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I was an accounting major in college. I was pretty good at accounting and auditing, but struggled in my finance classes. To be fair I only had to take two finance classes to graduate.
Now that I'm working in the "real world" I have a Roth and am obviously starting to contribute. This got me thinking about something I heard once in a Finance class.
Will someone explain to me what people mean when they say that very few people can "beat the market"?
Does this mean that, in the long run, few professional investors (and individual investors) will be able to get a higher return than the market provides? Sure some years might be better than others, but overall will returns revert to be about equal?
If so, why do we pay fees to these companies? Is it because they have a good idea of how to engage in asset allocation based on risk tolerance? If someone can't beat the market, why wouldn't I just put all my money in the S&P 500 and just tell them to stop charging me fees for managing my money?
Question asked and answered. You shouldn't pay much more than a percent in investment expenses at the most to have someone manage your money.
The reason that most fund managers can't out perform the market over time is that as a portfolio grows in size it has to diversify into more and more stocks, thus becoming more like the overall indexes.
The other option is to do your own stock research and buy them individually. But only if you want to spend a lot of time equivalent to a part time job at least to immerse yourself in investing.
If that sounds like too much time just buy funds that mirror stock indexes. Vanguard is one of the lowest expense companies in the industry.
I think you did answer your own question. It is possible to beat the market, but never a guarantee. The trick is you must focus on the cheapest actively managed funds. Those funds have the best chance at beating the market. But there is no guarantee, so you can't be faulted for just buying a cheap index fund.
But I'll use Vanguard Wellington as an example of a cheap actively managed fund that has beaten the S&P 500 over the last 20 yeas. Not by a huge margin, but it did so with much less volatility because it's a balanced funds (owns a mix of stocks and bonds). It only charges .26%, which drops to .18% once your balance hits $50,000. The premium it charges over what index funds charge is very small, so it's one example of a fund that's worth looking at. Another all stock fund would be something like Vanguard Equity Income. It has also beaten the S&P 500 over the last 20 years by just over 1 percentage point. That adds up over 20 years. It also only charges .26% and .17% for balances above $50,000.
Don't pay ANYONE to manage your money. Vanguard does not recognize "timing the market" as anything that an advisor does. Once you decide on a bond/stock allocation ratio, all you do is rebalance. Anyone with a 3rd grade education can do that. Don't pay anyone else to attempt to beat the market, pick winning stocks or pick winning mutual funds. Invest in index funds and rebalance. Done.
the problem is that the information age has made every stock picker pretty smart . they have actually gotten to good at what they do .
in order to beat each other someone has to make a mistake and mistakes are becoming rarer .
in order to buy low someone has to make a mistake and sell low .so stock picking has become a lot harder to do because everyone has been getting so good at it .
but there is a tipping point . as more and more index that may end up the mistake ,since with everyone piling in to the same stocks the value will be every where else .
Last edited by mathjak107; 08-17-2016 at 02:56 AM..
Will someone explain to me what people mean when they say that very few people can "beat the market"?
Does this mean that, in the long run, few professional investors (and individual investors) will be able to get a higher return than the market provides? Sure some years might be better than others, but overall will returns revert to be about equal?
You are pretty much correct in your thinking.
The catch, though, is the details. What exactly is "the market" and what does it mean to "beat it"?
For instance, the market can be:
- The S&P 500
- The total US stock market
- The global equities market
- The universe of all investible markets
- A specialty market (such as the Small Cap equities market)
- An index or benchmark
And then beating it can be:
- outperform on total return
- outperform on real (inflation adjusted) total return
- outperform on a risk-adjusted basis.
And to make matters worse, the time frame you pick to assess whether something has "beat" something else makes a huge difference.
In some sense the whole discussion about "beating the market" really does not make sense and becomes a pointless argument. It makes more sense, IMO, to define your investing goals and assess whether you are achieving those. Investing is not really a contest as to who does the best (at least it is not for me); it is a matter of achieving financial happiness.
Today most people seem convinced it is not worth trying to beat the market and so they index because it's low on the expense side. That's fine. If you want to invest differently I would suggest buying stocks yourself, and probably don't do it with all of your money. Maybe dump 3/4 into the index, and then the other 1/4 into a separate account where you buy your own stocks.
The market is not always correct, even with the information age in full swing. Perhaps somewhat ironically, the dot-com market in the late 1990's created one of the biggest valuation disparities in history (between "cheap" stocks and "expensive" stocks). Widespread access to press releases, earnings reports, stock quotes, etc, did not create a market that was more efficiently priced. This is because investing is as much about emotion as it is about intellect. The big mistakes that people make tend to be behavioral in nature. If you pay attention you will get a few "fat pitches" to swing at during your adult life, and then you should swing hard. Most people will dismiss this as being too dangerous, but again I'll point out that you shouldn't do this with all of your money.
Today most people seem convinced it is not worth trying to beat the market and so they index because it's low on the expense side. That's fine. If you want to invest differently I would suggest buying stocks yourself, and probably don't do it with all of your money. Maybe dump 3/4 into the index, and then the other 1/4 into a separate account where you buy your own stocks.
The market is not always correct, even with the information age in full swing. Perhaps somewhat ironically, the dot-com market in the late 1990's created one of the biggest valuation disparities in history (between "cheap" stocks and "expensive" stocks). Widespread access to press releases, earnings reports, stock quotes, etc, did not create a market that was more efficiently priced. This is because investing is as much about emotion as it is about intellect. The big mistakes that people make tend to be behavioral in nature. If you pay attention you will get a few "fat pitches" to swing at during your adult life, and then you should swing hard. Most people will dismiss this as being too dangerous, but again I'll point out that you shouldn't do this with all of your money.
do you have an account that you use for picking your own individual stocks? if so, could you provide your YTD, 1 yr, 3yr, 5yr, 10yr, Life returns?
nobody seems to do this, so i will post mine so people can see what i am talking about (info is mine except the total dollar amount):
The Market Return is the weighted average of every investible asset in the world including stocks, bonds, sovereign debt, real estate, commodities, exotic financial instruments, etc -- everything. It should include art, classic automobiles, vintage Rolexes and other non-traditional assets from the point of view of academic finance.
From the point of view of actual practitioners of portfolio theory and financial planning, it usually means the more liquid and traditional of these. It is a market basket of the Economy of Earth.
This points out that "beating the market" is a zero-sum game. Let’s say averaging all the investible assets together gives a Market Return of, say, 5%. In order for you to “beat the market” of the Market Return by earning more than 5%, someone else MUST under-perform by earning less than the Market Return of 5% because it all adds up to the Market Return of 5%. This isn’t the fictional Lake Wobegon where everyone is above average.
Note that when professional money managers talk about beating the market in the popular press, they usually mean beating the S&P 500 rather than beating the Market Return. Academic professors usually mean the true Market Return.
Expected returns of course are how much you make on average over time on an investment or a strategy, while risk (for most of us) is the possibility that over that time horizon you don’t get your expectation because the real world interferes.
Starting with the big picture, why is there a positive expected return on an asset or investment strategy? Let's make it even easier & say positive expected return relative to what academics assert is the risk-free rate of return, a one-month US government T-Bill? (Academics always define this as the risk-free rate of return).
There are 2 possible reasons.
In a rational world, you should earn a positive expected return from bearing a risk that some other people don't want to bear. And the risk/return function is neither linear nor constant over time -- you should earn a larger expected return when the downside risk can hurt you exactly at the point in time where it hurts the most, and less (or even zero) when the downside risk can only hurt you when all is otherwise well.
Second, in the real world that contains some irrationality, you can get some expected return at the expense of someone else's mistake (or, conversely, pay for your own mistake). Remember, this part is zero-sum to the Total Market Return.
Then, you need to parse expected returns along 3 dimensions, looking it from the point of view of both the rational case and the irrational case:
1. The expected return for owning any of the usual asset classes (stocks, bonds, commodities, real estate, etc).
2. The expected return you get from pursuing any of the well-known strategies such as value investing, momentum investing, and carry-based investing. These are fundamentally different from the returns in (1) as, for instance, in examining value investing you don't count the expected return from just being long stocks, but rather the extra return that has historically accrued to value stocks vs. the universe of all stocks. These strategies also tend to be far more dynamic than the asset classes in (1), changing their portfolio holdings more often through time.
3. The expected return you get from being willing to take the risk of being exposed to economic or other risks such as potential shocks to inflation, Russians invading the Crimea, the Chinese hypothetically deciding they want to promote the Yuan to replace the Dollar as a world reserve currency, Syrians deciding en masse to relocate to Europe, etc.
These are all somewhat connected & overlap a bit. For example, passive ownership of equities expose you more to risk of poor real economic growth than does passive ownership of bonds, which in turn exposes you more to the risks of higher-than-expected inflation. Small cap stocks expose you to more liquidity risks than large cap stocks. This goes on & on; there is no clear, clean decomposition of returns. You need to be comfortable with some ambiguity.
So... there are 2 ways you get a positive expected return, by taking a risk you get paid for that someone else doesn’t want to bear (roughly "beta") or by outsmarting someone else (roughly, "alpha"). There are 3 useful perspectives to examine the source of these expected returns: asset classes, systematic strategies, and risk factors. Still, you need to forecast expectations and risk for the future. The simplest way to forecast the future expected returns is based on how they have performed in the past 100 years. You can also forecast the future based on your theory of how the world should work (progressives and libertarians have very different views on how the world should work). And, you can forecast the future based on current valuation metrics such as Sharpe Ratios and the like. And of course it really would be nice if there were sort of a financial grand-unified-theory that explains it all, but there isn't.
This roughly is a 2x3x3 matrix where some components are not mutually exclusive and there is some overlap.
No I don't have a single account, nor even electronic records of all past transactions.
Does your brokerage report your IRR, and do they do it correctly? And can they give you an IRR using the same cash flows into some index? An account I held in the past did report a return on the account but it was not what one would have expected.
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