An excellent summary of several key concepts in investment worth reading: “So Few Market Winners, So Much Dead Weight” by Barry Ritholtz of Bloomberg View. Based on an earlier NY Times article that itself profiles new research by Hendrik Bessembinder from Arizona State University, Ritholtz notes that:
“Only 4 percent of all publicly traded stocks account for all of the net wealth earned by investors in the stock market since 1926, he has found. A mere 30 stocks account for 30 percent of the net wealth generated by stocks in that long period, and 50 stocks account for 40 percent of the net wealth. Let that sink in a moment: Only one in 25 companies are responsible for all stock market gains. The other 24 of 25 stocks — that’s 96 percent — are essentially worthless ballast.” Which brings us to the key concepts related to this observation: Concentration risk: This an obvious one. In today’s markets, returns are exceptionally concentrated within just a handful of stocks. Which puts the argument in favour of diversification through a test. Traditionally, we think of diversification as a long-term protection against risks of markets decline. But it can also be seen as coming at a cost of foregone returns. Think of holding 96 stocks that have zero returns against four stocks that yield high returns, and at the same time weighing these holdings in return-neutral fashion, e.g. by their market capitalization.
This post was published at True Economics on Sunday, October 15, 2017.