80/20 Rule on steroids: why is no one talking about this?
Only 4% of stocks account for all wealth creation
Sometimes, we’re amazed at how little this topic gets discussed in the investing world. Yet, it’s one of the most important insights every investor needs to print into their mind. Especially those who are, just like us, stubborn enough to think they can beat the index.
We would like to help you understand:
👉 Only a handful of stocks account for the majority of the market’s returns
This fact can be incredibly costly if ignored or underestimated. Let's get right to it, shall we?
You’ve probably heard of the 80/20 rule (Pareto’s Law). It applies to almost everything:
Personal development: 80% of your progress comes from 20% of your habits
Music: 80% of streams come from 20% of the artists
Business performance: 80% of revenue often comes from 20% of the customers
But does this also apply in the stock market? No, it does not. It is far worse.
Only 4% of stocks account for all wealth creation
Professor Hendrik Bessembinder studied over 25.000 stocks from 1926 to 2016. His findings were staggering:
Just 4% of companies account for all the market’s wealth creation.
An even smaller 0.3% of companies account for over 50% of total wealth creation.
Take a moment to let that sink in.
Below is an image from a separate study showing why.
If you look at the chart, you'll notice something striking: the majority of wealth creation comes from a small group of companies in the far-right tail. Meanwhile, the median company actually destroys value, losing about 54% over its lifetime.
The right tail, which represents just 7% of all stocks, holds the key to outperformance. While this slightly improves our chances of finding winners, the bigger lesson is clear: only a handful of stocks drive the market forward, while most destroy value.
We know, it’s a crazy statistic…
What makes it so difficult to outperform the benchmark?
The stock market index has a built-in advantage: it always includes the extreme winners. These rare companies propel the index upward, even though most stocks underperform or decline.
This makes beating the index incredibly tough. And the challenge gets even harder over time. If you underperform the index one year, you're facing the same uphill battle the next year due to the majority of stocks underperforming. This is why most individual and professional investors fail to outperform.
The harsh reality for individual investors
While we couldn’t find specific research on this, it’s likely that individual investors’ performance follows a similar pattern:
A small percentage of investors generate the majority of the gains.
Most underperform, and only a select few achieve outsized returns.
Being part of this small minority can be seen as a quest. For us, it is.
What does this teach us?
We’re searching for a needle in a haystack
This doesn’t demotivate us at all. It only makes our work more valuable (and fun). These insights show why doing in-depth research is essential. We consider it our mission to help you, and thereby also ourselves, find the top 4% of companies. To maximize our chances of finding these top-tier companies, we have a team of 4 dedicated researchers. The only way to do this, is by turning over as many stones as possible. Doing this yourself is nearly impossible…
Diversification is important.
Investing in just a handful of stocks is risky. Statistically, the chances of picking a winning stock from the top 4% are low. But by selecting 10-20 high-quality stocks, you immensely improve your odds. You only need one or two of these winners to drive excellent returns.
Be highly selective
Before making any investment, ask yourself:
"Is this company likely to be among the top 4% of winners?"
By adopting this mindset, you'll become much better at saying no to mediocre investments. This mindset will lead to you making stronger decisions and enjoying better results over time.
In this article, we learned that we’re playing a tough game. Perhaps, the toughest game. On the other hand, the rewards of consistently beating the index are huge over time, making it worth the time and effort. At least, for us.
We can’t fulfill our mission and help you discover companies that rank among the top 4% of performers. As a team of four, we do this by providing you with an in-depth analysis every week. By analyzing 52 stocks per year, we significantly increase your chances of identifying those rare, high-performing stocks.
» Join TDI-Premium and join our search
We hope each of you finds a company within the top 4% of performers and gets to reap the rewards of this investment.
Have a wonderful day and happy investing.
The Dutch Investors.
The Bessembinder study illustrates a key ingredient of the relative success of passive over active investing: if you buy and hold "the market" you (per definition) also buy and hold the 4% big winners wheras as an active investor you might miss those 4% of stocks that generate all the profits.
An intriguing post. I downloaded the study and am reading it now. My preliminary thoughts:
Saying that ~100-year returns of most stocks are less than those of 1-month treasuries is not nuanced enough and is akin to saying a lake is 1 meter deep on average. But there are areas with 20cm of water and those with 10 meters. One has to own stocks at certain stages of their lifecycle - ideally, growth and preferably not stagnation and decline. Buy and hold "forever" is rarely the best idea because nothing grows forever. At some point, returns start coming mainly from buybacks and dividends rather than earnings growth; the multiple shrinks and share prices stagnate. Plus the longer the holding period, the greater, it seems to me, the risk of disruption and obsolescence.
So one does not have to find the elusive 4% that outperformed during a very long period, longer than most people's lifetimes. One needs to find some stocks that outperform for 5, 10, 15 or 20 years. I have a feeling there are many more of those than 4%.