We all invest with the hopes that one day we will have enough money to live off our investments. The question remains, can a regular investor like us really beat the market? Do we have what it takes to win over the middlemen and institutions that have millions or even billions invested in the market? According to Terrance Odean, a finance professor at the University of California, Berkley's Haas School of Business, "Many of the mistakes investors make come from a lack of any understanding of the innate disadvantages they face."
David and Goliath
The answer to this question is not an easy one, and the answers will vary depending on who you ask. By "beating the market" we're talking about everyday working Americans who try to obtain greater capital gains and income return than the S&P 500.
David E. Y. Sarna author of "History Of Greed," explains it this way, "We all have some larceny in us. We buy securities because we think we know someone or something others don't. I don't think anyone can consistently outperform the S&P 500 without assuming greater than market risk."
Some of us might have the tools (and connections) required to make knowledgeable decisions that will lead us to a portfolio with higher returns, but others like stockbrokers, bankers and big corporations most likely have an advantage, right? While many people in the financial industry have insider information which they cannot legally trade on, they also possess the necessary financial statement analysis skills to develop a greater insight about a given company. Robert Laura, author of "Naked Retirement: A Stimulating Guide To A More Meaningful Retirement" and President of SYNERGOS Financial Group says, "The reality is there will always be a lure to try and beat the market, especially since those who have beat it consistently are revered so highly (Bill Miller, Peter Lynch) and/or are compensated well (hedge fund managers). I think the market can be beaten, but even a broken clock is right twice a day. Best way to describe it: It's possible but not probable."
According to Laura, the sad reality is, the average individual investor has little chance of beating the market. He says the common investor uses mutual funds, are stuck in 401(k) plans which essentially track the broader index, and pay higher fees as compared to stock, index funds or ETFs. Also many mutual fund type investments don't use stop loss order to protect gains and thus do not always provide the type of protection individualized portfolios can perform. As he puts it, "investors are set-up to fail from the get-go."
Investing in 401(k)s is no better. "Most 401(k)s aren't benchmarked and most companies don't have a good investment policy for selecting funds within the program. You can't even get some asset classes in many and most advisors are sales people, not fiduciaries and just taught how to sell funds," he adds.
The good thing is many more investors are taking responsibility and interest in their investments. They are taking the initiative to learn how their investments work and are less intimidated. Laura says investors are learning that individual stocks aren't as scary as everyone suggests and there is valuable information available to everyone if they know where to find it and how to apply it.
He adds, "The advent of ETFs and Index investing allow people to mimic the market, instead of trying to beat it, which is a better, less expensive perspective to have."
A Lost Cause?
Founder of FinancialMentor.com, Todd R. Tresidder, said in 2010 "All the evidence supports the disappointing fact that regular investors as a whole underperform the market. As long as they try to 'beat the market' they actually underperform."
The best way for regular investors to achieve better risk-adjusted returns is by focusing not on out performance, says Tresidder, but instead by losing less. In other words, regular investors have one competitive advantage - liquidity.
"Big investors are the market but the little guy is nimble and can buy or sell without affecting the market - something the big guy can't do. Systematic risk management can work to provide regular investors with similar or slightly improved investment performance relative to the market at substantially less risk," he says.
Helping the Odds
What can an investor do to increase their chances of "beating" the market? Laura says there are several things:
- Use low cost funds and/or a low cost platform for trades. The best way to make money is to save money.
- Establish and follow a discipline which translates into just doing what you said you are going to do.
- Give every investment in your portfolio a buy price, hold price and sell price along with one or two reasons to buy, hold or sell at that value. This gives you specific criteria to act and provides your portfolio with purpose and specific direction.
- Watch for headline risk. Set up email alerts for your investments so as new information comes out about them, you are aware of it in the early stages to consider changes. Mark your calendar for things to watch like earning dates, intellectual property timelines and industry reports like Federal Reserve meetings, unemployment numbers, new housing starts and other information that will affect the specific sector or security.
Sarna suggests investing in what you know and understand, such as solid, profitable small-caps and even microcaps in niches you can monitor and understand. These can appreciate much more rapidly than equivalently-priced large-caps.
The only way to get above market returns is to develop a competitive advantage says Tresidder. "It is either developed through knowledge and information flow, or it is developed through extensive research resulting in an investment strategy that exploits irregular market behavior."
According to Tresidder, the only way to outperform the markets is to develop a competitive advantage that exceeds transaction costs and passive market return.
The Bottom Line
The debate of whether an individual investor can beat the market is as old as the stock market itself. Those who have found fortune investing will often preach that they possess superior analytical skills which allowed them to predict the market. Those investors who suffer losses will tell a much different tale.
Options & FuturesPredated trades at regular intervals can instill confidence, not fear, for investors.
EconomicsThe better you understand why insider trading can be criminal, the better you'll understand how the market works.
Investing BasicsDon't rely on Wall Street analysts for information on these stocks.
Active Trading FundamentalsRisk is inseparable from return. Learn more about these measures and how to balance them.
Active TradingWriting bull put credit spreads are not only limited in risk, but can profit from a wider range of market directions.
InvestingAfter October’s better-than-expected employment report, a December Federal Reserve (Fed) liftoff is looking more likely than it was earlier this fall.
InvestingWhile stocks have rallied since the economic recovery in 2009, many active portfolio managers have struggled to deliver investor returns in excess.
RetirementWe discuss the advantages of seeking professional help when it comes to managing our retirement account.
Chart AdvisorThere has been lots of hype around the IPO market lately. We'll take a look at whether now is the time to buy.
ProfessionalsLearn what a typical early morning to late evening workday for a hedge fund manager consists of and looks like from beginning to end.
Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
Mutual fund investors have numerous items to consider when selecting a fund, including investment style, sector focus, operating ... Read Full Answer >>
Exchange-traded funds (ETFs) can generate capital gains that are transferred to shareholders, typically once a year, triggering ... Read Full Answer >>
A hedge fund is a type of investment vehicle and business structure that aggregates capital from multiple investors and invests ... Read Full Answer >>
While some Vanguard exchange-traded funds (ETFs) are available commission-free from third-party brokers, a large portion ... Read Full Answer >>
Vanguard completely waives any U.S. dollar minimum amounts to buy its exchange-traded funds (ETFs), and the minimum ETF investment ... Read Full Answer >>