In a recent discussion, Dr. Hendrik Bessembinder, a professor at Arizona State University, shared groundbreaking insights from his research titled "Do Stocks Outperform Treasury Bills?" His findings raise important questions about traditional investment strategies and provide a provocative realignment of our understanding of market returns.
Overview of Key Findings
Bessembinder’s work suggests that a significant majority of stocks have underperformed Treasury bills over their lifetimes. Specifically, his research indicated that only about 43% of stocks provided better returns than cash equivalents, meaning around 57% failed to outperform Treasury bills. This statistic is startling when considering that the general belief in the investment community is that stocks offer favorable returns over time.
Nature of Stocks’ Performance
Crucially, while the average stock return seems to exceed that of Treasury bills, Bessembinder explains this can be misleading due to skewness in returns. The average return is often bolstered by a small percentage of "home run" stocks that drastically outperform others. In his findings, only about 4% of stocks account for all wealth creation, emphasizing that individual investors may face uphill challenges in stock selection.
Market Dynamics
The implication of Bessembinder’s findings is profound: while many assume that investing in a diversified portfolio of stocks guarantees success, the reality is more complex. The distribution of returns is positively skewed, meaning that most individual stock outcomes—akin to those of venture capital investments—result in losses or low returns. Therefore, the odds of selecting winning stocks remain a matter of chance for most investors.
Historical Context
Bessembinder’s analysis utilized data from the CRSP database, focusing on over 25,000 stocks from 1926 to 2016. His methods accounted for the average logarithmic returns and the longevity of stock presence in the database. Interestingly, many of the stocks that underperformed either went out of business or were delisted for negative reasons. On average, a stock remains listed for about eight to nine years, leading to a significant rate of attrition among classified companies.
Implications for Modern Investors
Investors today face essential questions in light of Bessembinder’s findings. The notion that being merely a buy-and-hold investor is an effective strategy is challenged. For one, if the majority of stocks are underperforming, merely holding onto them without a well-defined strategy appears less advantageous. Bessembinder argues that investors should consider the concept of positive skewness, where maintaining a concentrated portfolio could yield substantial growth over time, especially if they can identify the few stocks that will become significant outperformers.
Active vs. Passive Investing
Bessembinder’s findings evoke thought-provoking discussions concerning active and passive investing. His research indicates that diversification is still crucial, as the wrong portfolio can significantly increase the risk of poor stock performance.
However, advocating for an aggressive stock-picking strategy could lead to overconfidence and increased risk. There is also the question of whether mutual funds that maintain a broad exposure to the market can effectively capture those skewed returns—do they benefit from enough skewness if they do not concentrate capital on winning stocks?
Future Research & Considerations
While Bessembinder’s research raises compelling arguments, further studies may focus on additional markets and other asset types to substantiate the universal applicability of these skewness phenomena. Recent exploration into international stocks yielded similar results, indicating that underperformance in individual stocks isn’t unique to the United States.
Ultimately, Bessembinder’s contributions convey a critical message: investors should be aware of the substantial variability in returns that individual stocks can present. By engaging prudently with the stock market, considering the odds, and focusing on long-term strategies, investors can create more robust portfolios.
Conclusion
Dr. Hendrik Bessembinder’s rigorous exploration into the performance of stocks versus Treasury bills challenges conventional investment strategy wisdom. As he notes, while only a small percentage of stocks drive significant market returns, individual investors should embrace a careful, research-based approach to stock selection while remaining aware of the inherent risks and complexities of the market.
With this understanding, investors may find renewed clarity in structuring their portfolios, balancing the allure of potential high returns against the reality of stock performance disparities that characterize the financial landscape.
Overall, Bessembinder’s findings underscore the importance of being well-informed, strategically diversified, and prepared for market volatility to ultimately achieve sustainable investment success.
