One of my all-time favorite books about investing is Jeremy Siegel’s The Future for Investors. In the book’s appendix, Siegel provides a list of the original 500 companies in the S&P 500, as well as how they had performed up until the book was written (i.e., from 1957-2003).
I went ahead and plotted their respective annual performances on a graph, because I was curious if it would look like a normal distribution/bell curve. Here’s what it looks like:
What we can learn:
It looks a lot like a bell curve, but with one giant exception: There are a whole list of companies that went to zero. This does not occur with a normal distribution.
Over this same period, the S&P 500 earned an annual return of 10.8%. In other words, 215 companies did better than the whole index. 285 did worse.
This is in keeping what I had guessed: More companies underperform than outperform. That’s because it takes multiple poor performers to make up for each superstar stock (such as the one that earned an almost 20% return per year).
The way I see it, this is an argument in favor of extreme diversification. If you pick stocks, your chances of picking one of the ones with a “negative 100% return” far outweigh your chances of picking one of the few at the far right of the graph.
Last point of note: In case you’re curious, the one stock with an almost 20% annual return is Philip Morris. Does that make anybody else a bit sad?
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