The more I write about investing the more I realize just how frustrated, confused and hopeless many people feel about investing. These people tend to fall into one of two groups.
Group 1 feel frustrated because they know they should be investing but can't seem to free up enough money to start investing.
Group 2 is terrified about the idea of investing. Or they have the attitude that "investing is not for them".
It's easier to help those in group 1 because they have the desire to invest. For them, it's a math problem. How do they free up enough money to invest? I touch on that in one form or another in nearly every article I write. Additionally, even if they only have a few bucks a month to invest, it can make a difference.
The people in group 2 have a bigger problem to overcome because they wouldn't choose to invest even if they had the money. One common response I get when I speak with people in group 2 is that they believe only wealthy people with access to the top investing advisors can achieve positive investing results.
That is not true. In this article, I will discuss how novice investors can beat the best on Wall Street.
Don't try to be a great investor
With most things in life the more effort, attention and time you dedicate to something, the better your results are likely to be. You've heard it a thousand times "practice makes perfect". If you want to be great at something you need to dedicate yourself to mastering your craft.
In almost any area of life, you will be better served by putting in more effort. The once exception to that rule is investing. The more effort you put into becoming a "good investor", the worse your results are likely to be.
This is one of the most difficult truths for investors to grasp. I'm amazed by the number of people who believe that if you simply "try really hard", you can obtain investment returns that outperform the general stock market.
There is no evidence to back this claim up. In fact, there is a lot of research that suggests the more you try, the worse your investment returns are likely to be.
Efficient Markets
With the exception of a handful of people, it is next to impossible for investors to "beat the market".
Whether or not someone could "try hard enough" and be "smart enough" to consistently outperform the stock market over the long term comes down to whether or not the stock market is "efficient".
In his 2003 paper titled “The Efficient Market Hypothesis and Its Critics”. Burton G. Malkiel defined an efficient market as a market where “prices fully reflect all known information, and even uninformed investors buying a diversified portfolio at the tableau of prices given by the market will obtain a rate of return as generous as that achieved by the experts”.
If the stock market is not efficient then it would be possible to "try hard enough" to find stocks that are mispriced and outperform the general stock market.
If the stock market is efficient then stock prices reflect all known information and no matter how hard you try you can't find that diamond in the rough that everyone else is missing.
While the efficient market theory is not universally accepted, the academic literature would suggest that the stock market is reasonably efficient.
The best on Wall Street can't beat the market
Whether the stock market is efficient or not is important because it can inform the optimal way to invest. If the stock market is inefficient, we would see the very bright and very rich people on Wall Streety consistently getting better investment returns than the general stock market every year.
Luckily, we can see how Wall Street investment fund managers have performed against the general stock market. Standards & Poor’s collects data on how actively managed investment funds perform against their benchmark index across the globe.
Over the past 5 years
82% of active fund managers in the U.S underperformed the S&P 500 index.
90% of active fund managers in Canada underperformed the TSX index.
80% of active fund managers in Europe underperformed the S&P Europe 350 index.
There is no country in the world where a significant number of actively managed funds beat their respective indexes.
So, why is this important? It is important because that means that getting exceptional investment returns is not a matter of "trying hard" or paying some high powered investment manager to "try really hard on your behalf".
This leads to the obvious question, then what is the best way to get exceptional investment results?
Invest in low-cost index funds
If Wall Street investment managers can't consistently outperform the market you can't either. If you accept that you won't outperform the market than the best you can do is match the returns of the general stock market. Which means investing in low-cost index funds.
An index fund is simply an investment fund that tracks a stock market index.
The most famous stock market index is the S&P 500, which tracks the performance of the 505 largest publically traded companies in the U.S. So, an S&P 500 index fund would track those same 505 companies.
If Apple made up 3% of the S&P 500 index on a given day, 3% of the value of the index would be made up of Apple stock.
As the make-up of the stock market index changes, the index fund changes to reflect that change.
If Apple stock started going on a run and eventually made up 6% of the S&P 500 index, the index fund would continue to buy Apple stock so that 6% of the value of the fund was made up of Apple stock.
The less you try the better your outcome
The best part about investing index funds is that they are incredibly simple, cheap and accessible. You can invest in index fund ETFs in any robo-advisor or online brokerage.
In two words, this is how you can obtain better long term investment results than most "professional" Wall Street investors; don't try.
Invest as much as you can spare into index funds and never check your account balance until you retire. In fact, don't even pay attention to what is happening in the stock market. The stock market is incredibly volatile on a day to day basis but over the long term, it has produced exceptional results.
If you're investing in index funds for the long term, you biggest risk is yourself.
If you follow the daily happenings in the stock market odds are you will get freaked out when the market falls off a cliff. When people get freaked out, they make a fear-driven decision to sell when the market is at the bottom. If you do that, you turn a "paper loss" into a "real loss" and miss out on gains when the market rebounds.
My message to people in group 2 who are terrified about investing or believe they can't get good results without a high-powered investment advisor; You can get great investing results and it's easier than you imagine.
This article is for informational purposes only, it should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions