In a recent article that highlighted the perils of owning individual stocks, I offered the historical evidence demonstrating how only a small percentage of stocks have accounted for all the gains provided by the market—with the vast majority earning a big, fat zero in aggregate cumulative returns, even before considering the impact of inflation or taxes.
The article included a study by Longboard Asset Management called “The Capitalism Distribution,” which covered the period 1983 through 2006. Longboard recently updated the study, so I thought I would share its findings, which serve to reinforce the risky nature of owning individual stocks.
The new study covers the period 1989 through 2015 and a total of 14,500 stocks. Over this period, the S&P 500 Index returned 10.0% and provided a cumulative return of 1,324%. The broader Russell 3000 Index produced almost identical results. It returned 10.1% per year and provided a cumulative return of 1,341%.
The following are some of the study’s important findings—findings that demonstrate just how risky investing in individual stocks, and a failure to diversify, really is:
- 1,120 stocks (7.7% of all active stocks) outperformed the S&P 500 Index by at least 500% during their lifetimes.
- 976 stocks (6.8% of all active stocks) lagged the S&P 500 by at least 500%, and 3,431 stocks (23.7% of all active stocks) dramatically underperformed the S&P 500 by 200% or more.
- 3,683 stocks (25% of all active stocks) lost at least 75%, even before considering the negative effects of inflation (which cumulatively was 96.3%).
- 6,398 stocks (44% of all active stocks) lost money, even before considering inflation.
- Almost two-thirds of all stocks (about 9,500 of them) provided no real return, even before considering the impact of taxes.
- The 80/20 rule works well in stocks. The best-performing 2,942 stocks (just more than 20% of the total) accounted for all the gains; the worst-performing 11,513 stocks (almost 80% of the total) provided an aggregate total return of 0%.
Despite these miserable odds—with only 20% of stocks providing 100% of the returns—investors who broadly diversified through passively managed index funds earned roughly 10% per year (less low costs) and a total return of more than 1,300%. That occurred because most indices are market capitalization weighted.
Successful companies with rising stock prices carry larger weightings in the index. Likewise, unsuccessful companies with declining stock prices receive smaller weightings. Companies showing continued declines are eventually delisted to make way for growing companies.
So, despite the fact that the average (mean) annualized return for all stocks on the S&P 500 Index is negative, the index can still deliver an overall positive rate of return.