Can Regular Investors Beat The Market?

Topic Covers |  Day Trading, ETFs, Investing Basics, Investment, Portfolio Management, Stocks


We all invest with the hopes that one day we will have enough money to live off our investments. The question remains, can a regular investor like us really beat the market? Do we have what it takes to win over the middlemen and institutions that have millions or even billions invested in the market? According to Terrance Odean, a finance professor at the University of California, Berkley's Haas School of Business, "Many of the mistakes investors make come from a lack of any understanding of the innate disadvantages they face."

David and Goliath

The answer to this question is not an easy one, and the answers will vary depending on who you ask. By "beating the market" we're talking about everyday working Americans who try to obtain greater capital gains and income return than the S&P 500.

David E. Y. Sarna author of "History Of Greed," explains it this way, "We all have some larceny in us. We buy securities because we think we know someone or something others don't. I don't think anyone can consistently outperform the S&P 500 without assuming greater than market risk."
 Some of us might have the tools (and connections) required to make knowledgeable decisions that will lead us to a portfolio with higher returns, but others like stockbrokers, bankers and big corporations most likely have an advantage, right? While many people in the financial industry have insider information which they cannot legally trade on, they also possess the necessary financial statement analysis skills to develop a greater insight about a given company. Robert Laura, author of "Naked Retirement: A Stimulating Guide To A More Meaningful Retirement" and President of SYNERGOS Financial Group says, "The reality is there will always be a lure to try and beat the market, especially since those who have beat it consistently are revered so highly (Bill Miller, Peter Lynch) and/or are compensated well (hedge fund managers). I think the market can be beaten, but even a broken clock is right twice a day. Best way to describe it: It's possible but not probable."
According to Laura, the sad reality is, the average individual investor has little chance of beating the market. He says the common investor uses mutual funds, are stuck in 401(k) plans which essentially track the broader index, and pay higher fees as compared to stock, index funds or ETFs. Also many mutual fund type investments don't use stop loss order to protect gains and thus do not always provide the type of protection individualized portfolios can perform. As he puts it, "investors are set-up to fail from the get-go."

Investing in 401(k)s is no better. "Most 401(k)s aren't benchmarked and most companies don't have a good investment policy for selecting funds within the program. You can't even get some asset classes in many and most advisors are sales people, not fiduciaries and just taught how to sell funds," he adds.

The good thing is many more investors are taking responsibility and interest in their investments. They are taking the initiative to learn how their investments work and are less intimidated. Laura says investors are learning that individual stocks aren't as scary as everyone suggests and there is valuable information available to everyone if they know where to find it and how to apply it.

 He adds, "The advent of ETFs and Index investing allow people to mimic the market, instead of trying to beat it, which is a better, less expensive perspective to have."

A Lost Cause?

Founder of FinancialMentor.com, Todd R. Tresidder, said in 2010 "All the evidence supports the disappointing fact that regular investors as a whole underperform the market. As long as they try to 'beat the market' they actually underperform."

The best way for regular investors to achieve better risk-adjusted returns is by focusing not on out performance, says Tresidder, but instead by losing less. In other words, regular investors have one competitive advantage - liquidity. "Big investors are the market but the little guy is nimble and can buy or sell without affecting the market - something the big guy can't do. Systematic risk management can work to provide regular investors with similar or slightly improved investment performance relative to the market at substantially less risk," he says.

Helping the Odds

What can an investor do to increase their chances of "beating" the market? Laura says there are several things:

Use low cost funds and/or a low cost platform for trades. The best way to make money is to save money.

Establish and follow a discipline which translates into just doing what you said you are going to do.
Give every investment in your portfolio a buy price, hold price and sell price along with one or two reasons to buy, hold or sell at that value. This gives you specific criteria to act and provides your portfolio with purpose and specific direction.

Watch for headline risk. Set up email alerts for your investments so as new information comes out about them, you are aware of it in the early stages to consider changes. Mark your calendar for things to watch like earning dates, intellectual property timelines and industry reports like Federal Reserve meetings, unemployment numbers, new housing starts and other information that will affect the specific sector or security.

 Sarna suggests investing in what you know and understand, such as solid, profitable small-caps and even microcaps in niches you can monitor and understand. These can appreciate much more rapidly than equivalently-priced large-caps.

 The only way to get above market returns is to develop a competitive advantage says Tresidder. "It is either developed through knowledge and information flow, or it is developed through extensive research resulting in an investment strategy that exploits irregular market behavior."

According to Tresidder, the only way to outperform the markets is to develop a competitive advantage that exceeds transaction costs and passive market return.

The Bottom Line

The debate of whether an individual investor can beat the market is as old as the stock market itself. Those who have found fortune investing will often preach that they possess superior analytical skills which allowed them to predict the market. Those investors who suffer losses will tell a much different tale.

Invest Like A Professional

Topic Covers |  Active Trading, Asset Allocation, Bear Market, Day Trading, Financial Theory, Hedge Funds, Investing Basics, Personal Finance, Portfolio Management, Retirement, Risk Tolerance, Stocks, Warren Buffett

For those investors who have been lucky enough to have survived one or more major market downturns, some lessons have been learned. For example, there always seem to be some firms that not only survive those downturns, but profit handsomely from them. So why do certain investment companies do better than others and survive market waves? They have a long-term investment philosophy that they stick to; they have a strong investment strategy that they formalize within their products and understand that while taking some risk is part of the game, a steady, disciplined approach ensures long-term success. Once the key tools of successful investment firms are understood, they can easily be adopted by individual investors to become successful. By adopting some of their strategies, you can invest like the pros

Strength in Strategy

A strong investment philosophy should be outlined before any investment strategies are considered. An investment philosophy is the basis for investment policies and procedures and, ultimately, long-term plans. In a nutshell, an investment philosophy is a set of core beliefs from which all investment strategies are developed. In order for an investment philosophy to be sound, it must be based on reasonable expectations and assumptions of how historical information can serve as a tool for proper investment guidance.

 For example, the investment philosophy, "to beat the market every year," while a positive expectation, is too vague and does not incorporate sound principles. It's also important for a sound investment philosophy to define investment time horizons, asset classes in which to invest and guidance on how to respond to market volatility while adhering to your investment principles. A sound long-term investment philosophy also keeps successful firms on track with those guidelines, rather than chasing trends and temptations. Since each investment philosophy is developed to suit the investment firm, or perhaps the individual investor, there are no standard plans to write one.
If you are developing an investment philosophy for the first time, and you want to invest like a pro, it's important that you consider covering the following topics to make sure the philosophy is robust:

Define Your Core Beliefs

The most basic and fundamental beliefs are outlined regarding the reason and purpose of investment decisions.

Time Horizons

While investors should always plan on long-term horizons, a good philosophy should outline your unique time frame to set expectations.

Risk

Clearly define how you accept and measure risk. Contrary to investing in a savings account, the fundamental rule of investing is the risk/reward concept by increasing your expected returns with increased risk.

Asset Allocation and Diversification

Clearly define your core beliefs on asset allocation and diversification, whether they are active or passive, tactical or strategic, tightly focused or broadly diversified. This portion of your philosophy will be the driving force in developing your investment strategies and build a foundation to which to return when your strategies need redefining or tweaking.

The Secret of Success

Successful firms also implement product funds that reflect their investment philosophies and strategies. Since the philosophy drives the development of the strategies, core style investment strategies, for example, are usually the most common in most successful product lines and should also be part of an individual plan. Core holdings or strategies have multiple interpretations, but generally, core equity and bond strategies tend to be large cap, blue chip and investment grade types of funds that reflect the overall market.

 Successful firms also limit their abilities to take large sector bets in their core products. While this can limit the potential upside when making the right sector bet, directional bets, practiced by hedge funds, add significant volatility to a fund that is judged by not only its performance but its relative and absolute volatility.

When defining an investment strategy, it is very important to follow a strict discipline. For example, when defining a core strategy, restricting the temptation to follow or chase trends keeps the strategy grounded. This is not to say that one can't have additional momentum strategies with different goals, as these can be incorporated into the overall investment plan.

Outlining a Strategy

When outlining a sound investment strategy, the following issues, which are similar to those of creating a philosophy, should be considered:

Time Horizon

A common mistake for most individual investors is that their time horizon ends when they retire. In reality, it can go well beyond retirement, and even life, if you have been saving for the next generation. Investment strategies must focus on the long-term horizon of your investment career, as well as the time for specific investments.

Asset Allocation

This is when you clearly define what your target allocation will be. If this is a tactical strategy, ranges of allocations should be defined, if strategic in nature. On the other hand, hard lines need to be drawn with specific plans to rebalance when markets have moved in either direction. Successful investment firms follow strict guidelines when rebalancing, especially in strategic plans. Individuals, on the other hand, often make the mistake of straying from their strategies when markets move in sharp directions.

Risk Vs. Return

At this point you should clearly define your risk tolerance. This is one of the most important aspects of an investment strategy, since risk and return have a close relationship over long periods of time. Whether you measure it relative to a benchmark or a absolute portfolio standard deviation, just remember to stick to your predetermined limits.

Putting the Pieces Together

It's important to remember that investment strategies define specific pieces of an overall plan. Successful investors cannot beat the market 100% of the time, but they can evaluate their investment decisions based on their fit to the original investment strategy.

After you have survived a few market cycles, you can potentially start to see patterns of hot or popular investment companies gathering unprecedented gains. This was a phenomenon during the Internet technology investing boom. Shares of technology companies rose to rock star levels, and investors - institutional and personal - lined up at their gates to pile on funds. Unfortunately for some of those companies, success was short-lived, since these extraordinary gains were unjustified. Many investors deviated from their initial investment strategies in the hopes of chasing greater returns. Individuals can model themselves after successful investment companies by not trying to hit home runs, instead focusing on base hits.

That means trying to beat the market by long shots is not only difficult to do consistently, it leads to a level of volatility that does not sit well with investors over the long term. Individual investors often make mistakes such as shooting for the stars and using too much leverage when markets are moving up, and tend to shy away from markets as they are falling. Removing the human biases by sticking to a set approach and focusing on short-term victories is a great way to fashion your investment strategy like the pros.

The Bottom Line

Taking cues from successful professional investors is the easiest way to avoid common errors and keep on a focused track. Outlining a sound investment philosophy sets the stage for professional and individual investors, just like a strong foundation in a home. Building up from that foundation to form investment strategies creates strong directions, setting the paths to follow. Investing like the pros also means avoiding the temptation to drift from your investment philosophy and strategies, and trying to outperform by large margins. While this can be done occasionally, and some firms have done it in the past, it is nearly impossible to beat the markets by large margins consistently. If you can fashion your investment plans and goals like those successful investment companies, you too can invest like the pros.

5 Tips For Diversifying Your Portfolio

Topic Covers |  Bonds, Financial Theory, Index Funds, Investing Basics, Portfolio Diversification, Portfolio Management, Risk Management, Stock Analysis, Stocks

For establishing a strategy that tempers potential losses in a bear market, the investment community preaches the same thing that the real estate market preaches for buying a house: "location, location, location."

Diversification is a battle cry for many financial planners, fund managers, and individual investors alike. When the market is booming, it seems almost impossible to sell a stock for any less than the price at which you bought it. When the indexes are on their way up, it may seem foolish to be in anything but equities. But because we can never be sure of what the market will do at any moment, we cannot forget the importance of a well-diversified portfolio (in any market condition).


Looking Back: A Lesson in the Importance of Diversification

With the luxury of hindsight, we can sit back and critique the gyrations and reactions of the markets as they began to stumble after the '90s, and again in 2007. Diversification is not a new concept. We should remember that investing is an art form, not a knee-jerk reaction, so the time to practice disciplined investing with a diversified portfolio is before diversification becomes a necessity. By the time an average investor "reacts" to the market, 80% of the damage is done. Here, more than most places, a good offense is your best defense and in general, a well-diversified portfolio combined with an investment horizon of three to five years can weather most storms. Here are some diversification tips:


1. Spread the Wealth

Equities are wonderful, but don't put all of your investment in one stock or one sector. Create your own virtual mutual fund by investing in a handful of companies you know, trust, and perhaps even use in your day-to-day life. People will argue that investing in what you know will leave the average investor too heavily retail-oriented, but knowing a company or using its goods and services can be a healthy and wholesome approach to this sector.

2. Consider Index or Bond Funds

Consider adding index funds or fixed-income funds to the mix. Investing in securities that track various indexes make a wonderful long-term diversification investment for your portfolio. By adding some fixed-income solutions, you are further hedging your portfolio against market volatility and uncertainty.


3. Keep Building

Add to your investments on a regular basis. Lump-sum investing may be a sucker's bet. If you have $10,000 to invest, use dollar-cost averaging. This approach is used to smooth out the peaks and valleys created by market volatility: you invest money on a regular basis into a specified portfolio of stocks or funds.


4. Know When to Get Out

Buying and holding and dollar-cost averaging are sound strategies, but just because you have your investments on autopilot does not mean you should ignore the forces at work. Stay current with your investment and remain in tune with overall market conditions. Know what is happening to the companies you invest in.


5. Keep a Watchful Eye on Commissions

If you are not the trading type, understand what you are getting for the fees you are paying. Some firms charge a monthly fee, while others charge transactional fees. Be cognizant of what you are paying and what you are getting for it. Remember, the cheapest choice is not always the best.


The Bottom Line

Investing can (and should) be fun. It can be educational, informative and rewarding. By taking a disciplined approach and using diversification, buy-and-hold and dollar-cost-averaging strategies, you may find investing rewarding - even in the worst of times