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February 20, 2017

Treasury bills outperform most stocks

One of the core beliefs of investors is that stocks deliver a better performance than safe treasury bills. But is this really true? A recent academic study has analyzed the performance of both asset classes and came to a surprising result: most common stocks do not outperform treasury bills! How is that possible and what does it mean for investors?

The solution to the puzzle

The study compared all the US stocks from 1926 to 2015 with one month US treasury bills. It showed that 58% of all stocks underperformed treasury bills! In essence, more than half of all stocks could not even keep up with safe treasury bills. To be sure, the stock market as a whole did perform better than T-bills. But that’s attributable mainly to those large returns from relatively few stocks. Actually, all the stock market gains were attributable to just 4% of all the listed stocks.

Unfortunately, the stock market doesn’t follow a normal bell-shaped curve. It doesn’t work out that half of all stocks outperform and half of all stocks underperform. There are huge tails when you look at the extreme over- and under-performers in the market. The distribution of stock market returns is driven by only a small percentage of really big winners!

What this means for you

Diversification is key because the winners in the stock market are a very small group that accounts for most of the total gains. If you missed in the last 10 years Apple, Google, Amazon and Facebook you will have lagged badly behind the S&P 500.

The results of this study also explain why active mutual funds underperform – they tend to be poorly diversified.

This is the real paradox of investing: equities are a critical component of any investment plan but investors should still avoid exposure to single stocks because they will never be able to achieve sufficient diversification.