Can Individual Investors Beat the Market? If so, how can you?
I recently read this astounding statistics. Between 1993 and 2012, fund investors have underperformed the S&P500 index by an average of 4% points a year.
Not only this, but the hedge funds have generally underperformed the index in the last 3 years significantly. And Buffett is now winning the bet with the Wall Street where he wagered $1 million that over a period of 10 years hedge funds cannot beat the S&P 500 index.
And yes, the often mentioned statistic that 80% of the mutual funds under-perform the index is true.
So, what chance do you have to beat the market.
Turns out, more than you can imagine.
But first, realize the following
- You can never hope to do better than the index by investing in index funds
- Think a good fund manager will do better? Think again. They are so much scared of under performing the index that most of them have turned into a closet indexer. This includes hedge funds
- Nobody cares about growing your wealth as much as you do – a fund manager’s compensation is not much different whether he gets you a 10% return or a 12% return. For you on the other hand, money compounds and over a period of years the difference is huge
In the world where everyone and their barber is indexing, if you keep your eyes open you will spot opportunities that everyone misses or ignores.
In some cases, the indexing phenomena itself can work for you by handing you a golden investment opportunity. Consider a stock that every other investor in the land is actively selling, for no good reason other than it was just removed from the index. Happens all the time.
Follow the herd and you will be selling this stock too. Step out of the herd and use a rational eye and you will be buying this stock hand over fist.
If fund investors underperform the index by 4%, who is out performing the index?
Let’s get back to discussing the statistic I mentioned at the top of this post.
It is not hard to realize that the return of the index is an average of the returns of the individual stocks that make up this index. Take it a bit further and you can see how the return of the index that represents the stock market is essentially an average of the returns of all the investors that invest in this stock market.
So far so good.
Now ask yourself this: If average fund investors perform 4% worse than the index, and the hedge funds are not any better, then there must be someone out there who is out performing the index to bring the average up.
This is a logical conclusion and there is no way to explain this away as a myth.
Despite the constant barrage of marketing from the mutual fund industry (and the media that does not know any better), you are not better off investing in a mutual fund – not even an index fund. Yes, you keep the costs down, in exchange for a guarantee of a mediocre performance.
Don’t know about you but “a guarantee of mediocre performance” is not what I insist on when I am looking for a product to buy.
Coming back to the original line of thought – if you remove the average mutual funds, and the average hedge funds, all you have left is an average individual investor who picks stocks on his own.
Believe it or not, a small investor who insists on picking stocks on his own, is the only type of investor who on average beats the market!
You probably remember Warren Buffett claiming that the small investors have incredible advantage over the wall street.
You never hear about them, because they are not the ones invited on CNBC or profiled in the Smart Money.
In fact the industry has a catchy name for these investors. They are often called the dumb money.
It is a little ironic to call winning investors dumb and losers “smart money”
How to Beat the Stock Market in One Word
Discipline in picking stocks
Discipline in choosing the right price to pay, and
Discipline in holding it for the correct time and selling when the targets are reached
It is all about setting a process and sticking to it with necessary tweaks over time as you learn for past investments.