Have you ever considered trying to beat the market? If so, you're not alone. A Google search for the phrase "beating the market" brings up 37.5 million results; a quick search for the same phrase on Amazon yields 493 matches in the "books" category alone.
Given the prevalence that this financial planning strategy exhibits — not to mention the attention paid to stock picking and market timing in the financial media — it's not surprising that many investment professionals recommend this approach to investors. But here at Premier, we've made no secret of the fact that we don't advocate market timing as part of a comprehensive financial plan. In fact, we often refer to market timing as "gambling." Here's why.
Leave Market Timing out of Your Financial Strategies
When so-called "gurus" in the financial media talk about ways to generate market-beating returns, what are they referring to? In most cases, "the market" (as in, beating the) refers to the Dow Jones Industrial Average or the Standard & Poor's 500 (S&P 500) index. However, when investors use one of these two indices as benchmarks, they're actually just comparing their portfolio performance to U.S. large-cap stocks, a single asset class.
This means that when investors attempt to beat the market, they're often not even using accurate benchmarks to gauge their portfolio's performance. Many investors don't realize that their portfolios generally contain more than just U.S. large-cap stocks. Rather, their portfolio probably contains investments across a range of asset classes, such as bonds, international stocks, small domestic company stocks, and more. In such a case, comparing your returns to an index like the S&P 500 or Dow Jones isn't accurate, as your portfolio probably contains asset classes not represented in that particular index.
Thus, if investors compare their portfolio returns to index returns, they're comparing apples and oranges — it's an inaccurate comparison. While sometimes returns may be higher, sometimes lower, than an index, this inaccurate benchmarking may cause investors to chase an index that's been doing well or abandon investments that don't seem to be doing as well. Either way, this behavior means that investors may be making incorrect decisions about how their portfolio is performing... and making decisions that could hurt their return.
Human Nature + Market Timing = Less-than-Stellar Wealth Management
It's human nature to want to beat the market; after all, the financial media (and many investment firms) present it as the wealth management strategy of choice. Unfortunately, quantitative evidence shows that most investors simply make unwise decisions when it comes to market timing, such as jumping in the market to chase a "hot stock" (i.e., buying when a stock hits a peak), then running away when the stock falls (i.e., selling at a low point.)
Research organization Dalbar has tracked investor behavior for more than 20 years, and the empirical evidence is clear: investors who practice market timing aren't "beating the market" by any stretch of the imagination. In fact, their annual Quantitative Analysis of Investor Behavior for 2014 found that the average mutual fund investor over 20 years underperformed the S&P by 8.9 percent.
That's why we don't advocate an active approach to investing. Year after year, study after study indicates that it's simply not possible to predict market movements with any accuracy. That means investors cannot reliably jump into the market at the right time, stay in for the right amount of time, then get out at the right time, at least not without a working crystal ball to foretell the future.
It's certainly understandable that investors seek certainty and want to avoid pain, but the markets just don't work that way. Volatility is a given, and it can't be predicted with accuracy... even by self-appointed "gurus" in the financial media.