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"Saying Stocks Are Risky is an Understatement"

"Superstocks" save the stock market as a whole

by Bob Stokes
Updated: April 05, 2017

Almost everyone knows that stocks are risky. Yet, new evidence shows that stock picking is fraught with even more risk than many investors might realize. Let's look at the return profiles of individual stocks from a recent academic study.

 

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[Editor's Note: The text version of the story is below.]

Every investor knows the stock market is risky. But most investors probably don't realize how risky.

Of course, some people have made fortunes in the stock market. But the stories of those who have surrendered their gains or never enjoyed them in the first place far outnumber those who buy and sell successfully. You just don't hear about them on financial TV.

Robert Prechter's just-published book, "The Socionomic Theory of Finance," says:

Many advocates for investing say that in the long run stock prices go up, making it a positive-sum game. But in actuality every stock could, and eventually does, go to zero.

That may appear to be a radical statement to you.

But a new study by Dr. Hendrik Bessembinder of Arizona State University looked at the return profiles of individual stocks throughout market history, and confirmed what Prechter wrote.

Here are comments and a chart from philosophicaleconomics.com (April 2017):

Most individual stocks perform poorly, while a small number perform exceptionally well.  The skew is vividly illustrated in the chart [above], which shows the returns of 54,015 non-overlapping samples of 10 year holding periods for individual stocks.

The majority of stocks in the sample underperformed cash.  Almost half suffered negative returns.  A surprisingly large percentage went all the way down to zero.  The only reason the market as a whole performed well was because a small number of "superstocks" generated outsized returns. ... To say that individual stocks are "risky", then, is an understatement.  They're enormously risky.

Even so, many investors have a high opinion of their stock picking skills. A March 2016 New York Times article titled, "Why We Think We're Better Investors Than We Are," says investors are overconfident:

Millions of amateur investors continue to actively buy and sell securities regularly. This despite overwhelming evidence that even professional investors are no more likely to beat the market than monkeys throwing darts at securities listings.

The article also notes that most investors display an optimism bias.

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