MUCH OF THE MEDIA commentary about investing positions the individual as a heroic figure. We are, it seems, all supposed to deploy our expertise in a battle to beat the market, with bragging rights going to the winners.
Problem is, this framing is based on three myths.
Myth No. 1: Your job is to outwit the financial markets.
Underlying this is the notion that the key to investment success is to have rare insights and expertise not shared by anyone else, along with nerves of steel and almost supernatural timing ability. “Star” fund managers trade on this perception, promoting their talent in picking tomorrow’s winners. As we know from painful experience, such stars tend to burn brightly before crashing to earth.
The fact is, markets are highly competitive. Millions of participants, including armies of rocket scientists and savants, buy and sell stocks, bonds and other securities every moment of every trading day in pursuit of an advantage. Algorithmic trading systems seek a timing advantage measured in micro-seconds.
Result? All publicly available information—from earnings news to economic data to the published opinion of every stock analyst and economist—is already baked into market prices. Outguessing the market requires that you have profitable information that no one else has—and that you can predict how the market will react to that information. And remember, getting it right just once isn’t enough. You have to do it over and over again.
There’s an element of Don Quixote to market-beating wannabees. They imagine they have an elusive and mystical edge that nobody else has. In reality, those who go out every day, like the Man of La Mancha, with the intention of beating the market only risk making a fool of themselves.
Of course, there will always be individual managers who do better than their benchmark in any given year. But there’s also plenty of evidence from academic studies that the winners don’t tend to repeat. On top of that, it’s hard to separate those with skill from those who are merely lucky.
Standard & Poor’s produces a regular scorecard comparing the performance of active managers to index returns. This consistently shows that most struggle to outperform common benchmarks. For instance, 80% of actively managed U.S. stock funds trailed the broad U.S. market over the five years through June 30.
This isn’t just a U.S. phenomenon. In the five years through year-end 2019, more than 77% of European stock funds lagged behind the S&P Europe 350 index. Over three years, it was closer to 80%. Even over one year, more than 70% of managers underperformed.
U.K. funds did better—at least over one year. In 2019, 73% of actively managed stock funds beat the S&P United Kingdom BMI. But take the comparison out over 10 years and the proportion of U.K. managers beating the market was less than a third.
Myth No. 2: Top fund managers happily share the fruits of their hard work.
Let’s say you decide you aren’t going to put your money with index-lagging managers. Instead, you’ll only invest with the stars. Moreover, let’s go even further and assume that you are indeed able to pick the future stars ahead of time.
Now ask yourself: If these managers are so good, why would they be charitable and share the additional value they capture with you? A stock-picker with the rare ability to identify winners year after year would presumably charge a significant fee for his or her service. Those fees typically absorb most of the additional return, or “alpha,” that these managers earn, leaving relatively little for their investors.
Myth No. 3: Success is hurdling some market benchmark.
You’ll likely find that some years you do better than the stock market averages and some years you fall short, usually without any change in effort on your part. Much will hinge on how your assets are allocated among and within stocks, bonds, cash and real estate, as well as how much you pay in investment costs.
For instance, if your portfolio is 40% in safe government bonds in a year when stocks soar, you aren’t going to do as well as your neighbor who’s 100% in stocks. Conversely, in a bad year for share prices, your portfolio is going to do significantly better.
But all this is a big distraction. Your real benchmark isn’t beating the stock market. Instead, it’s how you’re performing relative to the goals that you’ve set. This approach may not sound as heroic and sexy as the image of the individual investor bravely second-guessing the market. But it will almost certainly yield superior long-term results.
Robin Powell is an award-winning journalist. He’s a campaigner for positive change in global investing, advocating for better investor education and greater transparency. Robin is the editor of The Evidence-Based Investor, which is where a version of this article first appeared. Regis Media owns the copyright to the above article, which can’t be republished without permission. Robin’s previous articles include Yesterday Once More, No Need to Guess and What’s the Plan. Follow Robin on Twitter @RobinJPowell.