You are not likely to beat the stock market, despite all the cheer leading from the securities industry and the financial media. When you try to beat the public securities markets, unfortunately you are more likely to trail the market’s return, because of extra costs, taxes, and investment mistakes.
The idea that investors can beat the market is extremely widespread. The financial media, the financial services industry, and the selective recall of people at cocktail parties around the world perpetuate this notion. Given how modern public markets price securities, how likely is anyone to beat-the-market consistently and what does it really mean to do so? (See: How investment securities are valued – snapshots in time and The confusing investment securities market motion picture)
Consider that before costs and taxes, the average investor’s gross return will equal the market’s return. The market return will consist of all dividend payouts plus realized and unrealized capital gains or losses across all investors. The total return of a public securities market must equal the aggregated gross returns across all investors.1
Across all investors’ portfolios, there can be substantial variations in investment performance. Nevertheless, for every dollar of return in excess of the market return received by one investor, another investor will trail the market by a dollar.
At the outset, therefore, markets are symmetrical with respect to the aggregate returns of winners and losers. For every dollar that “beats” the market, another gets “beaten by” the market. Moreover, this is before any costs or taxes are taken into consideration. However, costs and taxes can both have a very substantial negative impact on returns. (See The Skilled Investor’s various articles on investment costs and taxation. To begin, see: Excessive investment costs are a huge problem for individual investors)
What would it really mean for you to beat the stock market?
Because of fluctuations in the value of portfolios composed of different securities, an investor’s returns are just as likely to trail the market return as they are to exceed it at any point in time. If you beat-the-market for any period due to random fluctuations, this would hardly be the basis of any genuine pride about one’s investment prowess.
Instead, to truly beat the market should require the demonstrated ability: 1) to beat the market consistently over an extended time and 2) to do so against an appropriate risk-adjusted market benchmark that truly reflects the [...]