Market averages tell the big story: if you buy the entire stock market, and sit on it, over long periods that investment portfolio has averaged about 8-10% per year.
I have no reason to believe it won't be similar for the future.
Averages tell you WHAT.
WHAT has the stock market returned over the long run? About 8-10% per year.
But HOW — HOW has the stock market returned 8-10% per year? — is a whole another question.
And the mode (i.e. the most common data point), rather than the average, tells that story. And answering HOW means looking at characteristics of individual stock performance through time.
Hendrik Bessembinder did that research. He has looked at the history of about 29,000 stocks in the United States, over the 90 years worth of good data we have for empirical stock analytics. He's also looked, on a slightly shorter time horizon because of available data, at about 64,000 stocks outside the U.S.
The mode is -100%.
The most common outcome from buying a stock is that you lose all your money.
Mind blown? Great. But read on, because it has implications for portfolio design, especially if you're a long-term investor.
Stocks have extreme skewness. Their long-term average is a positive 8-10% only because a handful of stocks return an ungodly positive %, pulling the average upward.
Most stocks stink. The average stock stinks. The most common individual outcome is the worst possible individual outcome.
The stock market is NOT a rising tide lifts all ships story. It is a haystack with unknown, but required, needles story. So buy the damn haystack.
Nvidia is up about 334,000% since it IPO'd. Apple, Amazon, and a handful of others share similar qualities. Since we can't know which stocks will become the next Nvidia, the best portfolio opts into owning thousands of likely future losers, simply (and elegantly) for the near-certain chance of ensuring at least small ownership in whatever the next Nvidia is. The most reliable way of capturing the expected 8-10% annual average stock market return is by owning a little bit of every stock (with larger weightings to bigger companies, and smaller weighting to smaller companies).
Our lives also have extreme skewness. We don't lie on our deathbeds remembering average days. We remember things like weddings and births and funerals — singular events with outsized impact.
Average, unremarkable days are the most common (modal) days. There are nearly three years of Covid-19 where I literally can't distinguish one day from another. Like a 1,000-days day. And it's not some distant childhood memory; it literally just happened.
There's useful information in that. It's worth unpacking the difference between averages in our lives, and averages in our investment outcomes, because it informs how to pursue success differently in each.
In life, we can marginally improve our average day to improve our overall happiness, and we should. Trying to make wedding days slightly better or funeral days slightly less sad really won't move the needle long-term. But walk an extra 30 minutes every day? Life-changing.
In life, the mode informs effective design. Improve the mode.
Want a better designed life? Consistently add a little bit more of the good stuff on generally forgettable days.
In investing, the mode should also inform effective design. But it's by accepting the mode and the information it provides.
Stocks don't care about you, so build around their inherent characteristics. The most common outcome from buying a stock is that you lose all your money, but also stocks broadly have positive, long-term expected returns. Good to know.
I have no reason to believe that the mode, a -100% return, will be different in the future. Yet I also expect skewness driving long-term positive, average returns to be persistent. Hendrik himself makes a similar comment in this recent podcast.
Research continues to show us, year after year, how silly it is to try and outguess the stock market. My friend Jeff Sommer asked Hendrik about trying to weed out the dogs, and only find the next Nvidias:
“I have no idea which companies will generate the best returns over the next 10 or 20 or 30 years," Hendrik said. “Probably it will be some companies we’ve never heard of. Maybe it will be companies that don’t even exist now.”
If we want more reliable investment outcomes — because the future is uncertain and we want the highest probability of achieving the long-term market average...we must sign up, with a meaningful portion of our portfolio, for something that sounds, quite frankly, rather silly.
In my fiduciary duty to clients, and my responsibility to investor wellbeing and success broadly — the mode is telling you, and I am telling you, my dearest readers, to do it anyway.
Want a great investment experience? Lose all your money.
End.