At Vickery Financial, we know that everyone wants a successful investment experience. Unfortunately, there are several obstacles in our way toward achieving that goal. Some of these obstacles are simply ‘frictions’ or costs that can be reduced but not entirely eliminated. These would include investment management fees, mutual fund expenses, trading costs and of course, taxes. Other obstacles can be thought of as ‘unforced errors’ – natural human behaviors and biases hard-wired in our brains that while useful for long-term survival as a species, often trip us up when it comes to markets and investing. Most of these behaviors stem from normal emotions such as greed and fear, and our desire to control the uncontrollable, but also from cognitive ‘short cuts’ that we make every day to preserve our precious mental energy.

Yet another obstacle in our path is the complex, unpredictable and sometimes frustrating actions of the financial markets themselves. No one ever said that successful investing is easy, and a fascinating new study released earlier this year by Arizona State professor Hendrick Bessembinder sheds some light on why it has been so difficult for investors to ‘beat the market’, even for professional money managers. Bessembinder studied the behavior of almost 26,000 stocks from 1926-2015 (nearly every publicly traded US company in that 90 year time frame) and discovered some salient features about the distribution of stock market returns:

  • Most stocks (58%) failed to outperform one-month Treasury bills over their lifetime.
  • More than half of all stocks actually lose money over time.
  • All of the gains in the stock market above Treasury bills over the last 90 years are fully accounted for by the top performing 4% (~1,000) of stocks in the database.
  • Half of that outperformance comes from just 86 stocks out of the 26,000!

So, while the stock market overall vastly outperformed the Treasury bill market, that performance was driven by an astonishingly small fraction of all publicly traded stocks outstanding. This study goes a long way toward explaining the underperformance of active managers vs. their benchmark indices – if managers failed to buy and hold the best-performing 4% of all stocks (at market weights), they very likely underperformed a passive index. In other words, each time an active manager picks a new stock to add to their portfolio, there is a 96% chance it will not be a significant driver of market-beating returns.

With so many ways to lose, a much better strategy is to win by not losing, which means owning a highly-diversified basket of nearly all global stocks (to make sure you own the top performing 4%!). Owning a small slice of thousands of world stocks may not be as exciting as trying to pick a few winners, but the evidence shows this is the best way to let the power of markets work for you and your financial goals.