Most Stocks Are Bad For Your Wealth
Most people will agree that stocks outperform cash over reasonably long periods. That is precisely why people invest their money. But in reality, more often than not, we tend to hear from both friends and family that they’ve lost money in the stock market. Why is this so?
Professor of finance at WP Carey School of Business at Arizona State University (Hendrik Bessembinder) shows us that most stocks actually destroy wealth. His research, first published in 2018, and updated in 2023, gives us the empirical evidence.
If you invested into global stocks (MSCI ACWI, gross div.) from 1990 to 2020, you would have had a cumulative return of +845.86%, or a 7.52% annualised return.
When you look into the data, Bessembinder’s research shows that 57.7% (36,818) of firms destroyed wealth. This means that long-term investing for most stocks did not work, investing for 30 years did not reap rewards. You were better off keeping your money in cash.
25,441 firms (39.9%) returned a modest return above the short-term cash rate such that 97.6% of the stocks in aggregate generated zero wealth.
This means that all the wealth creation was only from 2.39% (1,526) of firms.
The results also help to explain why active strategies, which tend to be poorly diversified, most often underperform.
— Hendrik Bessembinder
Another study found similar results when comparing individual stock returns to their local currency one-month bill returns over twenty years and found that the majority of individual stocks did worst than leaving the money in cash deposits in around 80% of individual markets.
The empirical evidence tells us that historically, the probabilities of picking a winning stocks is stacked against the investor as she is more likely to pick a wealth destroyer than a winner.
However, if you are undeterred by the massively unfavorable odds of stock picking, here are some insights into what you need to do to succeed.
What it takes to succeed as a stock picker
Bessembinder found that there are four factors that have statistical significance in explaining stock returns. One of it is “Larger drawdowns in the prior decade”.
Identifying the 2.39% of companies that will create wealth for you is not enough. Not only must you have superior information, you must also have nerves of steel.
These large drawdowns tend to occur multiple times in the very same stock. Apple is currently the largest company in the world by market capitalisation (as of 17 Jun 2024), however its journey to the top was no walk in the park.
May-Aug 1983, Apple shares declined -74%.
Feb 1992-Dec 1997, Apple shares declined -80%.
Aug-Sept 2000, Apple shares declined -76%.
Mar 2000-Mar 2003, Apple shares declined -79%.
Pick stocks at your own risk
The evidence is clear that a randomly selected stock in a randomly selected month is more likely to lose than make money. Unless you have information that supersedes all investors that you can capitalise on and possess nerves of steel, stock picking is likely a losing endeavour in building long term wealth.
We also show that even if professional managers are skilled in picking stocks, these benefits do not accrue to end investors.
There is a better way to invest.
Experience the difference today with an interest aligned wealth manager.
GYC applies the best ideas from financial science to develop a financial plan that is built upon a rigorously tested investment philosophy.