What Does it Mean to “Beat The Market”?

When it comes to investing, most people dream of picking that one stock that will generate them a small fortune overnight.

However, veteran investors tend to focus on a more “realistic” goal: beating the market.

As it turns out, though, this common goal may actually not be very realistic at all.

What is ‘beating the market?’

While competition can certainly range between investors, at the end of the day, many are trying to “beat the market.”

In short, this means choosing a portfolio that will outperform the S&P 500 Index.

The reason this is a major challenge – a benchmark of success, even – in investing is because anyone can simply choose to invest in an S&P 500 index fund.

Countless people do.

Straying from these stocks means risking the easy returns an S&P 500 index fund is guaranteed to provide.

Of course, it also means the potential to beat these funds and enjoy a very marketable reputation among investors.

Can beginner investors beat the market?

Probably not.

Most veterans don’t manage to regularly beat the market.

For a beginner to do so would be nearly impossible. There are three challenges that keep beginners from being able to do this.

1. Trading Psychology

For one thing, there’s trading psychology to take into consideration. The most predictable way to beat the market is by taking on more risk, which is incredibly difficult to do when you’re just starting out, especially when you may not have a lot of money to invest.

2. Industry-Related Knowledge

Another barrier for most beginning investors is that they simply don’t know enough about a given industry.

Most veteran investors become experts in a specific industry. Doing so gives them a valuable advantage over other traders because they have a better understanding of how the market will react to various influences.

Of course, some have this information because they’re insiders. Using access to this kind of nonpublic information is a serious crime known as insider trading.

3. The Discipline to Pick Individual Stocks

Whenever investors discuss the likelihood of beating the market, names like Warren Buffet and Peter Lynch are inevitably brought up. These men are legendary traders who seem almost supernaturally predisposed to picking winning portfolios that consistently outperform the market.

The problem is that both men developed the discipline long ago to only invest in one stock at a time. They would take months or even a year to do their research until they found a company they believed in. Then, after they made their investment, they didn’t budge, come what may. They knew full well that the market would move up and down, but they had the discipline and confidence to wait.

One of the most popular of Warren Buffet’s quotes about investing is, “Someone’s sitting in the shade today because someone planted a tree a long time ago.” That perfectly sums up the long-term approach he takes to investing.

There’s also a telling quote by Peter Lynch that aptly described his discipline when it came to building a winning portfolio: “Owning stocks is like having children: don’t get involved with more than you can handle.”

The cold hard facts

Sure, there will be other Buffets and Lynches, but they may  remain few and far between and they will likely only occur after decades of experience.

There’s actually evidence to prove this.

A study done by Wermers, Scaillet, and Barras looked at how 2,076 actively managed domestic equity mutual funds in the U.S. performed between 1976 and 2006. They found that less than 1% – literally, just 0.6% – of these funds were able to consistently beat the market.

Again, these are funds run by veteran investors, just about the furthest thing from beginners.

Taking a passive investment strategy

Aside from the experience required to consistently beat the market, the other barrier that keeps most investors from this level of success is all the overhead involved with hiring the right people.

First, there are the typical investment fees you’ll need to pay.

Then, there are taxes.

So even if you go with an S&P index fund, your profits may not outperform the market after you get done paying your overhead.

Fortunately, taking a passive investment strategy can help you keep this overhead to a minimum.

Although you’ll still need to pay taxes, of course, you won’t be paying for the same team of experts to manage your portfolio.

Furthermore, while it’s very unlikely you’ll “beat the market” in the short-term, but that’s hardly a necessary strategy for most people who simply want to save for a comfortable retirement.

Dollar-cost averaging also doesn’t require the same attention-to-detail an investor must have if they’re going to consistently time the market right.

One way to start long-term investing

Don’t focus on beating the market.

Focus on long-term results from consistent investing.