What does it mean when people say they "beat the market"? How do they know they have done so?
"Beating the market" is a difficult phrase to analyze. It can be used to refer to two different situations:
1. An investor, portfolio manager, fund or other investment specialist produces a better return than the market average. The market average can be calculated in many ways, but usually a benchmark - such as the S&P 500 or the Dow Jones Industrial Average index - is a good representation of the market average. If your returns exceed the percentage return of the chosen benchmark, you have beaten the market - congrats! (To learn more, read Benchmark Your Returns With Indexes.)
2. A company's earnings, sales or some other valuation metric is superior to that of other companies in its industry. How do you know when this happens? Well, if a company beats the market by a large amount, the financial news sources are usually pretty good at telling you. However, if you want to find out for yourself, you need to break out your calculator and request some information from the companies you want to measure. Many financial magazines do this sort of thing regularly for you - they'll have a section with a title like "Industry Leaders." We don't suggest you depend on magazines for your investment picks, but these publications may be a good place to start when looking for companies to research.
I think most people think of one index when they say they beat the market and it’s usually the S&P 500. The follow-up question should be, for what time-period are you referencing? The answer is usually for a short-time, not the long haul. I would say, just forget about beating the S&P. A healthy responsible diversified portfolio would hold lots of different investments, not just stocks. Comparing all those different investments to just one market is like comparing a piano chord to one little note. Best to calculate how much return you personally need from your investments and use that for comparison.
I know it's tempting to compare stocks to your portfolio especially during bull markets. Diversification can at times feel frustrating, you hear in the headlines that the market is breaking highs and you're hoping your diversified portfolio follows suit. It's critical to remember that diversification among asset classes like stocks, bonds, international and alternatives should show less volatility when the markets are down and when the markets are up. A diversified portfolio can reduce risk and increase returns as well.
An example we use is 2008. That year, the S&P was down almost 40 percent. A truly diversified portfolio should have lost less than half that, a huge difference to your bottom line. Ideally, instead of saying I beat the market, say I’m on track to meet my personal investment needs – boring but better.
That almost makes me chuckle...people are fond of saying that they "beat the market", but very few of them even know what that means, or if it's even true. There are many comparison market indexes, such as the Standard & Poor's 500 Index, the Wilshire 5000 index, the Dow Jones 30 Industrials index, etc. Possibly the broadest, most relevant index is the Wilshire 5000 index.
So, to know if the statement "I've beaten the market" has any value or merit, you'd need to know the following:
- Which market index are they referring to?
- Over what time frame?
- Is the performance before or after fees, costs, taxes, etc?
- How have they accomplished it (just to validate the possibility, or not)
Hope this helps. Performance reporting is meant to be standardized, but few individual investors use a standardized method, and it's not unusual for any two investors to have different returns during a given period due to timing differences, money flows, etc.
When someone says they “beat the market” they usually mean their portfolio(s) achieved greater returns than the S&P 500.
More people feel they beat the market than actually do so. Jackson National Life did a survey of financial advisors in 2013 asking how many had beaten the market in 2011 and 2012. Fully 75% of the financial advisors claimed they had beaten the market. That is not surprising if there is no data to verify the returns. Experiments have been done asking how many drivers feel they are better than average and 75% or so will say they are better than average. There is data for financial advisors for that period of time.
Cerulli and Associates did a study of actual returns of financial advisors. They found the cumulative return of financial advisors for 2011-2012 was 4%. The S&P 500 was up 17%. It is impossible that 75% of advisors beat the market.
When I worked for national firms those brokerages did not track actual performance. It was just a feeling not based on facts.
To be sure that a financial advisor does indeed beat the market that advisor has to have an independent party compute returns for all clients including those who terminate their accounts. Then a composite can be put together and compared to the S&P 500. You can see an example by checking my webpage www.adamsfinancialconcepts.com. Those returns can be audited and verified by an independent party.
Beating the market is difficult to do. Eugene Fama shared the Nobel Prize in Economics in 2013. His work showed fewer than seven percent (7%) of professional money managers actually beat the market over the longer term.
Very good question! My oldest kid who just starts to show some interests in investing asked me the same question the other day. When people say “they beat the market”, it usually means their investment or portfolios have generated a better return than what they benchmarked against. But, here’s the question-- which benchmark: S&P 500, Dow 30, or an international benchmark? Unless you only have one fund, say, a large-cap, S&P 500 may be more relative. On the other hand, if you have a portfolio with mixed asset classes, large-cap, international, emerging markets, and bonds, suddenly comparing your customized portfolio to the S&P 500 becomes inaccurate. It is like comparing apples with oranges. Should that be the case, you need to have your own customized benchmark to compare. Best!