3 Reasons You Could (MAYBE) Beat the Market, Even When Professionals Can’t

If you’ve spent any time at all reading personal finance information, you’ve probably heard that ‘you can’t beat the market’.  (That is, be able to obtain a higher return, after expenses, by actively trading than by investing in an index fund.)  After all, the argument has been made (including by me), most professional investors running actively managed mutual funds and hedge funds can’t beat the market.  They have lots of analysts, attention from all the media, and millions, usually billions of dollars available, so if their funds can’t beat the market, what makes you think you have any chance?  Just invest in index funds and match the market as best you can, rather than even trying to beat it.

A very solid argument, but here’s something to think about: What if it’s because the actively managed funds have so many analysts, money, and attention that they can’t succeed, rather than in spite of all those things?  What if, because you are an individual investor working on the small scale, you are, at least in some ways, better off than the professional fund managers?  As you might have guessed, that’s the point of this article, to show how you might have an advantage (or 3) over those professional fund managers when it comes to beating the index.

Yes, even beating out someone this stylish
Yes, even beating out someone this stylish

A note of caution before we begin, though: While it is possible that you can beat the market, it’s far from certain.  Think of it like running a marathon; while you can, theoretically, run 26.2 miles straight, it does not mean that you will, and definitely doesn’t mean that you should try if you aren’t putting in the effort to build up your running ability.  Be sure to practice those investing skills before moving your money out of index funds, if you even want to make an attempt at beating the market.  (I would stress as well that you don’t actually need to attempt to beat the market; keeping up with the market leads to pretty solid results over time, making index funds good investments.)

3 Reasons You Could (Maybe) Beat the Market


1. You Have Less Money
: I imagine you never figured this would be an advantage, in investing or otherwise, but it’s worth keeping in mind that having less money does actually provide some advantages.  As your investment total increases, into the millions or billions of dollars (aka, what most funds have to work with), you are unable to invest as high a portion of you money into a single company, particularly the smaller companies.  Putting $10,000 into a $100 million dollar market cap company will have essentially no effect, but $10 million would buy up 10% of the total stock and potentially greatly distort the price for that stock.  As a result, even if a fund identifies a stock with an amazing growth potential, if it doesn’t have enough of a market cap, it’s no good to that fund.

As a result, by having less money available you have a wider array of companies that you are able to invest your money in, and will have fewer concerns about how much money to invest in each one.  (Well, from a perspective of owning too much of the total company and distorting its value; you do need to be concerned that you are putting too much of your money into a single investment, but that’s an issue for another article.)  There’s a reason that even Warren Buffett has expressed a desire to have less money, if only so he could generate higher returns.

2. You Have No Clients: As a private citizen, you don’t have any need to disclose your investments and other holdings to your clients because, well, there are no clients.  This gives you numerous additional advantages when it comes to generating more money.  You have no need to keep up with other similar funds in order to draw in more business.  You don’t have to make sure that you stay on the good side of your clients and purchase whatever is ‘hot’ in your area.  You don’t need to ensure that you make your fund looks good come the quarterly report, or for that matter, pay any special attention to the passage of each new quarter at all.

Perhaps most importantly, you don’t need to worry about redemptions.  One reason that most funds were unable to take advantage of the low prices of many high-quality stocks following the downturn of 2008-2009 is that so many of the fund members were pulling their money out, leaving the fund managers with nothing to invest in the now inexpensive stocks.  With only yourself to worry about, you don’t need to be concerned that money will be removed right when it will be the most useful to invest.  (Granted, you might need to use that money yourself and/or you may have already lost that money via the investments, but well, at least you’ll be in control of that money loss, so to speak.)

3. You Have Much More Time: We mentioned quarterly reports in the last point, but that’s just the start of things.  For a mutual fund or hedge fund, there is the expectation to show excellent results on a regular basis to numerous investors.  This means those fund managers have to try to ensure that the fund performs at or above average every few months, without concern about how such actions will impact results over a longer time range, like, say, the length of time it takes a typical worker to save, invest, and be able to retire.

You, on the other hand, are trying to build up your net worth over time, and don’t care if you take a few temporary net worth declines if it leads you to substantial profits in the future.  By looking at the long term, you can keep in mind that sometimes you’ll take a loss before you achieve a gain in a particular investment.  It’s not always possible to show a profit every three months, but if you can take advantage of the longer time frame you have, you can end up beating the market over the course of years or even decades.

Before we end this discussion, though, one reminder: Even if all of this about individuals being able to beat the market is correct (and I am arguing against one of the prime points of all personal finance in general, and PF blogging in particular), it’s still not a guarantee that YOU, personally, will be able to do it.  If you aren’t willing to put in a LOT of time and effort (Jim Cramer, one guy who was a part of one of those funds once upon a time, suggests no less than an hour of research each week per stock), don’t even try.  Those index funds aren’t half bad for most of us (myself included), so don’t feel the need to put these points to the test.

It’s far from certain that you will be able to beat the market, but it does seem that it is theoretically, maybe, with just the right level of skill and luck, possible for individuals to do so.  Do you think that beating the market is really possible for individuals?

Image Source: Morguefile

2 Responses to 3 Reasons You Could (MAYBE) Beat the Market, Even When Professionals Can’t

  1. In short, No! “The market” is the collective, amalgamated view of every single market participant. If you think you know something that this ‘group’ does not, you may be delusional!
    Kurt @ Money Counselor´s last blog post ..The U.S. Declaration of Independence

    • A fair point, Kurt. But the argument here is not that you know something that the market participants do not (I’d never make that argument, particularly as someone who rarely even has the chance to glance at CNBC while folding laundry). The main argument is that the biggest, most influential members of the group, the ones who all but steer the market, have disadvantages that could allow us small individual investors to potentially sneak in and maybe (notice my repeated stress on the word MAYBE, in the title and otherwise) do a bit better than them.

      So, I suppose the question I try to pose is this: Is there enough opportunity opened by the reactions and limitations of the fund managers for the little guy to sneak in and make a profit? I think so, assuming they (the little guys, that is) can take advantage of those reactions and invest in a manner that leads to success over the market as a whole (like that laid out by Warren Buffett in his ‘Superinvestors of Graham-and-Doddsville’ article). It’s difficult, yes, but worth remembering that the market doesn’t always behave in a fully rational fashion, as noted in many of the linked sources, and it could be possible to take advantage of those irrational behaviors.

      Feel free to critique the issue some more; I love a good discussion!

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