Wealth creation in equity markets is driven by a tiny fraction of stocks—so small, in fact, that missing just a handful could cost investors millions. In this analysis for IFA Magazine, Sebastian Lewis of Vanguard unpacks the powerful lesson at the heart of diversification: don’t chase the outliers, own them all. Here’s why broad exposure, not bold bets, wins the long game.
‘Most stocks do not outperform Treasury bills.’ This provocative observation comes from Hendrik Bessembinder’s 2018 academic paper ‘Do stocks outperform Treasury bills?’ It’s a surprising conclusion, given that the average investor thinks stocks do indeed outperform government bonds (in this case, T-bills). We’re taught it pays more to own stocks than to lend money to a company.
Revisiting the conclusion, we should focus on the word ‘most’. This is crucial because equity markets are skewed. A few stocks rise sharply and pull up the average. While the common wisdom that stocks beat bonds holds true, Bessembinder’s research reveals that only a handful of stocks account for the total returns. So, just how few stocks are involved?
Bessembinder examined the share prices of nearly 64,000 global stocks between 1990 and 2020 and uncovered the following findings:
- ‘The five companies (0.008 per cent of the total) with the largest wealth creation between January 1990 and December 2020 were Apple, Microsoft, Amazon, Alphabet and Tencent. They accounted for 10.3 percent of global net wealth creation.
- The best-performing 159 companies (0.25 per cent of the total) accounted for half of global net wealth creation.
- And the best-performing 1,526 companies (2.39 per cent of the total) accounted for almost all net global wealth creation.’
The same conclusions emerge in several other studies and hold true for both US and global equity markets. Invariably, only a few stocks drove the performance of the entire index.
Plus five million percent
Another example: between 1926 and December 2023, 17 US stocks ‘produced cumulative returns of more than five million percent, good for $50,000 for every dollar invested in 1926. The strongest performance was a gain of 265 million percent, or $2.65 million for every dollar originally invested, for those invested in Altria Group all that time. Context is very important here, as the 17 stocks come from a sample of no fewer than 29,000 stocks.
A single share can cost an investor up to 100 percent of their investment. This is painful, but the potential loss pales in comparison to how far stocks can continue to grow. This crucial asymmetry can work to an investor’s advantage if they are broadly diversified. Because if there are only a few stocks that drive the price of financial markets, the opposite is also true: most stocks underperform.
The solution is diversifying
In 2024, a Vanguard analysis showed that an investor in the FTSE All World achieved a total return of 20.1 percent in GBP. This index includes over 4,000 stocks, with 69 percent of them underperforming.
In other words, the chances of picking the right stocks are small and stock returns are highly concentrated. The solution is to diversify. To quote Vanguard founder Jack Bogle, ‘Don’t look for the needle, buy the haystack.’
Even professional equity fund managers struggle to outperform market capitalisation-weighted benchmarks. For investors, it is more interesting to be in low-cost, widely diversified funds. This approach ensures they own the best-performing stocks that drive average gains.
Ten days can make up 45 percent
These winners change over time, making market timing particularly risky. Vanguard research indicates that an investor who initially invested £100,000 in the MSCI World Index (Total Return) would have earned £1.48 million between 1999 and 2024. However, missing the 10 best days in the market would have reduced this return by 45 percent!
In a forest, one unique tree may grow to the sky, but it’s very difficult to know in advance which one it will be. So, the challenge for investors is to remain disciplined and focus on the long term. This means buying the ‘forest’ of stocks in advance and accepting that many saplings will fail. However, there will also be winners, and diversification provides the opportunity to grow alongside them.
