Why is it so hard for individual investors, or even fund managers, to beat the market
First, let's look at the pros.
S&P Indices research says that over the past 10 years, 56.6% of all domestic funds underperformed the S&P 1500 composite. This index includes small-, mid- and large-cap stocks.
Such findings can inspire criticism, but drawing the right conclusion isn't as easy as it appears.
The critics of the fund industry overlook several realities.
Reality check No. 1: Some conservative funds — such as income funds — aren't designed to "beat the market." They are designed to distribute income and preserve capital by lowering risk. These funds naturally underperform, and there is nothing wrong with that.
Reality check No. 2: Nobody should expect talent among fund managers to be evenly distributed. Saying more fund managers underperform the market than outperform the indexes deserves a shrug and a so-what response.
The masters of any discipline will often deliver results that are far better than the average performance. That such masters are few in number isn't surprising.
Reality check No. 3: Part of the reason most fund managers can't beat the market consistently is because cash is not considered a valid position. A 100% or even 50% cash position would be hard to get past a fund manager's boss, committee or customer.
Is that the fault of fund managers? Probably not. Many understand that there are times when cash is king. But they are not going to fight the Zeitgeist.
What about individual investors
They also have problems beating the market, but usually for different reasons.
Many rely on "gut instincts" rather than research. This often leads to strategy switching, or throwing bits of different strategies together into a chaotic mess.
Admitting mistakes and cutting losses also can be hard for the individual investor. One bad stock, allowed to run to a loss of 30%, 50% or more, can kill a portfolio.
Lack of patience also can be a problem. Individuals may find it hard to wait for a high-probability opportunity. Cash is like a lack of courage, a thing of shame, to these investors.
They are consumed by the notion that somewhere, there is a stock taking off without them.
Actually, there always is. The problem is that in a serious market correction, the odds of finding that stock are far less than the odds of finding a loser.
How does IBD propose to get around these realities? Proper market timing is the only way to beat the market.
Many people say, "You can't time the market.
This is reminiscent of the tale about a man who went up to trumpeter Miles Davis and said, "You can't dance to that music." Davis looked at the man and said, "No, you can't dance to that music.
One reason market timing gets a bum rap is because few people are truly listening to the market. And if you don't pay attention, you'll never hear the tones.
Finally, asking why it's so hard to beat the market is probably the wrong question to ask.
A better first question might be: Why is it so easy to beat a bad market when you're not in it
OK, that's not truly a question, but it will lead to better answers.
- Investment & Company Information