Beating the Market

We all know that it’s hard to beat the stock market, which is why an article in yesterday’s New York Times caught my attention. “Can You Beat the Market? It’s a $100 Billion Question” was the headline and its author Mark Hulbert points to a new study called “The Cost of Active Investing” by Dartmouth finance professor Kenneth R. French to figure it all out.

The French study estimates total investment costs, including “the fees and expenses of domestic equity mutual funds (both open- and closed-end, including exchange-traded funds), the investment management costs paid by institutions (both public and private), the fees paid to hedge funds, and the transactions costs paid by all traders (including commissions and bid-asked spreads)…French then deducted what domestic equity investors collectively would have paid if they instead had simply bought and held an index fund...the difference between those amounts…is what investors as a group pay to try to beat the market.”

Given this information, Hulbert concludes that “the best course for the average investor is to buy and hold an index fund for the long term. Even if you think you have compelling reasons to believe a particular trade could beat the market, the odds are still probably against you.” While this may be true in the abstract, I have to weigh in from real-life.

In my experience, this data and every study like it, assumes that people (a) want to assume the responsibility for managing their portfolios and even if they do want to be their own investment advisors (b) they can not resist tinkering with their strategies as market conditions change. To my first point, I think that people engage independent advisors not to beat the market, but to make sure that they entrust their future to a professional who will make unemotional decisions that are in their best interests. I liken this to my decision to hire sub-contractors to do work in my apartment: could I actually paint the walls myself? Of course I can, but I choose to pay someone else who I believe can do it as well or better than I can.

To the second point, I have found that many people who say that they will buy and hold just can’t do it. In fact, last week as stocks were making new lows, I heard from plenty of folks who said that they were “DONE”. I am fairly certain that what people mean when they say this is that they are done for now, but when the stock market starts rising, they will jump back in. While it may not be worth the costs to hire other folks to beat the market, it may be well worth it to protect you from yourself.