In 2018, Hank Bessembinder, professor of business at Arizona State University, published a paper in the Journal of Financial Economics with the rather nonsensical question: Do stocks outperform Treasury bills? It seems nonsensical because, from 1926 to 2016, the approximately 25 300 companies listed on US stock exchanges, created $35tr in net wealth for its shareholders, in other words, $35tr more than what investors would have earned on US Treasury bills. But here’s the catch: All that net wealth was created by the top 1 092 companies, or 4% of the total, which means the remaining 96% of listed companies “collectively generated lifetime dollar gains that matched gains on one-month Treasury bills”.
One might easily conclude from this research that it is vitally important to pick the right stocks. But that is almost certainly the wrong conclusion. Bessembinder explains: “The results presented here reinforce the importance of portfolio diversification. Not only does diversification reduce the variance of portfolio returns, but also nondiversified stock portfolios are subject to the risk that they will fail to include the relatively few stocks that, ex post, generate large cumulative return.”
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Founder and director of investment website JustOneLap.com, Simon Brown, is finweek’s resident expert on the stock markets. In this column he provides insight into recent market developments.
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