NCPA - National Center for Policy Analysis


May 3, 2007

Stocks have been a great investment in the last 80 years, but surprisingly, investors in the stock market have not done as well as the stocks they trade, says Hal R. Varian, professor of business, economics and information management at the University of California, Berkeley.

The discrepancy, outlined in a new study by Ilia D. Dichev, a University of Michigan accounting professor, is that to calculate a meaningful measure of the investor's return, it is necessary to weight the yearly returns by the dollars invested during that year.

When this is done, according Dichev:

  • An investor who bought a value-weighted portfolio of stocks in the New York Stock Exchange and American Stock Exchange in 1926 and held them until 2002 would have earned an average annual return of about 10 percent.
  • By contrast, an individual who bought in 1926 but moved his dollars in and out of the market in the same pattern as the average dollar invested in the market would have earned a return of only 8.6 percent a year.

For Nasdaq, the difference between buy-and-hold and dollar-weighted returns is even larger:

  • An investor who bought the Nasdaq index in 1973 and sold in 2002 would have earned an average yearly return of 9.6 percent.
  • But the typical investor in Nasdaq earned only 4.3 percent over this period.
  • This is true not just in the United States -- the same thing occurred in 18 of 19 international markets that were examined.

Taken together, this research offers yet more support for the time-tested investment strategy of buy and hold, says Varian. Trying to outguess the market is a sucker's game.

Source: Hal R. Varian, "Sometimes the Stock Does Better Than the Investor That Buys the Stock," New York Times, May 3, 2007; based upon: Ilia D. Dichev, "What are Stock Investors' Actual Historical Returns? Evidence from Dollar-Weighted Returns," University of Michigan at Ann Arbor, December 2004.

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