Should Investors Try to Beat the Market?

One of the top goals of many investors and money managers is to beat the market.

This is typically defined as achieving better returns than the S&P 500.

Afterall, when you can simply invest in an S&P 500 index fund with a 0.05% expense fee per year, the higher expenses of actively managed funds require some sort of justification. Will they beat the market? Will they match the market but with less volatility? They need to earn their keep somehow.

But according to the S&P 500 SPIVA reports, almost 85% of actively-managed funds fail to beat the S&P 500 over a 5-year period:

Beat the Market Chart

Chart Source: S&P 500 SPIVA

The numbers get worse over 15-year periods; 92-95% of them fail to beat the market over that longer period of time.

And these are trained professionals, with CFAs or MBAs and tons of support staff doing research for them. Despite all of that, most of them still can’t do it.

More specifically, active funds as a statistical group tend to outperform during bear markets, and underperform during bull markets.

Investment professionals as a group are decent at preserving money with all sorts of financial tools and strategies, but aren’t very good at knowing when to let off the brakes and let their holdings soar during bull markets. As a result, most of them underperform over the course of a business cycle.

The results are worse for average investors, with normal non-financial jobs. As a group, they vastly underperform the market on average:

Average Investor Returns Chart

Chart Source: JP Morgan Guide to the Markets

That’s 2.6% in average annual returns for investors, compared to 7.2% returns for the S&P 500. And most of the tiny returns they make are eaten by inflation.

The reason the average investor does so poorly is that they tend to make too many portfolio changes too late. After markets have already fallen during a recession, they get scared and sell. Then they miss out on the recovery, and when stocks are high again, they get excited and buy.

They fully participate in the market downturns while missing a large part of the market upturns.

So, the average investor does terribly, and professionals on average do okay but still underperform. What is there to do?

Invest in What Makes you Invest More Money

Because the chances of any money manager or household investor beating the market are low, it’s perhaps not the best thing for most people to focus on.

So many investors want to know “how to beat the market“, when the real question to ask is, “how can I build the most wealth?” At least, enough wealth to reach your goals.

Here’s a chart I put together a couple years ago for my article on building wealth, showing how much wealth you can build based on your average annual rate of return and your average monthly savings rate:

Wealth Building Matrix

Even the world’s best investors only beat the market by a few percentage points per year over multiple decades.

Figuring out how to save more money and increase your average monthly contribution to your portfolio will go a lot further towards reaching your financial goals than figuring out how to boost your average returns by a percent or two.

That being said, it’s important not to derail your returns by falling for the common investor mistakes, like buying high and selling low, paying very high fees for underperforming active funds, or investing far too conservatively and not having much equity exposure ever.

However, once you avoid the major pitfalls, it’s really about how much you invest rather than precisely what your rate of return is.

Therefore, a good thing to figure out is what excites you. What makes you invest more money?

My Example: Dividends

I love dividend stocks, including safe high yield dividend stocks.

Specifically, companies and partnerships that have a 10+ year record of increasing their dividends through bull and bear markets alike.

There’s just something about building a collection of growing dividend streams that gets me excited.

There are many things I don’t like to do myself. I don’t ever work on my own car, and I’m not very handy for doing maintenance around the house, for example. I’d rather pay professionals for those areas. If my car makes a squeaking noise or if I have water under my sink, I call a mechanic or a plumber rather than try to fix it myself.

But other things interest me, and I like to dive down to the details.

I buy individual parts and build my own computers, for example. So I know the ins-and-outs of how my PC works from the inside and can tailor it precisely to my own needs. I just can’t get myself to buy pre-made computers anymore, like from Dell or HP. For my computers, I know the motherboard, the CPU, the RAM, the storage device, the cooling system, the graphics card, and exactly why I picked each of them specifically. I love how my computers run compared to all pre-built ones I’ve ever had before.

And I buy individual dividend stocks, knowing what their price-to-earnings, dividend yield, dividend growth rate, return on invested capital (ROIC), and other metrics are. I know the management teams, what their strategies are, and how long they’ve been with the company. I know many of the risks they might face, and what their opportunities are.

During times like this, when the market is somewhat highly-valued, I just can’t get excited about index funds. Throwing money into a pool of thousands of companies just feels “meh”. It’s so tied to global economic performance, and there are so many variables involved.

Sure, my primary retirement account filled with index funds is automatic, and so I put more money in every 2 weeks and I recommend you do the same. But I don’t push myself to add more, beyond what is automatic.

Instead, what pushes me to add more to my other investment accounts is when there’s an interesting investment opportunity that I want more exposure to. There’s an undervalued dividend growth stock I want to buy, to add to my collection or increase my exposure to if I already own it.

My individual stock portfolio has indeed modestly outperformed my index stock portfolio, but only because I’ve been willing to concentrate my holdings into a number of high-conviction picks.

The real benefit of individual dividend stock investing, instead, is that I’ve simply saved and invested more than I otherwise would have if I were not excited about what I’m investing in. A combination of a reasonably high income, a high savings rate, and a healthy rate of return has brought me out of poverty where I started to a point where I have much more wealth than is typical for my age.

For me, investing in dividend stocks leads me to invest more.