Why is it so hard to beat the market?
The lure of investing and making a lot of money in the stock market remains. Yet, the average investor has consistently underperformed the stock market by a substantial margin.1 Dalbar, which has been publishing this analysis for 29 years reports the same findings year after year.
Even after all of those years, why do investors keep buying individual stocks?
The tease of doubling your money
The Dalbar study is not all about stock picking. It has a lot to do with investor behavior—something that we see with many investors. Let me give you an example. In 2021 one of my clients contacted me about a large, rapidly growing company. The stock had risen about 60%+ during 2020 and this client felt that he should be investing in this company because it had done so well. At the time, the stock was trading at all-time highs and was considered expensive by a number of valuation measures.
When I spoke with him further, he did not realize this or the fact that he already owned the stock in several diversified funds. Then, in 2022, it fell by one-half. It has taken almost two years for it to recover from that decline.2 Thank goodness he did not concentrate a lot of his wealth in this one stock.
Wishing you had invested before the big run up
My point is that humans often look at recent history and expect it to be repeated again. In addition, humans also look wistfully at what could have been by somehow thinking: ‘If I invest now, I can have some of the great returns that have already happened.’ I’m hearing this now from some clients who want to get in on the big AI craze. Unfortunately, most of the time it is too late once the idea or stock has made it to the top of your news feed. And no one can turn back the clock as much as we wish for it. Historical returns are just that—historical, in the past.
Even professional investors like to have you believe that their stock picking is worth it. Nearly all investment managers, hedge funds, private equity funds and other institutional managers claim to have a “secret sauce” or “proprietary algorithm” that is able to outperform the market averages or invest with half the risk or both. I guess it is a business that Wall Street finds too good to give up. (When you see the fees that are earned by some institutional managers, you can see why.)
The future
The real question that every investor must answer is what is the future for the stock, the industry, the economy and the market? These are impossible questions to answer accurately and consistently over long periods of time. When I worked at various mutual fund companies early in my career, there were many very bright minds tasked with picking stocks to outperform the stock market. Few succeeded but when they did, it was almost always for a short period of time, one-year, three-years or occasionally five-years. Then, the tide would change and the investment would end up near the bottom of every list and ranking.
As the years passed, I grew tired of seeing great performing investments fall and take away all of the gains, and sometimes part of an investor’s original investment. It was painful to watch.
Taking a long term approach
At Financial Planning Solutions, we primarily use index funds and exchange-traded funds (ETFs) to execute client investment plans.3 These are diversified investments that mitigate the single company risk associated with holding individual stocks.
In addition, we take a long-term approach to investing. What is long-term? –a minimum of three- to five years or more. Our portfolios are built for growth, income, or stability based on a client’s individual risk profile and their lifestyle needs. It is an integrated approach that attempts to avoid being forced to sell when stocks are down or minimizes tax implications or both.
If you want to better understand why beating the market is so hard, you should pick up a copy of Burton Malkiel’s book, “A Random Walk Down Wall Street”. In this seminal book Malkiel states that the stocks of publicly-traded companies are efficient, meaning that there is very limited opportunity to uncover hidden value and beat the market. He concludes that a better way to invest is through passively managed index funds.
Got questions about investing? Give me a call. I’m happy to review your situation and investments. You can schedule a quick call with me by clicking HERE.
Lyman H. Jackson
Lyman@PlanWithFPS.com
617-653-3303
1Source: Dalbar.com and prnewswire.com on 7/22/2024, from the Dalbar Quantitative Analysis of Investor Behavior, published annually.
2This is just one story. I’ve seen this scenario repeated dozens of times over the years.
3The firm does use some proven actively managed investments in selected areas where we see opportunities or where we believe an index may have unusually high risks given current market conditions.
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