong growth mode, like FB and GILD. Investors who temper their gambler instinct with a more diversified and risk-adjusted portfolio will be able to capture multi-bagger gains while also maintaining a steady performance both in the short and long term.