Should You Care About Beating The Market?
“In an efficient market, at any point in time, the actual price of a security will be a good estimate of its intrinsic value.” – Eugene Fama, the “father of modern finance”
Efficient Market Hypothesis is the belief that all information relevant to stock prices is readily available and “universally shared” among all investors. Effectively stating that it is impossible to outperform the market. However, this theory holds several forms wherein it may be possible to capture opportunities in the market through disciplined and diversified investing strategies over time.
As humans, we have several barriers working against us when trying to beat the market. The primary one being, emotion. It’s natural for us to be concerned when there’s a drop in the market and overly excited when there’s an upswing. This leads us to buying and selling at the worst possible times – buying high and selling low. A recent Fidelity study shows us that if you miss even just 10 of the best days in the market through poor timing decisions, your returns could be cut by more than 50%!
As average investors, we typically get caught up in the short-term. We know that the S&P 500 has returned on average 10% per year since 1926. What most don’t realize is that, rarely has the market returned 10% in any one year, it’s typically much higher or lower than that in a given year. This lends us to trying to time the market, cashing out when we experience a down year, or chasing returns in a positive year.
The individual investor almost always undervalues the importance of diversification. Rather they look at past performance of the S&P 500 for example and assume that it’s indicative of future performance, so they see no need to invest elsewhere. An educated investor, however, knows this is not the case and over time will typically be better off in good times and bad than the undiversified investor. “Investing, to me, is buying a little bit of almost every company and holding them for a long time. The only bet you’re making is on human ingenuity to find productive solutions to the world’s problems.” – David Booth
Finally, there are expenses to consider. Not only is there a cost to owning the securities themselves but there are also taxes to consider. Inevitably, you will sell investments to have cash to fund your lifestyle. That’s the whole point of investing, right? Not to simply grow a pot of money, but to enable you to pay for things – experiences, a home, your doctor, your pet. This involves timing that isn’t always fully in our control. Life doesn’t happen in step with the market. And although we can strategize and tax-optimize to mitigate expenses and drops in return, the cost will never be zero. And more importantly, we must be okay with that. Don’t let your investment focus be tied to outperformance, that’s a losing a game. Instead, tie your investments to your goals. If your investing strategy performs in such a way that it provides for the life you want, then you’ve won, regardless of if you “beat the market”.