Beating the Market

I frequently make the case that individual investors have little hope of reliably outperforming the market by trying to pick investments on their own. A recent comment on a post from a couple months ago argued that individual investors do have some advantages that might help them reliably outperform the market.
The commenter pointed out that:

Mutual [...]

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A friend recently sent me an email asking for my advice regarding a one of his mutual fund holdings.
The fund underperformed the market pretty seriously over the last year. As a result, it now has 3-year and 5-year performance records that are below those of either an S&P 500 index fund or a Wilshire 5000 [...]

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Write one.
Then sell subscriptions.
Ta-da!
Troubleshooting (in case you need a little more help)
What’s that? You don’t have a history of successful stock picking? No problem: Just come up with any stock-selection strategy and back-test it to see if it’s worked over the past [period of your choosing].
It didn’t work? Again, no problem: Just continue [...]

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The smartest kid in your 4th grade class was probably the smartest kid in your 5th grade class as well. The best quarterback in the NFL this year is likely to be one of the best next year. The company’s top salesperson from this year will probably be near the top next year.
You get the [...]

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Get Rich Slowly (the single largest personal finance blog, I believe) recently began hosting a regular column from a Motley Fool writer.*
Score one for the bad guys.
But everybody loves the guys from The Motley Fool, right?
Spare me.
A few headlines to be found on Fool.com as I write this (5/7/09):

“5 Cold Stocks Heating Up”
“5 Stocks with [...]

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If you read many books–or academic papers–about investing, you’re bound to run into somebody talking about Efficient Market Theory (aka the Efficient Market Hypothesis).
In short, EMT argues that the hundreds of thousands of investors constantly bidding stock prices upward and downward creates a situation in which, at any given moment, a stock’s price must reflect [...]

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Let’s imagine a hypothetical group of 1,024 actively-managed funds. If we look at pre-expense results, roughly 50% of the funds should outperform the market each year. That means that after 7 years,

8 of the funds will have outperformed the market every year,
64 funds will have outperformed the market in at least 6/7 years, and
232 funds [...]

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Outperforming the market by picking stocks and/or market timing is rather difficult.
Less than 50% of actively-managed funds will beat a low-cost index fund.

So it seems to me that investing in an actively-managed fund is the rough equivalent of saying, “I don’t have an above-average ability to pick stocks, but surely I can do an above-average [...]

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I suspect that many investors don’t appreciate what’s really involved in beating the market on one’s own. Granted, I can’t blame them. After all, they’ve been told by countless marketers that it’s not only possible but easy.
A little background
Generally speaking, for any investment, the current market price reflects the market’s consensus of the value of [...]

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In  a comment on last week’s post about the psychological benefits of index funds, Kevin pointed out an article from Motley Fool arguing that the problem with index funds is that they don’t make any attempt to separate good companies from bad companies. And as a result, they end up investing in companies that perform [...]

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