When talking about stock returns, most people assume that individual stocks should produce positive returns. That's because the stock market has historically outperformed other asset classes like bonds. But surprisingly, the median monthly Returns for large samples of individual stocks please drum roll – zero. That's right. Henric Bessembinder has implemented it, Financial Analyst Journal In April 2023, we found that each month, individual stocks generate returns centered around zero. In fact, this depicts a “half, half free” scenario. Half of the inventory produces positive returns, while the other half has negative returns.
As an investor or advisor, how will you and your clients react to this? If this Zero Median return statistics are the only way to see stock performance, it is difficult to justify your investment in stocks at all. Convincing your clients to invest in stocks can be a difficult battle, especially if you are looking for short-term profits.
Volatility
In fact, there are many ways to assess your stock price, as well as focusing on the median monthly performance. One common approach is to measure stock returns Volatility. Volatility refers to how much the price of an inventory fluctuates, often measured using standard deviations. On average, the annual standard deviation of price-earnings ratio is approximately 50%. This means that individual stock prices can swing wildly throughout the year. Applying the 95% confidence interval, which is commonly used in statistics, this means that returns for individual stocks can change by about +/- 100% in a given year. This is huge. Essentially, individual stocks can double or lose all their value within 12 months.
This level of uncertainty makes inventory seem difficult, especially for those seeking stability. The idea that individual stocks are “half-complete, half-empty” proposals each month, and even more unstable every year can scare potential investors. However, it is important to remember that stocks are primarily intended for long-term investments.
While nervous, short-term ups and downs are part of our journey towards creating long-term wealth.
So, what happens when you shift your focus to long-term individual stock returns? Shouldn't we expect more consistency over time? Bessembinder also looked at long-term inventory performance, but the findings were not at all consolation. In the long term, 55% of US stocks were below the return on US Treasury bills. This means that more than half of the individual stocks have been worse than the safest government-supported investments. Perhaps even more surprising is the fact that the most common outcome of individual stocks is a 100% loss, a complete obstacle. These findings suggest that investment in individual equities is a risky effort, even if it takes a long-term approach.
Typically, when investors and financial analysts assess stock performance, they focus on two important statistical measures. Median (such as mean or median return) and Volatility (Measured by standard deviation). This traditional analytical method often leads to negative or at least discouraging stories about investments in individual stocks.
Why does everyone invest in stocks when returns are near zero in the short term, very unstable in the medium term and dangerous in the long term?
The answer is, as history shows, despite these challenges, stocks far outweigh other asset classes, such as bonds and cash, over the long term. But to really understand why, we need to look beyond the typical first two parameters used in stock returns analysis.
The third parameter for evaluating stock performance: positive skew
Traditional analyses focus on the first two parameters (central value and volatility), but miss the key components of stock returns. Positive Skew. Positive skew is the third parameter of the stock return distribution and is key to explaining why stocks have historically outperformed other investments. If we focus solely on central values and volatility, we basically assume that stock prices follow a normal distribution similar to the Bell curve. This assumption works well in many natural phenomena, but does not apply to price and earnings.
Why is it not good? This is because stock earnings are not compliant with natural law. They are driven by human actions. Humans are often irrational and driven by emotions. Unlike natural events that follow predictable patterns, stock prices are the result of complex human behavior, such as fear, greed, speculation, optimism, and panic. This emotional background means that stock prices can shoot dramatically when the crowd gets hooked, but can only drop to a -100% limit (the stock lost all value) ). This is what creates positive skew with inventory returns.
Simply put, the downside of inventory is limited by 100% losses, but the rise is theoretically unlimited. Investors can lose all their money in one stock, but another stock could skyrocket and earn 200%, 500% or more.
This one Return asymmetry – The fact that profits can be far beyond losses – it generates positive skew.
This skew is combined with the multi-period combined magic and explains much of the long-term value of investing in stocks.
Learn to withstand tail events
If you look at the stock return distribution, you will notice that the long-term value from investments in the market comes primarily from the tail event. These are rare but extreme results that occur at both ends of the distribution. A long, positive tail is smaller and produces a greater return than compensates for frequent losses. Big positive tail events must outweigh big negative events because inventory produced historically high returns.
The more positively skew the return distribution, the higher the long-term return.
This may sound counterintuitive at first, especially when traditional portfolio management strategies focus on eliminating volatility. Portfolio construction discussions are often centered around methods. Smooth ride comfort Both positive and negative by reducing exposure to extreme events.
The goal is to create a more unpredictable and less volatile return stream that can be felt safer for investors. But avoiding them will help you avoid anxiety Tail Eventinvestors eliminate both big losses and big profits. This reduces positive skew, resulting in a dramatic reduction in overall returns.
Hidden Costs of Managed Equity
A typical “managed equity” strategy eliminates all stock losses (no returns below zero). For example, well-known investment companies offer managed S&P 500 funds that avoid all annual losses while limiting returns to less than 7%. Since it is virtually impossible to predict daily returns, this feat of return is achieved simply by retaining the zero-cost S&P 500 option colour. Over the past 40 years, when the S&P 500 produced more than 11% a year, the strategy has produced a modest return of 4% a year.
In other words, avoiding emotional tail events means missing out on the very benefits that are the key factor in long-term wealth creation. Investors who concentrate too much on smoothing turn are more consistent, but with a dramatic lower return over time.
To truly benefit from stock investments, you need to embrace both the emotions and rewards that come with positive skew. This means Learn to live at a tail event. They may be uncomfortable when they occur, but they are an integral part of long-term success in the stock market.
The most successful investors will recognize this and simply accept that the inevitable volatility and tail events are important to achieving high returns. By learning to assess positive skew and associated tail events, investors can maximize the profitability of the stock market.
Learn love rather than fearing slowly.
