How a few high-impact successes drive up overall average outcomes in investing, business, and creative projects. How to harness positive skewness using a barbell approach. Learn when to mitigate risks and when to embrace them.
Topics covered include:
- What is positive skewness and how does it manifest in investing, business and creative endeavors
- How power laws and the 80/20 rule work
- Why we shouldn’t beat ourselves up if we aren’t incredibly successful
- When should we reduce positive skewness and when should we embrace it
Show Notes
Long-Horizon Stock Returns Are Positively Skewed by Adam Farago and Erik Hjalmarsson—SSRN
Wealth Creation in the U.S. Public Stock Markets 1926 to 2019 by Hendrik Bessembinder—SSRN
The Coffee Can portfolio by Robert G. Kirby—csinvesting
Active vs Passive Investing U.S. Barometer Report—Morningstar
Table 7. Survival of private sector establishments by opening year—U.S. Bureau of Labor Statistics
How Many Podcasts Are There? (New 2024 Data) by Josh Howarth—Exploding Topics
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Transcript
Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today is episode 482. It’s titled “Unlocking the Power of Positive Skewness. Strategies for Investing Business and Creativity.”
Most Stocks Underperform
I recently came upon several really fascinating studies on the long-term performance of the stock market. The first study was by Hendrik Bessembinder and his co-authors, and the second study was just by Hendrik Bessembinder, who is a professor of finance at Arizona State University.
In the first study, they looked at the long-term returns of 64,000 global common stocks, going from January 1990 to December 2020. They’ve found that 55% of US stocks and 57% of non-US stocks underperformed one-month US Treasury bills. In other words, their compound return of the majority of stocks didn’t even beat cash.
Further, they’ve found that in the US only 2.4% of the firms contributed to the $76 trillion dollars of global stock market wealth creation. Outside of the US, 1.4% of the firms contributed to the $30 trillion in net wealth creation. Only a tiny percent of the stocks generated the vast majority of the wealth. It’s even more narrow than that. Five firms, 0.008% of the total, accounted for 10% of global net wealth creation. That was Apple, Microsoft, Amazon, Alphabet, and Tencent. 159 firms. 0.25% of the total accounted for half the global net wealth creation. Now, that’s the first study.
The second study went for a longer time period. It was just focused on US public stocks from 1926 to 2019. Bessembinder looked at 26,000 firms and found that only 42% of the firms created positive wealth for their shareholders, while 58% of the firms actually reduced shareholder wealth. And that’s relative to Treasury bills. Think about that. If we could identify those few stocks that dramatically outperform, we’d be very, very wealthy.
Positive Skewness Defined
What Bessembinder and his co-authors found for the stock market—and it’s a concept that we have discussed in a number of episodes—is the global stock market and individual stocks demonstrate what is known as positive skewness. When something is positively skewed, the average outcome, the average return for the stock market will be higher than the middle return, because of the extreme outcomes. Those few stocks that did incredibly well hold up the average return for the stock market, while the vast majority actually didn’t even contribute to positive wealth.
In their study, they’ve found that the mode—the mode being the most frequent return shown for the stocks over those time periods—was a complete loss of capital. Negative 100%. What that means is, according to the authors, is the most common outcome for individual stocks over a long period of time is to lose all your money. But they also point out that there were other examples where the stock gained over 1,000%. So while many stocks fail, there’s also the potential for exceptional gains if we can identify the few stocks.
Now, the authors warn that their studies don’t contradict the fact that broad exposure to the stock market, such as through an ETF or an index fund, does outperform Treasury bills by a significant amount. They write the mean or the average buy and hold return across stocks in their sample greatly exceeds the US Treasury bill return, at each horizon we study. So different time horizons, they’ve found overall the stock market outperformed Treasury bills, but the returns were driven by a small percentage of the stocks, with the vast majority underperforming, and many completely losing all the money.
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