Unlocking the Power of Positive Skewness: Strategies for Investing, Business, and Creativity
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Walking the money for the rest of us. This is a personal financial on money, how IT works, how to invest IT in, how to live without worrying about IT. I'm your host, David time.

Today is episode forty two title, unlocking the power of positive Stevens strategies for investing, business and creativity. I recently came upon several really fascinating studies on the long term performance of the stock market. The first study was by hendrick besim inder and his coauthors in the second study was just by herc besenval der, who is a professor of finance at arizona university.

In the first study, they looked at the long term returns of sixty four thousand global common stocks going from january nineteen ninety to december twenty twenty. They found that fifty five percent of U. S.

Stocks and fifty seven percent of nine U. S. Stocks under performed one month U. S. Treasury ills. In other words, their compound return of the majority of stocks didn't even beat cash further. They found that in the U.

S, only two point four percent, the firms contributed to the seventy six trillion dollars of global stock market wealth creation. Outside of the U. S, one point four percent of the firms contributed to the thirty three thousand dollars in net wealth creation. Only a tiny percent of the stocks generated the vast majority of the wealth.

It's even more narrow than that five firms point zero zero eight percent of the total accounted for ten percent of global net wealth creation, that was apple, microsoft, amazon, alphabet and ten cent hundred and fifty nine firms point two five percent of the total account for the global net wealth creation. Now that's the first study. The second study went for a longer time period.

IT was just focused on U. S. Public stocks.

From nineteen twenty six to twenty nineteen, bebita looked at twenty six thousand firms and found that only forty two percent of the firms created positive wealth for the shareholders, while fifty eight percent of the firms actually reduced shareholder wealth. And that relative to treasure bills. Think about that.

If we could identify those few stocks that dramatically outperform, be very, very wealthy. What best ambinder and his coauthors found for the stock market, and is a concept that we have discussed in a number of episodes, is the global stock market and individual stocks demonstrate what is known as positive skill. When something is positively skill, the average outcome, the average return for the stock market will be higher than the middle return because of the extreme outcomes.

Those few stocks they did incredibly well pulled up the average return for the stock market, while the vast majority actually didn't even contribute to positive wealth. In their study, they found that the mode, the mode being the most frequent return shown for the stocks over this time period was a complete loss of capital. Make IT of one hundred percent.

What that means is, according to the authors, is the most common outcome for individual stocks over long period time is to lose all your money. But they also point out that there were other examples where the stock gained over a thousand percent. So while many stocks fail, there's also the potential for exceptional gains if we can identify a few stocks.

Now, the authors warn that their studies don't contradict the fact that broad exposure to the stock market, such as through an etf for an index fn, does outperform treasury bill by a significant amount. They write the mean of the average bin hold return across docks in their sample, greatly exceed the U. S.

Treasury bill return at each horizon. We study so different time horizons. They found overall, the stock market outperformed treasure bills, but the returns were driven by a small percentage of the stocks, with the vast majority under performing and many completely losing all the money.

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In the early years, when I became an institutional asset manager, I came across an article by Robert in a book. IT was a compilation of classic investment essays. This particular one was the coffee can portfolio, originally published in the journal of portfolio management.

And curb mentioned that a coffee camp portfolio, the concept harkened back to the old west, where people would put their viable possessions in a coffee can and hide IT under a mattress. And the key was to to select valuable things, and then maybe later they would be worth a lot. This idea of a coffee can, porta folio stocks, came to curb back in the fifties when he worked for a large investment count organization.

That's actually the name that many firms back in the day, they would just call themselves investment councils, their business, they say, to preserve capital, not to create capital. They would pick individual stocks. They would often, once, as talks did well, they would rebaLance, reduced the way and invest in others.

They had one client, IT, was a couple, and curb mentions that her husband, a lawyer, handled the financial fairs. So carbis firm was managing some of their assets. The husband died after a decade of being with carbis firm, the sudden death, the wife at that point said that he had additional securities to add to the portfolio that curbs firm was running.

And IT was a sizeable amount, but IT was an outlooking portfolio, curry said. There was some stocks that had values of less than two thousand. There were several that were inaccessible, hundred thousand, and there was one stock, xerox, worth over eight hundred thousand.

Turns out what the husband had been doing with purchasing all the stock recommendations, changes that were made in the portfolio, but he would never sell. And that coffee can portfolio did Better than carbis overall from did because of the positive skies of that basket of stocks with some doing extremely well. Xerox, a hundred thousand dollars a group to bringing up the average.

So that's an example, again of positive stuss. The chAllenge though is we don't know which of those stocks will do that well. And we know that because that what professionals are trying to do, they're trying to outperform the overall stock market.

And if we look at morning stars active passive study over a twenty year period, only between ten and twenty percent of active managers or perform a comparable index funder etf of a similar style, the best majority under perform. Now maybe it's because they're always rebalancing and they're not lending their winners run. That could be maybe if porta folio manager did that, they would do Better.

But there's a fishing aspect of IT because as we saw in that earlier study, over the long term, most of the stocks will under perform. Many will completely lose all the money. But even within that sample, there will be active managers that do extremely well, much, much Better than a benchmark and their peers.

That was our job as investment consults to try to identify ahead of time which of the firms were skilled enough to outperform the index. And I can tell you, not only is a very difficult performs to outperform, but to try to identify which one's will is super difficult. So we have a positive skies in the stock market where a few stocks do incredibly well, much Better then the the median stocks and and Frankly, most stocks.

Another study by adam fargo and eric as marsin found that volatility is what drives skill ness as well as the time frame. So a five year time frame with asset that are less, there's less positive skills. You have fewer extreme events, stocks doing tremendously Better than others.

But over longer time frames, thirty years, and if there are more violated al assets, you'll have significantly more positive stuff with some others holdings doing incredibly well. Now this aspect of positive skills and investing just doesn't apply to individual stocks or the other stocks. Market IT applies to our investment portfolios, a diversified portfolio, a number of asset classes.

Depending on the time frame or the person, the outcomes can be dramatically different. We discuss this earlier this year in episode four eighty. How much wealth we have when we retire obviously depends on how much we save and market returns. But as we pass through time, some people will do incredibly well and their portfolio will bring up the over average of, let's say, a portfolios of other investors that are kind of saving through that period. It's because of this positive stress.

Some of the outcomes will will be poor and if the portfolio or a violation, then will see more positive cuss, 因 that episode actually was epson for sixty。 There was a study that showed that a one hundred percent stock purfoy lio investing over a thirty year time window, saving for retirement. They were looking at the financial outcomes of retirees.

And being one hundred percent stocks, the average outcome was greater than a traditional baLanced fund approach of sixty percent stocks for forty percent bonds or even a fifty fifty that one hundred percent stock prophete did Better than a target date fund where the sponsor's reducing the allocation to stocks as the target day to the retirement start day gets closer. Now I point out that the average outcome did Better. And we would expect that because one hundred percent stock portfolio is more violated than a fifty fifty stock bombs portfolio, so the hundred percent stock will be more volatile.

You'll see more positive extreme outcomes because they are doing a scenario analysis. Is moni carlo different time horizons they they did was known as booths strapping as they picked random years and created a number of portfolios based on the returns. And they found that, on average, one hundred percent stocks did Better.

That should raise a red flag because we're discussing positive student. The hundred percent stock allocation had a seventeen percent chance of retirement ruin basically running out of money because they they continued this approach not only through savings, but also through through retirement and spending using traditional spending amounts, four percent spending a rule and one hundred percent of stock portfolio. Seventeen percent time people ran out of money because of the higher of volatility of being a hundred percent stacks. So while the average outcome was great, almost twenty percent of the people ran out of money. And that's not what you want as a retirement.

But take away from the lens of investing as relates to positive stress is that the greater the diversity, including a variety of asset types using index funds and E, T S, with hundreds of, not thousands of holding, lower volatility and a shorter time horizon that leads to less positive stress, which means that the media or middle outcome will be closer to the average, that the average and the mini outcome won't be that different because of the shorter time horizon, the greater diversity and the lower volatility. Also, we can reduce positive students and investing by rebalancing, just like Robert curry did at his home. Now by rebalancing, we're not letting the winners run.

We're reducing the positive skills so that most of the time the outcome will be successful. We're just were missing out on those more rare times where things go incredibly well, bringing up the entire average. So there's a give up when we try to reduce positive cuss.

We're not going to be fabulous ly successful at investing because we bring down the volatility and seek to reduce positive experience so that we reduce the probability being ruined in a missing our long term goal. Before we continue, let me pause and share some words from this week. sponsors.

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Another example, positive experience is a parallel where there's a mathematical relationship where a small number of items have a large impact while the majority have a much smaller impact. Those extreme events that bring up the average, we see parallels in and wealth distributions in society. You have billionaires, and most people are not even close.

Like the median household income in the U. S. Is about eighty thousand dollars or so, but the average income is much higher than that, and the average twice is much higher because we have outliers billion's the size of cities.

Few cities like new york, L. A, mexico city, others bring up the average city size around the world. Where's most cities have a much smaller population.

We see IT in business. Armin podcasting, the medium podcast only gets two hundred listeners per episode. The average podcast, it's much more because there are a few podcast, other they do incredibly well.

Our podcast is in the top one percent of podcast buy listens for episode that helps spring up the average. But most podcasts actually fail. Look an estimate at how many podcast are out there.

And IT looks like it's it's around spotify, around four point seven million. That's how many they have on the platform, not how many are active, but just how many are out there. So let's say there's four to five million podcast that have been created shows since podcasting came about.

How many do you think actually published an episode or how many episodes published in the last ten days? Only two hundred and thirty thousand and some of those podcast, the podcast daily. So only a fraction of the podcast that exist or used to exist, actually still podcast on a regular basis is called pod fade.

That's an example. Positive skies where the vast majority fail or they just not publish anymore while the few that continue, even if that a small subset gets the majority of listens. Same for youtube.

Very similar. Same for businesses. This is data that are link to in the notes by the beer labor statistics. Fifty to fifty five percent of businesses failed in the first five years. Only one third survive after ten years, and twenty percent after twenty years.

And if we look at the average revenue and profits to crossed private businesses, that average would be much higher than the middle, the media, the mode. The most frequent outcome would be to go out of business. The medium would be much less getting by don't okay.

Where's ever would be much higher because of those that do incredibly well. Now that doesn't mean that the media don't run equality business. And this is where we let me think about positive students. We can beat ourselves up because we're not incredibly successful at what we do. Our youtube channel isn't the most popular or isn't meeting our expectation.

And if you're in any creative endeavor or financial business and diverse natural to want to compare, and we're always comparing ourselves who ever doing Better than us, but often times you're doing Better because of luck. Something about the algorithm, pick them, recommended them, people discovered red them, sure they're good at what they do, but that doesn't mean the median youtube or isn't good. The equality isn't there.

There's other elements that contribute to IT. That's why you go to an industry conference less dear, my sons and I went to fin con. I don't like to attend the sessions.

I just like to to meet up with people I know and and get to know new people because invariably, especially the keynote sessions, somebody will come. They're been incredibly successful at podcasting, let's say, or their blog. And then they'll try to tell us this is what you do to be successful, like gas.

And then the things they tell you to do with the same things everybody else is doing, do quality work, have an email list, keep connecting things like that, which work, but they don't work to the extent of somebody that's incredibly successful because there's an x factor often, that's look how then do we use power laws and positive skill to our advantage in investing in business and our creative endeavors? Well, first, we want to lower the volatility. We want to reduce the probability of ruin.

If we're starting a business, we want to bootstrap that business instead of taking outside funding. The vast majority of firms that take outside funding, such as from venture capitalists or into investors, they fail. That's the model because often times they've taken this funding and they're trying to grow, grow, grow, gain markets, but they haven't really fleshed out their product quite yeah and that doesn't quite have the fit and they blow through a lot of capital and then the funding stops and they ve never figured out a successful business model.

We're doing this with asia camp. This is our our stock market research service, where we help individual investors analyze index funds and locate capital based on expected returns, valuations, dividends we launched a year ago. It's been a continual iteration, trial and air.

What is IT that takes to get traction with potential subscribers? What do they want? How can we approve IT? How do we Better explain what IT is? But we both strapped IT because we knew it's gonna anything IT takes time to figure that out, define that right fit.

And we lower the volatility by not being beholden to outside investors. We can low volatility. In terms of our career choice, dentist as a career exhibit less positive skills.

The average income for dentist is closer to the median income for a dentist. Now we can choose a highly violated career or endeavor to recognize the failures. Rate is high and it's Better to have a backup, a reserve. And if we were an actor or a singer were trying to a podcast and that's or enemy, we we want to make sure living expenses are low because IT can take time. And in that endeavor, we need to structure a life.

Our financials, assuming that we're going to be the media and outcome and try to get to just just try to get to the middle that we can make IT just doing okay, recognizing perhaps will be that extreme outcome that's extremely successful. Not likely because IT isn't just a question of hard work or skill, is usually something else outside of our control, and we call that luck. And so when we're doing anything, assume we're gonna strive for the middle outcome, keep the volatility down so that the the probability of ruin is low.

Another example, positive stress is the eighty twenty rule. Eighty twenty rule s says that eighty percent of the effects comes from twenty percent of the causes. So in a business, eighty percent of the sales might come from twenty percent of the customers.

And so there is an example positive you is because a few of those customers probably generated book of the revenue. But the eighty twenty just sort of focusing on this paradox principle that eighty percent of the effect the outcome is because of twenty percent of what's there. We can use that principle along with positive skills, with any endeavor.

We try multiple things, are doing lots of experiments, and then we focus on what's working. We focus on the twenty percent, and then we try to make that twenty percent Better and see what's working. And hopefully, that allows our endeavor or to be successful, not massively successful because that's out of our control, but reasonably successful because we're focusing on those things that have broken out of the pack.

Better exhibiting the positive is the morale outcome, whatever is working focus on that. Another example of my investing is crypto currency. I was first learned about bitcoin in twenty twelve and then experimented with IT over the years.

We've done twenty five episodes in the past decade on IT coin, both regular podcast episode plus episode we discussed in episode first bitcoin episodes in April twenty fifteen. I purchased bitcoin shortly after that and have been adding to IT as well as other cyp to currencies. I purchase light coin about the same time as I purchase bitcoin, and light coin just basically worth about what I was.

It's appreciate a little bit, but not the type of success we've seen with bitcoin then. And I have many crypto to thirteen. Most haven't done anything. Bitcoin in the theory um have done incredibly well. Bitcoin and a theory um have brought up the overall value of my crypto portfolio such that it's worth ten percent of my net worth.

And now on i'm in a position do I let the winners run? And after doing this, the national debt series episodes the episode on currency to basement with fiat currencies and seeing how bit point has evolved, its institutional acceptance, its regulatory acceptance, that the fact there are now bitcoin eat at. And to the point that I used to just keep rebalancing, i'll just let IT run.

It'll be an example of hopefully taking advantage of positive skill. Not knowing what's gonna en, but recognize IT could in more likely fall fifty percent again, I don't think go to go to zero, but there is always that chance. But i'm in a let positive stress work in my favor when IT comes to bitcoin, i'll see how that works out.

I will check back in five years. There are times so that we went to benefit from positive skenes where we want to speculate, we want higher volatility, we want to let our winners run, but we don't want to do IT in a way that can ruin us for much. What we reduce, the impact of positive business, we diversify.

We seek to law of volatility, the likelihood of ruin, our exposure to negative extreme events. We purchase insurance, home insurance. We discuss that.

Last week, I finally found a policy for thirteen hundred dollars a year so that, that was good on that front. Often times, we have a barbell approach. There are aspects of our lives that we want to be exposed to, positive business and the benefits of that.

That's on one side of the bar belt, but there are others where we don't want to be exposed to IT. So they were not ruined, but we have those experiments and we're iterating. We'll see what works out and we'll see what's working.

And then we double down on that, leveraging the eighty twenty principle and keep iterating and trying. But we don't beat ourselves up if are not incredibly successful because most people aren't. And we can control that.

We can control the quality of what we do, the quality of our communication, quality of our work. We can control the outcome. And we want to build a lifestyle based on the median outcome. And if we happen to get successful, incredibly successful, please don't write a book telling people these are the ten steps to how to do that because there is that x factor of luck and it's not formulation. That's just the way power law's work.

There's that level of unpredictably and unexplainably of any thing that extremely successful, which is why so hard to pick which movie would be successful or book or any other creative endeavor or business for that matter. That's our discussion on the power of positive skills. Thanks for listening.

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