Are You Beating the Market?
Why Most Investors Do NOT Beat The Market
Studies have shown that only a small percentage of individual investors can beat or even match the long term stock market returns. There are two main reasons for this. The primary culprit is that most try to time the market. They add to their holdings during boom times and pull out when the market drops. Not only does this “Buy High & Sell Low” activity cause them to miss out on market rebounds, which it has always done, but it also further reduces returns by adding unnecessary transaction fees and taxes.You may think the other main factor that causes individual investors to trail the stock market’s historical returns is poor stock picking but this is not the case. The lack of diversification is by far a greater contributing factor. Investors often wrongfully think that their stock picks are superior to others and therefore don’t need to hold many in their portfolios. They often refer to diversification as “di-worse-ification” because they believe owning many stocks will cause them to have average returns. In actuality, anyone whose stock market investing performance is matching the market’s returns is doing much better than the majority of individual investors.
Both of these factors are related to investor psychology. Most squander their returns by believing they can predict the markets and which individual stocks will outperform others. This mentality is reinforced by popular media outlets that highlight the latest stock picking guru or fund manager who has blown away the major stock market averages with their recent picks. These outperformers will always exist simply due to the law of averages. With so many people picking stocks someone’s going to rise above the averages. What is rarely covered are the 75% of mutual funds that trail the market averages most years or the large number of hedge funds that fail. Individual investors chase after these hot stock picks and funds usually to see them revert back to the mean by underperforming their peers.
A good example of this is Bill Miller’s Legg Mason Value Trust mutual fund which beat the market for 15 year years in a row from 1991-2005, the longest streak of its kind. Investors who tracked the results thought they were missing out on riches by not investing in this market guru’s picks and continued to pour money into the fund. Since then his fund has lost over 60% of its value and drastically underperformed the market.
Should I Invest in the Stock Market?
Investing in the stock market is a dilemma. There is no refuting that historically it is the best performing asset class far outpacing bonds, commodities, real estate, and gold. To achieve these returns investors must be able to survive periodic bear markets and crashes however. The financial crisis of 2007-2009 has given us a painful reminder of just how brutal the stock market can be. If you want guaranteed returns you have to accept low rates of return which often do not even keep up with inflation.For those who decide to invest in stocks you must realize that the value of your investment is out of your control. The most widely accepted theory is that stocks are valued based on their underlying company’s fundamentals and its future outlook. In actuality their value is determined by nothing less than how much someone else is willing to pay for the shares that you own. The whole system is based on confidence and when markets are unstable that confidence erodes and share prices plummet as we are seeing now.
If you have decided to accept these risks in return for higher long term returns then let MarketBeaters guide you along the way. Our disciplined approach to long term investing has a track record of consistently outperforming the general market. Learn More or Sign up now!
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