Yep, I said it – most stocks stink. I can almost hear you saying, “what a huge hypocrite you are John.” Just the other day in debunking the myth of the 10% annual return in stocks, I suggested sticking with stocks for the long run, and now I’m here telling you most stocks stink?? #hypocrite (Actually the truth is most stocks do worse than stink but this is a family-friendly blog so we’ll keep it PG-rated.)
Admittedly, I do sound a bit like a Debbie Downer, or worse. But here’s the thing – two things can be true at the same time. For example, I don’t want to (ever) do the dishes AND they need to be done – two absolute truths. When it comes to investing, many stocks underperform AND playing the long game is still the secret to investment success. Both can be true. Bear with me and let me explain before chucking your virtual tomatoes my way!
We’ve been led to believe that stocks generally go up over time. However, the harsh truth is that they don’t. JP Morgan’s eye-opening research on the Russell 3000 index (which is a benchmark for the U.S. stock market) from 1980-2020 reveals some startling facts.
A Rocky Road for Stocks
During those 40 years, nearly half of the stocks (44%) in the Russell 3000 index incurred a “catastrophic loss,” plummeting by 70% from their peak, and never bounced back. Think about that – over 40% of companies over 4 decades lost more than 2/3 of their value that was never recovered!1
Why So Negative?
Even more shocking, 42% of stocks in the index actually experienced NEGATIVE returns from 1980-2020. In other words, stashing your cash under your mattress might have been a better bet than investing in 40% of the index. Let this sink in – two out of every five stocks in the index over 40 years lost money on average every year. My friend Alex Bates wrote a short and sweet piece on the uphill battle of recouping losses that’s worth checking out here.
The Forest Flourishes Amidst a Lot of Fallen Trees
Despite this doom and gloom, the Russell 3000 index still managed an average annual return of 12% from 1980-2020. So the excessive number of losing stocks cannot be attributed to a bad decade . . . or four. It’s hard to fathom that 40+% of stocks lost money during a period that saw above-average returns for the market as a whole!
Stock-Picking vs. Blackjack: Place Your Bets
Between 1980 and 2020, only one in three stocks beat the index. So if you’re trying to pick winners, you’re more likely to end up with duds. Meanwhile, blackjack players have a 42% chance of beating the house on a given hand. Hit me!
Diamonds in the Rough
A mere 10% of stocks were what we call “megawinners,” soaring 500% or more above the Russell 3000 index. These rare gems carried the market, despite the overwhelming number of underperformers.
The graphic below from Vanguard illustrates this oddity in a brilliant visual. The median stock in the Russell 3000 index had a cumulative return of just 7% over 40 years while the average cumulative return was 387%. How is the average so much higher than the median? The rising tide from a few rockstar stocks (at the bottom of the chart) lifted all the boats in the index.
If you’re as stunned by these facts as I was, welcome to the club. Here are three takeaways:
- Diversification is the Name of the Game. A small number of stocks do the heavy lifting. Trying to guess which ones will soar is like finding a needle in a haystack. The smarter move? Invest in the whole haystack.
- Beware of Single-Stock Bets. Holding a large chunk of one stock is risky business, no matter how much you love the stock or working for the company. Remember, two out of every three stocks underperformed the index. A good company doesn’t necessarily make a good stock. It’s not about the company, it’s about understanding the odds of success. See takeaway #1.
- The Perils of Picking Stocks: As the data shows, picking individual stocks is more of a gamble than it seems. If you’re gonna do it, keep it to a small slice of your portfolio…think of it as a “cheat day” indulgence. More on this strategy in a future post.
The NFL Draft is tonight. In a 2005 whitepaper, Nobel prize-winning economist Richard Thaler found the most successful NFL teams are NOT the ones with the top draft picks, but those with the most picks. His research concluded that to be successful, teams should trade down in the draft in exchange for more draft picks. The more darts you have, the better your chance of hitting the bullseye.
JP Morgan and Vanguard’s insights suggest investors should take a page from the NFL playbook. Remember, two things are true – most stocks stink AND (because that’s true) you should own a large basket of them to win the long game.
Castle Quote:“It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent. There must be some wisdom in the folk saying, ‘It’s the strong swimmers who drown.’” — Charlie Munger
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