The process of initially entering financial markets is difficult that is a given – only a fool thinks it is easy although social media does a good job of convincing people that it is simple. The process is made all the more difficult because the industry is littered with stupid homilies that don’t work and professional participants who don’t take the time to think through how stupid their actual advice is. I should clarify when I mean stupid I mean lacks evidence and the people who push these ideas are too stupid to understand that they are lacking in evidence.
My current favorite is the notion that you just keep on buying the market – this is a variation of dollar cost averaging under a slightly new paint scheme. Usually, this idea is based on an infographic such as the one below.
Such an infographic pushes the idea that stocks always go up but it is flawed by the simple fact that it is an example of survivor bias. That is pick a series of stocks that back up your narrative and present them and being the default endpoint for all stocks. The implication from this is that you just keep buying companies that you are invested in and everything will be alright. However, there is a problem beyond the notion of survivor bias and that is the simple fact that most listed stocks go nowhere – this is a shocking fact for investors who believe that all stocks are moving all the time. Evidence has shown that in the US experience and experience should be no different here that only 2.4% of all stocks outperform treasury bills. This means that 97.6% of all listed shares provide very little value over and above investing in cash.
Bessembinder who has expanded his research found that –
- A concentrated number of stocks generated very large compounded returns.
- A staggering 90 companies accounted for almost half of all accumulated shareholder wealth since 1926.
- The top 4% of companies generated ALL shareholder wealth creation.
- Buy and hold profitability dropped dramatically over time thereby negating one of the key selling points of the strategy that it worked over long periods.
This research also apparently holds true for international markets as well. Bessembinder apparently expanded his work to include some 64,000 global companies over 30 years and the results held true for these markets as well.
- Five companies account for 10.3% of all shareholder wealth
- Some 159 companies accounted for 50% of shareholder wealth
- All of the shareholder wealth was generated by just 1,526 companies.
The implications for this for your traditional buy and hold investor are quite staggering – it suggests that if you are a passive investor then your chances of success are extremely poor. It also to some degree explains the poor performance of fund managers who default setting passivity.
If you are not active and by that I mean cutting your losses and letting your winners run then your chances of generating an outsized gain of any sort are extremely low and reduced to somewhat of a lottery. Lotteries are fine for those of an amateur disposition but if you actually want to be in charge of your fate then you require a much more active approach than simply clinging to the mantra of it will be alright if I just keep bying because at the end of the day, all you are doing is digging a deeper hole for yourself.