I have previously written about the odds being significant against any investor (professional or not) trying to beat the market. I have also written how just performing the same as the market (no better, no worse) will generally see you much better off than the majority of investors. For this reason, I conclude that index returns are greater than most investor returns.
Which begs the question….
Why is it so difficult to beat the market?
Higher fees
Trading in and out of the market and active investing both incur higher fees than you would pay if you just invested in the market and left it. Fees are a big contributor to how much money you make.
For example, an investment of $10,000 a year for 30 years will provide approximately $1 million on fees of 0.5% and pre fee returns of 7.5%. Now assuming the same scenario but with 1.5% fees, your balance would be $830,000 or so. $170,000 less.
Obviously there is more to an investment than fees, but it is hard to know in advance which funds will outperform. Fees are known and within your control.
More risk
Trying to beat the market requires making more concentrated decisions. Picking certain shares or niche segments that you think will perform better than the rest.
With more concentration, you have less diversification. Less diversification means you have a greater chance of greater losses than you would otherwise. Especially if your decision proves wrong.
Market timers think that diversification is for losers or dummies. With diversification you are sure to hold some losers. But you are also sure of holding on to winners. Picking and choosing you are not assured of anything.
Greater volatility
It is not intuitive for everyone, but larger losses require greater gains than you need otherwise.
Concentrated investing can have higher highs than you would receive otherwise, but they can also have much higher losses. If a particular share or niche fund loses 50%, you need 100% gains just to get back to your starting point again. Whereas if you were invested more widely and lost just 20%, you would only need 25% gains.
It’s not enough to look at average returns. Because you can have the same average return between two investors, but one could have much more in the pocket due to not having such low lows. Averages don’t matter as much as risk adjusted returns, aka money in your wallet.
Short term focus
Most market timers go after short term trends, rather than focus on the long term. They aren’t willing to ride out periods of under performance. Selling losers just before they turn around and become winners. Also buying winners by chasing the current fads just before they turn into losers.
The old adage of buying high, selling low, definitely applies to a lot of market timers out there. Chasing fads and trends AFTER they have already been recognised and priced in, and selling good shares AFTER they have dropped in price.
The behaviour gap
Trying to beat the market involves making more regular decisions. More decisions opens up more mistakes. As much as we like to think we are great decision makers, we all have inherent biases.
Overconfidence bias where we think we know more than everyone else. Recency bias where we place too much off an emphasis on the here and now which can lead to assumptions about how long current conditions will continue. Resulting where we correlate outcomes to the decisions we made, where a result may have not much to do with what we did or didn’t do. Hindsight bias where everything that previously happened seemed obvious. Attribution bias where good results are a result of our own actions and bad results are the result of some external factor(s). Confirmation bias where we deliberately seek only information that confirms our own beliefs. To name a few.
There is a reason that investors perform much worse than the markets. The reason is we are terrible decision makers. By making active decisions towards certain shares or niche funds you are far more invested in the results than if you were not so actively involved. More invested means more tinkering.
From the Morningstar mind the gap study:
The difference between investment returns and investor returns
You saw the difference 1% in investment fees can make. Add onto that over a 1% penalty for investor behaviour and we as investors are leaving a lot of money on the table.
Don’t know when to stop
If you are losing money or not gaining as much as the market, when will you decide to stop? You have a hard decision to make. Try and recover from your losses and double down on the strategy or bite the bullet and accept defeat.
Lose sight of goals
Investing when done right serves a purpose. Money is there to be used eventually. You want to invest according to your goals and when you need the money. By investing for the sole reason of beating the markets and not according to your goals, you won’t know when you have enough to meet your needs. Thereby taking on too much risk for far too long.
Too much trust in the news
By attempting to beat the market you will typically digest as much news and financial commentary as you can.
For one, following short term events for something that should be long term is a recipe for failure. Secondly, reacting to news is so difficult because you can just as easily find a reason for why something won’t happen instead of why it will happen.
You have to first predict exactly what is going to happen. Then decide exactly when it is going to happen (it is no good being too early or too late). Then decide to what extent the event will have. Then you have to predict how the collective millions of people investing will react to said event. Then you have to decide when or if to sell. Then you have to decide how long the said event will last and to what extent. Then you need to determine yet again how the millions of investors will react to the news. Then you need to decide when to buy back in.
You need a lot of predictions to go right and that is why economic and financial commentators are so often wrong.
How many people thought the share markets would tank big time during Covid? Not only did they not tank, but they went up. House prices also went through the roof. No one was predicting that.
Too much time
It is time consuming being an active investor trying to better the market. All the time spent analysing the markets and making buy and sell decisions. It is like a full time job.
Not only does it take all that time, but it also takes up a lot of mental bandwidth in your head.
I don’t know about you, but I would much rather be thinking about more important things in life like how to better life for my family and I, or how to improve my physical health, or how to help someone in need. I have enough to worry about without adding the full time stress of timing the markets.
Final Thoughts
There are a handful of investors that will beat the market. The chances of you being one of them are not good.
Investing in the index is not for dummies or losers. In fact, investing in the index will see you better off than 80% of investors over the long run and for much less hassle.
The index is the gold medal standard. The smart option.
Doing nothing when it comes to investing is highly underrated. This of course assumes you have a solid investment plan to begin with.
If you need an investment plan or recommendations , then get in touch today.
The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here