by Only 8% of professionally managed funds beat the market over a period of 15 years.
Between 1999 and 2018, the average investor had an annualized return of 1.9% while the S&P 500 returned 5.6%.
So why do we continue to try to beat the market and fail time and time again?
In this post I’ll explain why you most likely won’t beat the market, and what you can do to increase your performance.
Contents
Why we try to beat the market
We all want to beat the market. “Beating the market” means to outperform a stock market index, typically the S&P 500. So if the S&P 500 has an annualized return of 5.6%, then beating the market would mean your portfolio exceeds a return of 5.6%.
Beating the market in the short-term is easy. Anybody can outperform the market on any given day. The goal for many is to beat the market over a long period of time.
We all think we have some extraordinary stock picking abilities. We read the news, we listen to podcasts, we read CNBC and watch Mad Money with Jim Cramer. We hear the latest stock tips from our co-workers at the water cooler. Remember water coolers? So pre-COVID…
We’re inspired by investors like George Soros and Warren Buffet, who have made an incredible amount of money from their investments.
Sometimes we get a gut feeling like: Apple is gonna go up big this year! Or Microsoft has been under-performing lately… time to buy!
What we don’t realize is that beating the market consistently over the long-term is extremely difficult not just for average investors but even for seasoned professionals.
I’m talking about professionals who study markets for a living. People who work full-time, 40-80 hours a week trying to determine the best investments. If they can’t beat the market, how can we?
Why we don’t beat the market
Most Professional fund managers don’t beat the market
What percentage of money managers beat the market?
In a comparison of professionally managed large cap funds, S&P Dow Jones Indices determined that after 10 years, 85 percent of large cap funds underperformed the S&P 500.
After 15 years, nearly 92 percent underperformed the S&P 500. Source: CNBC
To frame it another way, only 15% of professionally managed large-cap funds outperformed the S&P 500 after 10 years, and only 8% outperformed after 15 years! Yes, the professionals who sit at their desks and read financial reports, compare key ratios, and perform complex calculations all day every day are only beating the market 8% of the time!
That is an abysmally low success rate for people who invest for a living!
Imagine a basketball player making only 8% of their shots…
Or a baseball player getting a hit 8% of the time…
You are not a professional fund manager
We’ve just established that professional fund managers are beating the market only 8% of the time.
These are professionals who are investing 40+ hours a week reading financial reports and performing complex stock valuation calculations.
What percentage of investors beat the market? Likely less than 8%.
You still might have full confidence that you can beat the market. After all, you’re smarter than the average investor. That’s why you’re learning more on this blog!
Fine, if you still think you have extraordinary skills, you can try this Beat the Market Game which let’s you buy and sell based on real stock market valuations from the past. Let me know how you did!
You are human
The trading mantra is “Buy low sell high”.
It’s easy to examine the S&P 500 from 2017 to 2020 in hindsight. Here’s what an ideal trading scenario would have looked like:
Sadly, what tends to happen is this:
FOMO
When the economy is doing well and the stock market is humming along, we get the Fear of Missing Out (FOMO). We think that the only path is up and if we don’t throw our money into the market now, we’re going to miss out on huge gains!
Unfortunately, often times it is at these precise moments that the market is due for a correction downward.
Looking at the Figure 2 above, there were numerous times when the news painted a rosy picture of the economy, only for stocks to plummet shortly after.
In March 2011, commodities were all the rage. Silver was going nowhere but up! My FOMO kicked in and I bought silver at $40 a share. Today it’s valued at $21 a share. OUCH…
Loss Aversion
We (as humans) tend to react differently to gains and losses, even of the same magnitudes.
In this example of loss aversion from Wikipedia, a $.05 gain provides a value gain of 17 units, while a loss of $.05 provides a value loss of 40 units.
So you can imagine that a $100 loss hurts much more in magnitude than the pleasure received from a $100 gain. This phenomenon is called loss aversion and it tends to negatively impact the investment decisions we make. The fear of loss can cause us to sell too early, or never buy in the first place, and thereby miss out on huge gains.
When the market hits a local bottom, our reaction to loss aversion kicks in.
After experiencing a large decrease of say, 20% or 30% from the peak, you might feel that it’s best to just sell now to avoid further losses. Because the pain of another 20% loss is just too much to bare. Does this feeling sound familiar to you?
Unfortunately, often times it is at precisely these junctures that the market is due for a correction upward, as can be seen in Figure 2 above.
In November 2014, I bought Amazon stock for $338 a share.
By January 5, 2015 it had hit $290 a share. It felt absolutely terrible to be down over 10% in just two months.
Luckily, the price recovered to $354 by January 26. I thought, what a relief! …
I quickly sold my stock, thinking that I’ve got my money back plus a small profit and I don’t wanna risk losing anything again (my loss aversion kicked in).
Besides, the P/E ratio was extremely high, which could have been an indication that the stock was overpriced.
Now we all know today that Amazon basically dominates the online shopping market and that it’s done phenomenally in the past few years. How phenomenal?
As I look at the stock price in 2020, it sits at $3008 a share!!!
It pains me to think I missed out on an absolutely crazy run and huge gains… all because of my loss aversion. We sure know how to time it perfectly don’t we?
The average investor seriously underperforms the market
What percentage of investors beat the market?
According to a J.P. Morgan Asset Management study, the average investor had annualized returns of 1.9% from 1999 to 2018. Over the same period the S&P 500 returned 5.6%. It’s clear to say that the average investor significantly underperformed and did not beat the market. Sadly the average investor, couldn’t even keep up with inflation of 2.2% over the same period!
Going Forward
Moves to make today:
Rather than picking individual stocks, ensure that you have a diversified portfolio, one that includes an S&P 500 index fund that closely matches the performance of the market. There’s no guesswork involved, no extensive research or ratios to calculate. You’ll be way ahead of professional portfolio managers who do this for a living and who also underperform 92% of the time.
By investing consistently in low cost index funds, month after month, using the dollar cost averaging strategy, you’ll match the performance of the index (less any fees) in the long run every since time.
Temptation to beat the market:
We all have that temptation to pick stocks sometimes because it’s fun! I get it.
Like Monica Geller from Friends buying shares of ZXY because it sounds “Zexy”.
But like professional fund managers, 92% of the time, if not more, you’ll be throwing your returns away.
Buying these “fun” stocks should be like adding candy to your diet. It’s tempting and exciting, but you wouldn’t make it a staple of your diet, just like you shouldn’t make “fun” stocks a staple in your portfolio.
Personally, only about 5 to 10% of my portfolio is comprised of personal (fun) stock choices. Everything else is mostly low cost funds like index funds.
My portfolio is a lot happier and has performed much better since I implemented this strategy. In my early twenties I bought many individual stocks, and you guessed it, significantly underperformed the market.
When you realize that you can’t beat the market, it frees your mind and your time to do other things. While some poor sap spends her week crunching numbers, you’ll be sitting in a hammock somewhere knowing that your portfolio has a 92% chance of beating hers. You’ll be doing substantially less work, getting better results, and moving closer to financial freedom.
Now I wanna hear from you!
Have you been able to consistently beat the market? Has FOMO or loss aversion affected your returns?
Everyone should read this.
Agreed, thanks for the comment.
With the Coronavirus pandemic in full view and stocks plummeting, it’s really hard to fight against the urge to sell… A few months later since the nadir in March, if only we invested more (doh!). I agree it’s really too hard to play the game and expect that we can beat the market.
Yup, trying and failing to time the market is a painful lesson to learn. One I have learned one too many times haha.