Why Trying to Beat the Market Usually Fails

Key Takeaways

• Markets quickly incorporate new information into stock prices.
• Most professional fund managers fail to outperform their benchmark indexes over long periods.
• Diversification helps investors capture market returns while reducing unnecessary risk.
• Long-term investment success comes from discipline and planning, not predicting the market.

The Contest in 1906

In 1906, at a country fair in Plymouth, England, 800 people participated in a contest to guess the weight of a slaughtered and dressed ox.

Statistician Francis Galton observed that the average guess was 1,197 pounds, just one pound away from the actual weight of 1,198 pounds.

Interestingly, the winning guess was further from the true weight than the average of all 800 guesses.

Galton called the average the “popular” figure because every other guess was either too high or too low.

In other words, the wisdom of the crowd was greater than the wisdom of any individual participant.

What This Has to Do With Investing

Now think about the stock market.

Every day, billions of dollars are traded as investors buy and sell stocks based on new information, expectations, and opinions.

Every trade has both a buyer and a seller. One person believes a stock is worth buying, while another believes it is worth selling.

For a stock price to move, new information or changing opinions must enter the market. The moment that information becomes known, investors begin acting on it and the stock price adjusts.

The assimilation of information is incredibly fast.

Key Point: We cannot reasonably expect to stay ahead of millions of other investors all the time. If we are trying to outsmart everyone else, we are playing a difficult game.

Efficient Markets

This concept is known as efficient markets.

Efficient markets suggest that stock prices quickly reflect publicly available information, leaving little opportunity for investors to consistently identify mispriced securities.

The evidence supporting this idea is compelling.

According to long-running SPIVA research, most actively managed fund managers underperform their benchmark indexes over long periods of time.

In other words, if you are selecting a fund manager because you expect them to outperform the market, the odds are not in your favor.

But it gets worse.

Just because a fund manager outperforms during one period does not mean they will outperform during the next. Research has shown that repeat outperformance is surprisingly rare.

A Star Is Born?

One of the most successful fund managers of his era was Bill Miller, who outperformed the S&P 500 for 15 consecutive years ending in 2005.

Reflecting on that streak, he once said:

“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.”