Can You Beat the Market?

“Beat the market? The idea is ludicrous. Very few investors manage to beat the market. But in an astonishing triumph of hope over experience, millions of investors keep trying.” — Jonathan Clements, author

Decades of research indicates trying to identify in advance which stocks will outperform is a fool’s game. If you had to guess the top three best-performing stocks since the market bottomed in March of 2009, which would you guess?

I recently posed this question to friends, family, and colleagues — their collective answers were highly predictable. Household names like Amazon, Google, Microsoft, Boeing, and Apple topped nearly everyone’s list. Most of the people I surveyed owned these stocks individually because they thought they would make superior investments.

However, the top three best-performing stocks are companies you’ve likely never heard of, let alone would have hand-selected for your portfolio. They are Patrick Industries, Jazz Pharmaceuticals, and MGP Ingredients.

Picking the right stocks is a futile exercise for almost everyone. How futile? When stated in terms of lifetime dollar wealth creation, the entire gain in the U.S. stock market since 1926 is attributable to the best-performing 4% of listed companies. Said differently, 96% of all stocks over the past 90+ years have added nothing to the stock market’s total returns — and more than half of all stocks delivered negative real lifetime returns.

The SPIVA scorecards provide additional insight. As of June 30, 2018, 98% of US Small Cap managers and 92% of US Large Cap managers underperformed their respective benchmarks over the previous 15-year period. Would you ever accept a bet with odds of 2/100, or even 8/100?

So why can’t even the best and brightest money managers beat the market? Markets are an efficient, zero-sum game. There are winners and losers, but the net of all trading must be zero — before accounting for biases and cognitive errors. Participation isn’t free either; when you account for fees and trading costs, plus the occasional lousy decision, the advantage a handful of people seem to have fades to zero.

It’s not just about finding a good company and hoping it holds a competitive advantage. Stock performance isn’t about how well a company performs; it’s about how well (or poorly) it performs relative to investors’ expectations. Beating the market isn’t about speculating better than the crowd — it’s about speculating how the crowd will behave.

Every time you buy or sell a stock, there’s someone else on the other end of that trade making the opposite bet. Roughly 95% of daily volume is made up of institutional participants. It’s likely not your neighbor, Roger, on the other end of your trade — it’s firms that employ some of the brightest minds in the world, stocked with Ivy League-educated professionals and PhDs. Knowing who you’re up against is critically important.

Instead of trying to be one of the very select few who beat the market, here are three things you can do to increase your odds of investment success:

It’s not impossible to beat the market, but the data shows it’s incredibly unlikely — and especially unnecessary since passive investing exists as an easy, readily available alternative that research has shown consistently produces better results. No one has been able to reliably and persistently beat the market, and your future self will thank you if you don’t try.