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Stocks are for Losers?

Written by Nickel - 8 Comments

What would you say if I told you that, on average, the majority of stocks lose money over time? Would you call me crazy? After all, we all know that the stock market has done nothing but increase over the long term. Right? Well…

According to an interesting piece in the latest Money Magazine by William J. Bernstein (author of The Four Pillars of Investing), it’s not that simple. In fact, looking at the past 30 years, “the top-performing 25% of stocks were responsible for all the gains in the broad market.” The remaining 75%, on the other hand, “collectively generated annual losses of around 2%.”

If stock market’s long-term gains have been produced by a relatively small proportion of stocks, why not just invest in these “superstocks” and ignore the rest? The problem here lies in accurately identifying the superstocks. Make a few mistakes and you’ll dramatically underperform the market.

As Bernstein puts it:

“Remember that the point of investing isn’t to aim for the highest possible returns. It’s to make sure you don’t die poor. Yet trying to optimize your performance by seeking out the needles in the haystack is a sure way of becoming, well, poor.”

The solution? Diversify your equity investments as broadly as you can. Perhaps the easiest way of doing this is to buy total market index funds that cover both domestic and foreign stocks.

Source: Money Magazine

Published on May 21st, 2009 - 8 Comments
Filed under: Saving & Investing

About the author: is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!

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8 Responses to “Stocks are for Losers?”

  1. 1
    J. Brumley Says:

    An interesting but not surprising stat. I’d like to know more about how and where we got his stats, though Bernstein is reputable enough that I won’t dispute it. On a semi-related note…

    Having been a ‘full-service’ broker as well as chief analyst at a trading newsletter (where we sold the advice via e-mail rather than dispensed it via the phone), I found something similar in both positions – the 80/20 rule applies here in the financial world too.

    Well, actually it was the 100/20 rule, where 100% of any given portfolio’s gain was attributed to just 20% of the trades in that portfolio.

    It didn’t matter if it was a short-term trading account, long-term investing, mutual funds, options… it was the same 100/20 (give or take) every time. And, we were better than average stock-pickers.

    The thing is, those portfolios were consistently profitable with a respectable alpha. Sometimes it was better than other times, but always positive over 6 month time frames or greater.

    My point is, just because most stocks end up worthless isn’t inherently a reason to avoid the market – that’s just the norm. As the data above said, the aggregate net gain was still positive even with all the attrition. So, in a modest sense, I find the idea slightly discouraging – though I don’t think Bernstein meant it to be.

    In the bigger picture, I think it’s a bit of a nudge for all of us to be a little better than average, and learn to cut bait sooner. I think alphas would sky-rocket with just a tad more discipline…which I think was Bernstein’s indirect message.

    Thanks for the link – an interesting discussion all investors should have with themselves.

  2. 2
    Corporate Barbarian Says:

    I like index funds, too. At least with index funds, you’re not missing out on any gains – you’re investing in the overall market. It’s impossible for me to find the needles in a haystack, so I just invest in the haystack.

  3. 3
    Manshu Says:

    How was that stat calculated? It doesn’t sound right to me. Did he take an index and used stock prices from thirty years ago and sometime in the last few months and then calculated their CAGR?

  4. 4
    Nickel Says:

    Manshu: It’s based on a study by Dimensional Fund Advisors. There are a few (but not too many) details in the original article, which is linked at the end of mine.

  5. 5
    Len Penzo Says:

    Something is wrong there…

    If the top-performing 25% of *all* stocks were responsible for 100% of the gains in the broad market, then it follows that 100% of the remaining 75% had to show losses.

    It seems extremely hard to believe not one of the bottom 75% showed a gain of any kind over the survey period.

    I’d buy a statement like “the top-performing 25% of stocks were responsible for *most* of the gains in the broad market,” but not “all” of the gains.

    Of course, the numbers can usually be manipulated to make pretty much any point you want just by handpicking the dates you buy and sell the stocks.

    As always, there’s lies, damn lies and statistics.

    Then again, maybe I should read the article for myself instead of shooting from the hip.

    Nah. It’s a holiday weekend and I am going to fire up the BBQ instead. lol

    My $0.02 (after taxes)

    Len

  6. 6
    J.Brumley Says:

    To Len Penzo – I agree….I’d like to see the math too, though I don’t doubt it.

    I suspect what’s being factored in here is the number of companies that never become ‘large caps’, or even ‘
    small caps’…. he’s counting the ones that start, tread water for a while, and then implode – the ones we don’t even hear about.

    MOST STOCKS NEVER MAKE IT PAST THE BULLETIN BOARD STATUS IF THEY START THERE (80% of BB stocks are delisted or fold, while 20% graduate). I don’t know of the stats for listed stocks, but I suspect it’s comparable. I’m guessing pink sheet stocks are even worse in terms of ‘graduation’.

    So from that point of view, there is an edge in sticking with stable, reasonably-sized companies that are beyond the ‘likely to fail’ stage.

  7. 7
    Andrew Weinberg Says:

    I think what is misleading is that the numbers apply to any given year, not the entire period. If it was for the entire period, you would just invest in the top 25% stocks and call it a day. The problem is that for every year those stocks that make up the top 25% are rotating and all but impossible to select in advance. By investing in the broad market, you are ensured to be picking up all of the 25% stocks and you don’t have to worry about picking a handful of stocks that are all part of the 75% group.

  8. 8
    Sean Says:

    Len, I don’t think that he meant to categorize the stock market into a permanent top 25% vs bottom 75%. You seem to think that some stock could be in the bottom 75% and somehow still be ahead. He meant that whenever the market is measured on a yearly basis you’ll see that it’s always only 25% that account for the overall gains. Those stocks in that 25% are not locked in by any stretch though.

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