Investing in stocks has long been seen as one of the best ways to grow wealth over time. But how often do individual stocks really beat ‘safer’, low-risk alternatives like UK government Gilts or US Treasury bills?
Many investors enter the market assuming that if they hold a well-researched stock long enough, it’s bound to outperform these “safe havens.” However, the findings from Hendrik Bessembinder’s ground-breaking research, “Do Stocks Outperform Treasury Bills?” offer a stark reality check.
Let’s explore Bessembinder’s study and its implications for investors, particularly those aiming to hand-pick individual stock winners.
The Surprising Truth About Stock Performance
Bessembinder’s research offers a fascinating and, at times, sobering analysis of stock performance. By looking at U.S. stocks between 1926 and 2016, he found that the stock market’s wealth creation is incredibly concentrated. This wasn’t just about measuring a few successful stocks. It was about revealing that the majority of individual stocks don’t contribute meaningfully to long-term market returns.
Here are a few key takeaways from his research:
Most individual stocks underperform Treasury bills. More than half of all stocks listed on the market over the last century have failed to beat the returns generated by one-month Treasury bills. In other words, for every stock that might deliver huge gains, there are many more that will underperform or even lose money over time.
A small number of stocks create the market’s wealth. According to Bessembinder’s data, a mere 4% of all stocks have been responsible for generating the entire net gain of the U.S. stock market. That’s right—just 4% of the companies have accounted for all the wealth creation in the stock market over the past 90 years.
The odds are stacked against you when picking winners. The vast majority of stocks either break even or generate losses for investors. This means that the odds of picking a long-term outperformer from a pool of stocks are much lower than one might expect.
The Difficulty of Picking Stock Market Winners
What does this mean for stock-picking investors? First and foremost, it highlights just how difficult it is to consistently select stocks that will deliver superior long-term performance.
Think about it—most individual stocks do not outperform Treasury bills, which are considered among the safest investments. This means that while the stock market overall has delivered strong returns over time, those gains are driven by only a handful of truly exceptional companies.
Consider some of the high-flying stocks that have dominated headlines in recent years—Amazon, Apple, Microsoft, or Nvidia. These are the types of companies that create massive wealth for shareholders. But for every one of these winners, there are hundreds of companies that either stagnate or fail to deliver significant long-term gains.
Bessembinder’s research suggests that picking stocks is less about identifying solid performers and more about finding those rare, transformative companies. These “unicorns” are exceedingly difficult to spot in advance, even for the most experienced investors.
Why the Rewards Are Huge if You Get it Right
Despite these sobering odds, the potential rewards of picking a long-term winner cannot be overstated. If you do manage to invest in one of those rare companies that delivers huge gains, it can have an outsized impact on your portfolio’s overall performance.
Take Amazon, for example. An investment of just $1,000 in Amazon at its IPO in 1997 would have grown to over $1.6 million by 2020. This kind of performance dwarfs the returns of most other investments, and even those of many other stocks within the same time frame.
Similarly, stocks like Apple and Tesla have also made their long-term shareholders incredibly wealthy. These are the types of companies that account for the majority of the stock market’s wealth creation over time.
The lesson? While picking winners is incredibly difficult, when you do hit on one, the payoff can be life changing.
How Can Investors Tilt the Odds in Their Favour?
So, with the odds of stock-picking success so low, what can investors do to improve their chances of benefiting from long-term wealth creation? Bessembinder’s research suggests a few strategies:
Diversification Is Key
Given that only a small number of stocks account for most of the stock market’s gains, diversification is essential. By holding a broad range of stocks, you improve your chances of capturing one of those rare winners. This is where index funds and ETFs shine. Rather than trying to pick individual stocks, you can invest in a fund that holds hundreds or even thousands of companies. In doing so, you’re more likely to be invested in those few companies that drive market returns.
Play the Long Game
Timing the market is incredibly difficult, if not impossible. Many of the companies that generate significant returns do so over decades, not months or years. Investors who try to time their entry and exit from individual stocks are often left disappointed. Instead, adopting a long-term buy-and-hold strategy allows you to ride out market volatility and benefit from the long-term wealth creation of stocks.
Consider Your Risk Tolerance
If picking winning stocks is such a challenge, it’s worth asking how much risk you’re comfortable taking on. For some investors, the idea of potentially missing out on the next Amazon might be enough to justify the risk of stock-picking. Others, however, may prefer a more conservative approach, focusing on broader market indices or including bonds and other low-risk assets in their portfolios to balance risk and reward.
Focus on Companies with High Growth Potential
While it’s almost impossible to predict the next market leader, there are certain traits that many of the big winners have in common: disruptive business models, strong competitive advantages, and the ability to scale. These qualities don’t guarantee success, but they’re often present in the stocks that go on to outperform the broader market.
Bessembinder’s research is a valuable reminder for investors: the stock market is an engine for wealth creation, but most individual stocks don’t drive that engine forward. Only a few companies are responsible for the stock market’s long-term gains, and the chances of picking those companies are slim.
For those who enjoy the thrill of stock-picking, the potential rewards can be astronomical. But for most investors, a diversified, long-term approach is a more reliable way to ensure you capture the wealth generated by the stock market as a whole.
The stock market’s success story may be driven by a handful of stars, but by staying diversified and thinking long-term, every investor can have a role in the journey.
Carl Roberts, Director
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Risk warnings
The value of investments and the income derived from them may fall as well as rise. You may not get back what you invest. This communication is for general information only and is not intended to be individual advice. You are recommended to seek competent professional advice before taking any action. All statements concerning the tax treatment of products and their benefits are based on our understanding of current tax law and HM Revenue and Customs practice. Levels and bases of tax relief are subject to change. This blog is based on my own observations and opinions.
