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.
“Beating the market” is a common phrase that means an investor’s performance was better than the S&P 500 or the general U.S. stock market.
This phrase isn’t the most accurate statement in the world of investing because there are so many different markets—such U.S. stocks, international stocks, emerging market stocks, U.S. bonds, international bonds, real estate investment trusts (REITs) and commodities, just to name the most well- known.
As an investor, it is important to define markets and group similar investments in order to compare these to a performance standard—what’s called a “benchmark.” A benchmark typically follows a well-known index and serves as the most representative measure of performance for a specific asset class.
Most people will just look at their performance and compare it to the S&P 500, but I would argue that if you truly want to understand how well you are doing as an investor, it is better to compare the securities (stocks, mutual funds, ETFs) to how they are performing compared to the index that best represents the same part of the investment world. For example, if you bought an emerging market mutual fund in your IRA, you should compare that fund with an emerging market index. You would not compare an emerging market mutual fund with the S&P 500:
They share none of the same stocks, the listed companies frequently contend with different risks and opportunities—and their economies and political environments can vary widely as well.
You can find online performance reports for mutual funds by going to a search engine and typing the fund’s name and “Morningstar.” This should take you to Morningstar’s website. Then click on the “performance” tab within the website. The chart below shows the performance of Vanguard’s Total Stock Market Index Fund, which is a U.S. stock fund, compared to a U.S. stock market benchmark. (Morningstar references benchmarks as “categories” shown in the below link. In this case, the benchmark is Category (LB) – U.S. Large Cap Blend).
If we compare the Vanguard fund against its benchmark in 2015, the Vanguard outperformed the benchmark (+0.29% vs. -1.07%):
The best method for you to start to review your portfolio’s performance against benchmarks is for you to look at one of your investment account statements. In the case of a 401(k), for example, start with your investment statement or with a 401(k) online performance report. Each investment option will be named; a benchmark will be shown directly underneath the investment. If you are not familiar with the benchmark, you can either Google the name of the index or call your 401(k) customer service number for more information.
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.
"Beating the market" just means that someone has out performed a relative benchmark or index. You see, instead of investing in certain stocks or funds, some people can choose to invest in ALL of them, which is essentially like investing in the entire market or index. However, what I see people missing and not fully understanding is that certain benchmarks pertain to certain sectors of the market. Unless you are comparing everything apples for apples, your comparison will be incorrect. One common benchmark is the S&P 500. However, the S&P 500 is made up of only U.S. Large Cap stocks. So, if you have international holdings in your portfolio and you're comparing your performance to that of the S&P 500, you won't be able to tell if you've actually "beaten the market" or not. See below for a reference on different sectors of the market and some common benchmarks.
Large Cap US stocks: S&P 500
International stocks: MSCI
Intermediate Bonds: Barclays US Agg Bond
Global Real Estate: S&P Global REIT
Large Cap Value stocks: Russell 1000 Value
Large Cap Growth stocks: Russell 1000 Growth
Small Cap Value stocks: Russell 2000 Value
Small Cap Growth stocks: Russell 2000 Growth
There are a lot of benchmarks out there. Just remember that when you're looking at performance, you have to be comparing apples to apples in order to truly know in you're beating or outperforming the market.
Joe Allaria, CFP®