Great Debates: Can the Market Be Beaten?

Over the short term, there’s no doubt that the market can be beaten. Every year, whether through luck or skill, there are plenty of stock funds that outperform the market averages. But what about the long term? As the time frame gets stretched, the number of winners shrinks.

This is no great surprise. Before costs, investors collectively earn the market’s return, because together we are the market. After costs, we must—as a group—lag behind. As the years pass and the investment costs mount, the chances of outperforming the averages grow slimmer and slimmer.

To be sure, there are investment heroes who beat the odds and come out on top. Berkshire Hathaway Chairman Warren Buffett, with his five-decade record of beating the market, is probably everybody’s favorite example. But in many ways, this is the power of anecdotal evidence: We remember big lottery-ticket winners, whose smiling faces make the evening news. We forget about the millions of losers, because they’re never mentioned.

As you will learn in the financial markets chapter, there are strategies—such as overweighting value stocks or putting more in smaller-company stocks—that have generated market-beating returns over long periods. But the academics who have documented these results typically note that the extra reward comes with extra risk. In addition, if you aren’t careful, any performance edge could be devoured by investment costs. Still, if you pursued these strategies by buying and holding low-cost index funds for many decades, there’s at least a moderate chance you could earn returns that are better than the broad market averages.

But this is hardly the sort of strategy that appeals to most folks who are looking to beat the market. Instead, they envisage buying funds run by hotshot managers, dabbling in initial public stock offerings and actively trading individual shares. These strategies are no doubt entertaining, they appear to be an easy road to riches and they generate enough occasional winners to keep investors coming back. But they’re unlikely to succeed over the long haul, in part because of the high investment costs involved.

Next: Step No. 4: Select Investments

Previous: Rebalancing Within Asset Classes

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