The Surprising Truth: Only 4% of Stocks Drive Most of the Market’s Gains

When most people think about the stock market, they imagine a vast sea of opportunity. The common wisdom is that, over time, “stocks always go up,” and that investing in equities is the surest way to build long-term wealth. But what if I told you that the vast majority of stocks actually don’t beat safe government bonds over the long run? That’s the jaw-dropping conclusion of a landmark study from the W. P. Carey School of Business at Arizona State University, which found that just 4% of stocks are responsible for nearly all of the U.S. stock market’s net gains since 1926.

The Groundbreaking Study: Do Stocks Really Outperform Treasuries?

In 2017, Professor Hendrik Bessembinder published a now-famous paper titled “Do Stocks Outperform Treasury Bills?” The study analyzed the lifetime returns of every publicly traded U.S. common stock from 1926 through 2016, a staggering dataset covering nearly 26,000 stocks. The goal was to find out whether investing in stocks is truly superior to the safety of U.S. Treasury bills (T-bills), which are often considered the world’s safest investment.

The results were as surprising as they were unsettling. Over half of all stocks, about 57%, delivered lifetime returns lower than one-month Treasury bills. Even more astonishing, just 4% of stocks accounted for the entire net gain of the U.S. stock market above T-bills. The remaining 96% of stocks, when combined, essentially matched the returns of T-bills or lost money. In other words, the market’s legendary long-term growth is not a tide that lifts all boats. Instead, it’s more like a lottery, where a tiny handful of winning tickets deliver all the riches.

The Mechanics: How Can So Few Stocks Drive the Market?

The explanation behind this phenomenon lies in what statisticians call “positive skewness.” Most stocks deliver average or below-average returns, while a small number deliver extraordinary results. Think of companies like Apple, Amazon, Microsoft, and Berkshire Hathaway, whose meteoric rises have created trillions of dollars in wealth. These outlier stocks are so successful that they more than compensate for the underperformance or outright failure of the majority. In fact, Bessembinder’s research found that just 90 companies, less than 0.4% of all stocks, accounted for half of the total wealth creation in the U.S. stock market over 90 years.

Another important factor is the lifespan of a stock. Most stocks don’t stick around for long. The median lifespan of a publicly traded company is less than seven years. Many are acquired, go bankrupt, or simply fade away. The market’s history is littered with once-promising names that are now footnotes.

Why This Matters. The Case for Diversification

If only a tiny fraction of stocks are responsible for the market’s gains, what does this mean for your investment strategy? Owning a broad portfolio increases your chances of capturing those rare, market-beating winners. If you concentrate your bets on just a few stocks, the odds are stacked against you. Even professional fund managers, with all their resources, struggle to consistently pick the next Apple or Amazon.

This is why index funds and ETFs have become so popular. By owning the whole market, or at least a broad swath of it, you’re guaranteed to own the next generation of superstar stocks, even if you don’t know which ones they’ll be. Index funds ensure you benefit from the market’s positive skewness, rather than falling victim to its many losers.

To put some numbers to it, imagine you randomly pick ten stocks. Statistically, it’s likely that at least half will underperform Treasury bills, and there’s only a tiny chance that you’ll pick a true winner. By owning hundreds or even thousands of stocks, as in a total market index fund, you virtually guarantee that you’ll own your share of the next big winners.

The Realities of Stock Picking: Is It Still Worth It?

Given these odds, you might think stock picking is a fool’s errand. Indeed, most actively managed mutual funds underperform their benchmarks over time. But why? The answer lies in the incentives and constraints facing professional money managers. Fund managers know that underperforming the market can cost them their jobs, so they “hug” the index, making only small bets away from the benchmark. Many funds are required by law or by their own rules to hold dozens or even hundreds of stocks, diluting any big bets. Additionally, managers are judged on quarterly or annual performance, making it hard to hold onto long-term winners through periods of volatility.

But individual investors aren’t bound by these constraints. This is where stock picking can still make sense, if you do it thoughtfully. You have the flexibility to invest in as few or as many stocks as you want. If you have high conviction in a company, you can make a concentrated bet. You’re not judged by quarterly reports, so you can hold onto a promising stock for years, riding out short-term volatility. Plus, you don’t have to worry about losing your job if you underperform the market for a year or two.

If you’re able to identify and hold onto one of the rare, market-beating stocks, the rewards can be enormous. Just ask early investors in Amazon, Apple, or Tesla.

The Problem with “Index Hugging” in Mutual Funds

Many actively managed mutual funds charge higher fees than index funds, but their portfolios look suspiciously similar to the index. This is called “index hugging,” and it’s a way for managers to avoid the risk of underperforming the market by too much. But it means investors are often paying for active management without getting much true active management at all.

The result is high fees that eat into your returns, without the benefit of bold, contrarian bets that could deliver outperformance. If the manager isn’t truly trying to beat the market, you’re better off with a low-cost index fund that keeps more of your money working for you.

Lessons for Investors: How to Apply This Research

At my firm, I select individual stocks for clients, even though we also hold a significant allocation to index ETFs. My approach focuses on investing in industry leaders, companies that consistently generate high returns on capital and are committed to raising their dividends, rather than cutting them. This discipline alone helps filter out the vast majority of underperformers, allowing us to avoid roughly 95% of the companies that historically lag behind. By combining this strategy with a strict emphasis on only buying companies at reasonable valuations, I believe the odds of selecting stocks that outperform the market increase substantially.

One limitation of the W.P. Carey School of Business study is that it compares Treasuries to the entire universe of stocks, without considering the underlying fundamentals or financial health of those companies. As a result, some investors might come away with the impression that stock picking is futile and that the odds are overwhelmingly against them. In reality, that’s not the case. The key for investors is to conduct thorough valuation analysis. Successful stock picking hinges on the ability to assess both the economics and the valuation of a business. If you can’t value a company, you can’t effectively pick its stock.

While the study offers fascinating insights, it’s important to remember that statistical research can sometimes be used to support a particular narrative, potentially obscuring other important factors. Ultimately, disciplined analysis and valuation remain at the heart of successful stock selection, despite what broad statistical studies might suggest.

Disclaimer:
The information provided in this article is for general informational purposes only and does not constitute investment, financial, legal, or tax advice. While every effort has been made to ensure the accuracy of the information, First Shelbourne makes no guarantees regarding its completeness or reliability. Readers should consult with a qualified financial advisor before making any investment decisions. Past performance is not indicative of future results. Investments involve risk, including the possible loss of principal. First Shelbourne is not responsible for any actions taken based on the information provided herein.