The Myth of Beating The Market

Every investor enters the stock market with the same fundamental goal: to make money. Yet for many, simply earning a positive return isn't enough. The real ambition is to outperform the market, whether that means beating the S&P 500, identifying the next trillion-dollar company, or achieving returns that professional investors can only dream of. But what many investors fail to recognize is that consistently beating the market is far more difficult than it appears. Due to readily available access to financial information, individual investors feel that they have an advantage when attempting to beat the market. However, investors are at a disadvantage due to market efficiency and the psychological factors of investing.

According to the efficient market hypothesis, it is nearly impossible to beat the market. Due to the fact that financial information on companies is very easily accessible, it is quickly acted upon by the market. If a company announces a breakout earnings report, investors will quickly buy more stock to take advantage of the upsurge in the stock price. This quick reaction results in investors not profiting from the breakout as much as they could have. When an investor reads a positive article about a company, they may decide to buy the stock; however, the stock may have already reacted positively to this information. This results in the investor paying a higher price for the stock, therefore resulting in a lower profit. Simply finding a good company to invest in does not necessarily mean that the investor will profit. A company may have great revenue, expand its operations, and dominate its industry, but if its stock has already reacted positively to this information, then the stock may not be a good investment.

Not only are individual investors at a disadvantage, but hedge funds and mutual funds also have trouble beating the market. With readily available financial information and expert traders, one would think that these funds have an easy time beating the market, but that assumption is wrong. If expert investors with lots of financial resources have difficulty beating the market, individual investors with little financial knowledge find it almost impossible. Psychological factors also contribute to investors having difficulty beating the market.

An investor's emotions greatly impact their investment decisions. The stock market is heavily based on psychology. With some investors buying stocks and others selling stocks, the stock market can be unpredictable. Some investors buy stocks when the stock price of a company skyrockets, while others choose to sell. Investors can get caught up in the hype of a stock that has been performing well and overlook important information regarding that stock. An investor can see that a stock has doubled in price and want to buy the stock so that they can earn a profit, but this may not be the best decision. The investor may believe that the stock will continue to increase in price when, in reality, the stock has had a large increase and the expectations for the stock have been exceeded. Once the stock price stops rising, the investor will want to sell the stock, but the stock price will drop, and the investor will panic and sell their stock at a large loss. Some investors can make poor investment decisions due to psychological factors like these. Transaction fees, capital gains taxes, and miscellaneous fees also play an important role in whether or not an investor has profited. An investor may have a winning investment strategy, but if they have lots of fees, whether that investment strategy is profitable becomes a toss-up.

People who support active investing, or attempting to beat the market, often argue that markets are not completely efficient. Sometimes, companies are severely discounted, and investors can take advantage of this. While this is true to an extent, many investors overlook the obstacles involved in trying to beat the market. Successful active investors like Warren Buffett have been able to time the market and accurately predict stock prices; however, the average investor does not have these advantages. In order to find a stock that is undervalued, an investor must be able to understand the company's financial statements. An investor must realize that the market has not reacted rationally to a company and accurately predict that the market will eventually realize this. An investor must also have patience to wait for a stock to appreciate and hope that market conditions will not change before they sell the stock. These are the traits of a successful active investor. Not only do you need to do research, but you must also realize when your research is correct, and you must have patience to ensure that you are rewarded for your research.

When you consider all of the obstacles an investor must overcome when attempting to beat the market, passive investing, or simply buying a broad market index fund, is a much safer and more reliable option. Rather than trying to find individual stocks to beat the market, buying a market index fund allows you to take advantage of the success of many companies at once. Not only is passive investing easy, but it also has low expenses. Buying a market index fund is much cheaper than hiring an investment manager to beat the market. While passive investing does come with risk, it is less risky than active investing. Passive investing is essentially a set-and-forget type of investment. When the market experiences a downturn, an investor with a passive investing strategy experiences losses just like everyone else, but passive investing eliminates the difficult task of trying to find stocks that will beat the market.

When we consider all the obstacles individual investors must overcome to beat the market, passive investing is a much safer alternative. While most investors would believe that they have an advantage when attempting to beat the market, they are mistaken. Confidence in one's ability to beat the market, access to financial information, and individual interest in the stock market are not factors that contribute to an investor's success in beating the market. In fact, the desire to beat the market may even harm an investor's profits. Finding the next big stock to experience a large upsurge is not necessarily a part of a successful individual investing strategy. Not only can confidence in the ability to beat the market lead to investors making poor investment decisions, but it also puts them at a disadvantage compared to individuals who have difficulty beating the market. In a world where everyone is trying to find an advantage to beat the market, you must realize that you may not have an advantage when attempting to beat the market. However, understanding that you may not have an advantage when attempting to beat the market may be the advantage that you need to understand that you should not try to beat the market.