Purpose of this article: to convince you that a switch to passive investing will boost your chances of hitting your long-term investing and wealth generating goals

Bullet Point Summary

• Since 1926 the entire gain in the U.S. stock market is attributable to just 4% of stocks.
• Well over 40% of stocks generated 0% return since 1989 and underperformed even Treasury Bills.
• To top this off, the top 86 stocks have created 50% of the total $32 trillion generated in the stock market from 1926 to 2015.
• These improbable sounding stats point to a mathematical principle called Positive Skew, which ensures that only a handful of active investors will pick and own the right stocks that turn into big winners.
• The Positive Skew of stock market returns ensures there will always be more losers than winners.
• Consequently, switching to passive investing and indexing is the only tangible and consistent solution to combating the dynamic of Positive Skew.

Overview

I consider myself an educated investor that at best can generate okay to modest returns on average. Even though I take the time to evaluate individual stocks, invest in companies at “the right” price point, and hold for the long-term, I can’t consistently generate over-the-top returns in my active portfolio. And neither can many of my smart counterparts on Wall Street with their enormous informational and financial resources.

Inherently I have always known that trying to beat the market is a fool’s errand. And while books like Fooled by Randomness and A Random Walk Down Wall Street remind me of the difficulties of consistently besting the market, it was an article on Bloomberg I recently read that put the nail in the coffin of active investing for me. 

The thesis of the article is very simple: 

Not only can’t humans outdo benchmarks, we can’t even fight them to a draw.

Why Do We Suck So Hard at Consistently Picking Winners?

While it is important for active investors to do their homework when it comes to compiling an investment strategy the actual reality of the stock market is that all this effort is futile. When push comes to shove the fundamental reason why active investing sucks so hard is that the distribution of returns in the stock market is bizarrely lopsided. 

Because of the statistical principle of Positive Skew (see picture below), only a handful of active investors will pick and own the right stocks that turn into big winners. The rest of the market simply will not. 

The Positive Skew of stock market returns means that there will always be more losers on the left side of the distribution than winners who end up on the right side of the distribution with better than average returns.

History Clearly Shows Stock Picking Losses for Most Active Investors

The math and statistics are simply not in your favor if you are an active investor. The nature of the stock market is such that the odds are stacked against active investors when it comes to consistently picking winners. On average, there will be a small number of extreme winners, a small number of extreme losers, and a ton of stocks that will oscillate around average performance. As a result, most everyone outside of an indexer owns mostly deadbeat stocks.

The following chart from A Wealth of Common Sense shows exactly this as well over 40% of stocks generated 0% return since 1989 and underperformed even Treasury Bills. 

And in 2017, Hendrik Bessembinder found that since 1926 the entire gain in the U.S. stock market is attributable to just 4% of stocks. And to top this off, he also found that the top 86 stocks created 50% of the total $32 trillion generated in the stock market from 1926 to 2015.

Just stop for a second and let that all sink in… And once you have, call your active money manager and request a change in strategy. 

Conclusion: Switch to Passive Investing

For most of us, switching to passive investing and indexing is the only tangible and consistent solution to combating the dynamic of Positive Skew. With active investing comes a much greater chance of underperformance that inherently comes when you attempt to pick stocks. And consequently, active investors need to realize that the statistical disadvantage of Positive Skew is an uphill battle that most of them will lose. 

It’s simply impossible to actually know which companies will be the outsized winners (think about trying to place a bet on Amazon and Google circa 1998). The only real option is a diversified passive investment strategy which spreads your investment dollars across a lot of different companies. This simplistic and effective approach is best positioned to beat the statistical dynamic of Positive Skew in the stock market.