The Reality of Good Investments

Photo by Towfiqu barbhuiya / Unsplash

As much as I promote the benefits of stock investing for the long run, it is important to remember that most individual stocks are terrible long-term investments.   

If The Stock Market is Good, How Can Most Stocks Be Bad? 
J.P. Morgan Asset Management published the distribution of returns for the Russell 3000 from 1980 to 2014. 40% of all Russell 3000 stock components during that time lost at least 70% of their value and never recovered. 

I point this out because if you have previously been burned in the stock market and say things like, “If I buy a stock, it is most likely going to go down!” You aren’t wrong. Long-term stock market returns are the byproduct of a small number of companies that perform exceptionally well.

As Morgan Housel writes in his blog post, Tails, You Win, “Long tails [the name given to statistical anomalies that would show up at the very tail end of a standard distribution curve - like the blip on the far right side of the chart above] drive everything.” 

Why Is This Important? 
Whether you are investing in stocks, private companies, or real estate, you can’t overlook the importance of diversification.

While our cognitive biases trick us into thinking we can spot winners and avoid losers, the research says otherwise. According to this study, from 2004 - 2013 venture capital firms, staffed by some of the best and brightest minds in finance, lost money on 65.8% of the companies in which they invested. And even when those early-stage businesses managed to produce positive returns for their early investors and were successful enough to become listed on a public stock exchange, statistically, 40% of those winners likely went on to become publicly traded enterprises that generated catastrophic losses for their shareholders in the long run.   

Keep those numbers in mind next time someone suggests you abandon your broad-based investment strategy in favor of a concentrated position that seems like a sure thing.