Can You Beat the Market? Yes. Is It Likely? No.
Updated: Mar 13
In 1965, an interesting study appeared in the Journal of Applied Psychology. Two researchers, Caroline Preston and Stanley Harris, surveyed 50 drivers and asked them to rate themselves for safety-consciousness and general driving ability, focusing particularly on their last time behind the wheel. About two-thirds of the respondents said they had been about as careful and competent as usual. Some went so far as to say their last driving experience was “extra good.” What makes this interesting is that each of these drivers’ last outings had ended in accidents serious enough to require hospitalization. According to police reports, 70% of the accidents were the fault of the drivers in the study. Sixty percent of the drivers had histories of past traffic violations, about half of their vehicles were totaled in the accidents, and about half of them faced criminal charges as a result of their mishaps.
Clearly, there was a disconnect between these drivers’ perceptions of their own abilities and reality. And this applies to more than driving behavior. Many of us have a tendency toward overconfidence in our abilities in other areas of life. This certainly applies in the investment world; both individual and professional investors exhibit a strong tendency to believe in their ability to “beat the market” by picking stocks or other investments that outperform. This belief, however, is borne out neither by research or the investors’ own experiences, in most cases.
Interestingly, this belief persists, even though the investors understand that outperforming the market is difficult. The problem is not that they don’t recognize the obstacles; rather, they consistently hold a higher than warranted opinion of their ability to surmount the obstacles. And yet, year after year, both individuals and professionals are unable to outperform industry benchmarks in their selected markets. For example, the 2020 SPIVA (S&P Index versus Active) Scorecard indicates that during the 20-year period ending December 2020, 94% of large-capitalization funds and 88% of mid- and small-capitalization funds underperformed their index benchmarks. In other words, the vast majority of professional fund managers would have achieved better results by simply “buying the index” than by using active-management measures.
Mutual fund managers, of course, are acutely aware of where their annual returns fall in relation to the market indexes; each year their funds’ performances relative to industry and index benchmarks are reported. Individual investors, however, may be less accurate when judging their own returns. In a 2007 study, 250 individual investors of varying experience levels were asked to estimate the returns achieved in their portfolios for a previous period. Researchers found that the correlation between investors’ estimated returns and actual returns was no better than random in its accuracy. Additionally, more than 75% of them underperformed benchmarks, and while only 5% of the investors believed they had achieved negative returns, in fact, around 25% of them had done so.
One important takeaway from all this information is that a professional, fiduciary wealth manager can make a big difference in the returns on your portfolio over time. Rather than trying to pick “winning” stocks or time the market, we work with our clients to structure portfolios that allow the market to work for, rather than against, the investor. If you would like to learn more about the value of having a fiduciary wealth manager, ethically and professionally bound to act always in your best interest, click here to read our whitepaper, “The Informed Investor.” And if we can help you or answer any questions, please contact us.