“Market efficiency” makes it very difficult for individual investors to “beat the market.” Making their own decisions, individual investors perform so poorly that on average their investment returns lag behind the returns that one would expect from random stock selection.
The average professional trader does somewhat better than amateurs do, and professionals probably do so, in part, at the expense of the amateurs. However, on average, any actual performance advantage delivered by professionals is significantly less than the average fees they charge for their services. (See: The illusion of superior professional investment manager performance)
Securities markets in modern industrialized countries tend to price traded assets relatively close to their risk-adjusted expected values. When market prices tend to reflect fully all available information about a security, then those markets are considered “efficient.” This is particularly true in the United States with its broad, real-time, and relatively transparent or relatively honest financial markets.
Of course, the media has been filled with stories of industry misconduct and fraud since the market crash. Nevertheless, U.S. markets still do a reasonably good job of providing a highly liquid forum where knowledgeable and willing buyers and sellers can trade at arms length at prices that are determined by supply and demand rather than manipulation.
This relative “market efficiency” makes it very difficult for individual investors to “beat the market.” In fact, academic studies have shown that, left to their own decisions, individual investors perform so poorly that on average their investment returns lag behind the returns that one would expect from a completely random stock selection process. (See: What is the cost to individual investors of sub-optimal portfolio diversification?)
When higher investment costs, increased taxation, and the value of one’s personal time are considered, the efforts of amateur individual investors to “beat the market” become even more clearly uneconomical.
Nevertheless, the illusion that one can beat the market persists very widely. The securities industry keeps telling them it is possible. Brokers push individual security recommendations and individuals buy them hoping to outperform the market. (See: Can you really beat the securities markets?)
Rarely are individual investors sufficiently disciplined to compare their personal portfolio performance against an appropriate market index benchmark. Instead, as a herd, they to move their money into the most recent hot sector, after securities prices have already run up. Many do not really understand their personal performance and substitute costly activism for a [...]