Investing in individual stocks has long been thought of as a gateway to financial success for many, but recent research may challenge this conventional wisdom. An eye-opening study by Henric Bessembinder published in the Financial Analysts Journal in 2023 unveiled a surprising truth – the median monthly return for a vast array of individual stocks is zero. This finding paints a mixed picture of the stock market — half of the stocks produce positive returns while the other half yield negative returns, leaving investors pondering their next move.
Reassuringly, there are alternative ways to gauge stock performance beyond the constrained lens of monthly median returns. One common approach is to assess stock returns in terms of volatility. Volatility refers to the extent of fluctuation in a stock’s price, typically measured by standard deviation. With an average annual standard deviation of around 50%, individual stock prices can wildly swing throughout the year. This level of uncertainty may seem daunting for those seeking stability. However, understanding the importance of long-term investing in stocks can alleviate some concerns.
When focusing on long-term individual stock returns, one might anticipate more consistency over time. Yet, a closer look at Bessembinder’s research reveals a less than comforting reality. Surprisingly, 55% of US stocks underperformed US Treasury Bill returns over the long run. Additionally, the most common outcome for individual stocks was a 100% loss — a stark reminder of the high-risk nature of investing in stocks.
Traditional methods of assessing stock performance often overlook a critical parameter: positive skew. Positive skew is the third component within stock return distributions that explains why stocks have historically outperformed other investments. Contrary to popular belief, stock returns follow unique patterns driven by human behaviors. This emotional backdrop results in the potential for monumental gains that can outweigh the possible losses, creating a positive skew.
Investors are urged to embrace both the emotional highs and lows associated with investing in stocks to unlock the full potential of market gains. While it may feel unsettling to weather tail events, they are essential for achieving long-term success in the stock market. By learning to appreciate positive skew and its imperfections, investors can navigate the unpredictable nature of stocks and reap the rewards that come with it. So, rather than fear the skew, learn to love it and watch your investments thrive in the ever-evolving stock market landscape.
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