Protecting and growing your retirement nest-egg is one of your most important financial responsibilities. Ensuring that your nest-egg is sufficient to fund your lifestyle in retirement often means putting at least part of it at risk in the stock market.
Unfortunately too many people are swayed into believing that being a successful stock market investor means you have to actually beat the market. Beating the market is really, really difficult, especially over longer periods of time. It’s a tough job, but why is it so difficult?
Picking outperforming stocks is hard
A recent article from one of our favourite authors and commentators, Larry Swedroe, highlights some data points from studies that indicate why stock pickers might have such a tough time beating the market:
- The Russell 3000 Index of the largest 3000 US stocks delivered an annualized return of 12.8% between 1983 and 2006
- While that’s an impressive return over that period and achievable for anyone investing in a Russell 3000 Index fund (if there was one in 1983!), trying to beat that index by picking stocks would have been a formidable task – here’s why:
- the median annualized stock return was only 5.1% and the average stock actually lost money, -1.1% annually
- 39% of stocks lost money
- half of the stocks that lost money lost at least 75% of their value
- 64% of stocks under-performed the Russell 3000 Index
- just 25% of stocks were responsible for all of the gains.
- only 48% of stocks returned more than one month Treasury bill returns
No wonder it’s so difficult to beat market indices. Outperforming stocks are really hard to find!
Even the pro’s find it difficult
Even professional money managers get it wrong. According to research from Standard and Poor’s, only 1 in 20 US-based domestic mutual fund managers managed to beat a basic market index (S&P 500) over the last 15 years. A lot of the problem is that most funds don’t even survive with only 34% of funds that were around 15 years ago still in existence today – funds don’t usually get retired for good performance.
If you’re a Canadian investor your odds of picking a winning US-focused mutual fund are even worse. In this case Standard and Poor’s research identified not a single fund manager that was able to beat the S&P 500 over the 5 years through 2016. Over 3 years and 10 years approximately 2% of managers were able to beat the benchmark index.
And this is just fund performance – if you weight the fund returns by the amount of money invested at each time period (an indication of how good individual investors are at timing their fund investments) the results are even worse. People tend to invest more in funds after they’ve gone up and take money out after they’ve gone down – poor investor behaviour makes fund under-performance even worse.
The good news is that you don’t have to play the game to win
So it’s hard – outperforming stocks are rare, professionals can’t seem to do it either, it’s impossible to identify the very few (if any) professionals that can outperform in advance and for those few that do, it’s difficult to attribute their success to luck or skill after the fact.
But while most individual investors (amateur and professional) get it wrong, the beauty is that collectively they do a great job at allocating capital and discovering efficient market prices – the result is a market than can be accessed in a very liquid, simple, diversified and low cost way via index mutual funds and ETFs (exchange traded funds). The efficiency of the market means that you can put your money at risk and be confident that over the long run sensible risk taking should be rewarded with commensurate investment returns. Trying to outperform the market in any meaningful way just isn’t worth the additional time and cost. You may get lucky but the odds are clearly against you.
With your retirement nest egg you want to be an investor, not a speculator! Investing in a sensible way that is geared towards your willingness, need and ability to assume risk will give you a better chance of meeting your financial goals. Why risk what you have for what you don’t need by playing a losers’ game? As legendary investor and author Charles Ellis says, “the best way to play the losers’ game is not to play”.