Is the Stock Market Beatable?

Why Most Investors Do NOT Beat The Market

Repeated investment performance 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 following a major drop, but it also further reduces returns by adding unnecessary transaction fees and taxes.  A Morningstar study showed that the average stock investor trailed the major market average’s performance by 24% from 2001-2011. Furthermore, a similar Dalbar study over a 20 period ending in 2010 showed the S&P 500 averaged a 9.1% return while the average US stock investor achieved only a 3.8% return.  Don’t be fooled by the recent declarations that “buy and hold” is no longer effective.

You may think the other 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.  Superior diversification strategies are what trump the average individual investor’s returns rather than pure stock picking prowess.

In actuality, anyone whose stock market investing performance matches the market’s returns is doing much better than the majority of individual investors who continue to under-perform with untimely trading and incurring many unnecessary commissions. Marketbeaters suggests you invest for the long term through solid diversification and use of tax sheltered accounts such as IRA, SEP, or Rollover 401Ks.

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 out-performers 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 under performing their peers.

Some investors get whipped up into a frenzy after hearing of a hot stock tip they foolishly try to get in on the action.  Investors seeking to capitalize on trading patterns might do better in the futures or Forex market.

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’s losses reached over 60% of its prior value and has drastically under performed the market.  The plain truth is that there are no stock picking guru out there.  Over time everyone succumbs to the law of averages.  Consider the following facts that support this:

  • As of late 2020, 85% of active managers were trailing the S&P 500 after 10 years of tracking.  Over a 15 year history the percent of failing stock pickers jumped to 92%. This percentage is actually much higher if you count all of the funds that folded which don’t get included in the statistics. – CNBC
  • A 2019 study by S&P & Dow Jones Indices reported that 65% of actively managed funds lagged their passive index counterparts in 2018.  This was the 9th year in a row this has happened!
  • Historically 85% of large cap funds will under perform the S&P 500 over a 10 year period.  92% will underperform over a 15 year period.  – National Business Report (March 2019)
  • A 2017 study by S&P revealed that over the prior 15 years actively managed funds overwhelmingly underperformed their benchmarks (92% of large cap, 95% of mid cap, & 93% of small cap funds failed)
  • 40% of mutual funds in operation in 2004 had shut down by 2014 (source: Morningstar).  Funds that consistently beat the market rarely shut down.
  • Total return for investors from 2009-2013 averaged 6.4% verses a return of 7.7% had they remained fully invested which shows that trying to time the market rarely works.  -Morningstar study Nov 2013)
  • The average US stock fund returned just 2.1% verses the S&P 500’s return of 9.1% over the 12 months ending in July 2012.  -Kiplinger’s Personal Finance (Oct 2012)
  • In the past 5 years, more than 2 of every 3 mutual funds followed by Morningstar under-performed their underlying stock or bond index.  -Smart Money magazine (Feb 2012)
  • 64% of Large cap mutual funds under performed the S&P 500 in 2010.
  • More than 25% of actively managed stock funds under performed their corresponding indexes by greater than 5% in 2010. Only 7% outperformed by the same margin on the upside.
  • The S&P 500 returned an average of 8.4% between 1988-2008. Only 21 of 57 mutual fund families outperformed the index during the same period.
  • The S&P 500 beat 75% of actively managed mutual funds from 2002-2007.
  • The S&P 500 Index has returned 13.5% over the past half century vs. 11.8% for the average mutual fund on an annualized basis.
  • Only 11% of large company funds finished in the top half of their peer group in each of the past 5 years.
  • About 3/4 of active professional fund managers lag the S&P500 in an average year.
  • Only 12% of all mutual funds have outperformed the S&P 500 Index since 1970.
  • The average stock mutual fund replaces nearly its entire portfolio over the course of a year which generates trading costs that don’t get included in a fund’s expense ratio making their performance results actually worse than reported.
  • Over 80% of investment letters fail to beat the market over the long term according the the Hulbert Financial Digest.
  • Only 4% of diversified US stock mutual funds generally beat the performance of the S&P 500 Index over any given 10 year period.
If you want to calculate your long term performance verses the stock market you’ll need to maintain accurate records. Stay in line with financial regulations.  Original documents often need to be retained for proof of stock ownership in class action lawsuits like the large IPO case from 1999-2001 which was recently settled.