Investing in individual stocks can be a daunting prospect, especially when faced with statistics that show a median monthly return of zero. But looking beyond the short-term numbers reveals a more encouraging picture of stock market performance.
Volatility: The Rollercoaster Ride of Stocks
While individual stocks may have a zero-median monthly return, their volatility is what sets them apart. Stock prices can fluctuate wildly, with an average annual standard deviation of about 50%. This means that an individual stock can potentially double or lose all its value within a year. This uncertainty can deter investors seeking stability, but it’s crucial to remember that stocks are long-term investments.
Short-term fluctuations are part of the journey toward long-term wealth creation.
However, looking at long-term stock performance reveals that over 55% of US stocks underperformed US Treasury Bill returns. This high-risk nature of investing in individual stocks highlights the need to explore beyond traditional measures of stock performance.
The Third Parameter for Assessing Stock Performance: Positive Skew
Traditional analysis often overlooks the positive skew of stock returns, which can explain why stocks have historically outperformed other investments. Stock prices, driven by human emotions, have an asymmetric return distribution where gains can exceed losses. This asymmetry, combined with multi-period compounding, contributes to the long-term value of investing in stocks.
Learning to embrace tail events is crucial for achieving high returns in the stock market.
The Hidden Cost of Managed Equity
Managed equity strategies that aim to eliminate volatility and downside risks often result in lower overall returns. Avoiding emotional tail events means missing out on the large gains that drive long-term wealth creation. Embracing volatility and tail events is key to unlocking the full potential of stock market gains.
By understanding and appreciating the positive skew and associated tail events, investors can navigate the ups and downs of the stock market to achieve long-term success. Learn to love, not fear the skew, and reap the rewards of stock market investing.