Rely on the Wisdom of the Crowd

By: Joe Morgan

Nov 30, 2023 | StocksLong-Term PortfolioDiversificationInvestment StrategyInvestment Philosophy

Prefer to listen rather than read? Pair this post with Deliberate Money Moves Podcast: Rely on the Wisdom of the Crowd.

In 1906 at a country fair in Plymouth, UK, 800 people participated in a contest to guess the weight of a slaughtered and dressed ox. Statistician Francis Galton was there and observed that the average guess of 1197 pounds was just 1 pound from the actual weight of 1198 pounds.

The winner’s was actually further away than the average guess. He proclaimed the average to be the “popular” figure as every other guess was too high or too low. In other words, the wisdom of this crowd was far greater than any individual member.

Think now about the stock market. Each day $440 billion of trades occur, meaning that much money is bet toward a stock going up or down. And consider that every trade has a buyer and a seller, meaning an equal number of people believe the stock will go up or down from that printed stock price.

So, for a stock price to move, it takes some bit of new information or opinions from the buyers and sellers. And the minute that bit of information is discovered by any of them, it will be reflected in the price of the stock.

In other words, the assimilation of new information is lightning quick and we cannot expect to be ahead of that many people all the time. If we are playing against all those other people, we are playing a loser’s game. We cannot “beat the market.”

Efficient Markets

This is what is meant by “efficient markets” – that markets soak up all new information instantly leaving no room for “smart” investors to win consistently. According to a report by Dow Jones, 89% of large company fund managers underperformed their index over the most recent 10 years. That is to say, if you were picking a fund manager and expecting him or her to outperform, you had an 11% chance of success. But wait, it gets worse.

Just because a fund manager outperforms over one period does not mean they will outperform over the next. Research shows that repeat performers come in around 35%. Therefore, even if you outperformed once, there’s only a 35% chance you will outperform again (even though we might expect this number to be closer to 50%)!

A Star Is Born?

So, who has the best track record? That’s easy, Bill Miller outperformed his index for 15 years in a row ending in 2005. He once said his streak was “an accident of the calendar. If the year ended in different months it wouldn’t be there and at some point, the mathematics will hit us. We’ve been lucky. Well, maybe not 100% luck – maybe 95% luck.”

And so, the absolute best fund manager in history says, truthfully, that his success was 95% luck. Let that sink in. Oh sure, we can win some of the time when we guess the markets, but overwhelmingly the evidence says we will ultimately lose.

What Gets In the Way?

Now, I’m guessing none of this is a huge surprise to you. Nearly everyone I speak to about this topic nods their head in agreement and may even state the words “No one can beat the market” but at some point, usually during the same conversation, they will ask “What do you think about Amazon?” or “Do you think I should buy more stocks today?”

You see, like most everything else in life, it is ourselves that gets in the way of doing what’s right. Call it overthinking or ego or whatever, but it comes from a good desire to do what’s best.

And that’s what makes it so dangerous. Because we have good intentions we sometimes will entertain the worst, most destructive ideas if there’s even a chance our intentions will be fulfilled.

The Good News

You don’t need to beat the markets. You see, this entire subject – beating the markets – is a distraction from what you really need: a portfolio that delivers the returns that will allow you to do what you want in life.

If we invest in a market-like portfolio, with wide diversification and diligence around our appropriate asset allocation, we can predict the return it will provide fairly well. It takes planning to ensure we can do everything we want given the realistic returns we can expect from such a strategy.

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