Photo: Flickr / x1brett/
“Beating the market” means trying to earn an investment return greater than that of the S&P 500 index, one of the most popular benchmarks of U.S. stock market performance.Investment fees are one major barrier to beating the market. If you take the popular advice to invest in an S&P 500 index fund, your investment will perform identically to the S&P 500 and investment fees will be subtracted from those returns, preventing you from beating the market.
Look for funds with ultra-low fees of 0.1 to 0.2% annually and you’ll be close to equaling the market.
Taxes are another major barrier to beating the market. When you pay tax on your investment returns, you lose a significant percentage of your profit -15% or more, depending on your holding period.
Investor psychology presents a third barrier to beating the market. People have a tendency to buy high and sell low because they’re inclined to buy when the market is performing well and they sell out of fear when the market starts to drop. This buying and selling behaviour makes it impossible to beat the market.
One way to try to beat the market is to take on more risk; but while greater risk can bring greater returns, it can also bring greater losses. Success is not guaranteed. You might also be able to outperform the market if you have superior information, but those with superior information are often insiders, and trading on material, nonpublic information is a serious crime called insider trading.
Some investors have made fortunes through what appear to be superior analytical skills. Household names like Peter Lynch and Warren Buffett achieved their successes through picking individual stocks. Many more individuals you’ve never heard of have attempted similar strategies and failed. Even most professional mutual fund managers can’t beat the market, and while this is not a popular theory, Lynch and Buffett may have just been exceptionally lucky, even if they are financial whizzes. Highly regarded economists have, in fact, shown that a portfolio of randomly chosen stocks can perform as well as a carefully assembled one.
Yes, you may be able to beat the market, but with investment fees, taxes and human emotion working against you, you’re more likely to do so through luck. If you can merely earn the same returns as the market, you’ll be doing better than most people.
This story was originally published by Investopedia.
Business Insider Emails & Alerts
Site highlights each day to your inbox.