Psst! Wanna Be a Better Investor? Then don’t follow the stock market or the economy!
I’m going to let you in on a secret!
It’s going to sound like a strange claim, but nobody who understands how the stock market works is going to be able to refute it. Here goes:
I have an investment account comprised of three index funds. If I died today, and if that money was just allowed to grow over time, it would beat the vast majority of professional investors.
Over the first five years, it would probably beat 70 percent of professional investors.
Over a ten year period, it would probably beat 80 percent of professional investors.
Over a fifty year period, it would probably beat 98 percent of professional investors.
I used the word “probably” because I can’t be sure, exactly, what percentage of investment professionals would lose to a dead man’s investments, but my trend is correct. The longer the duration, the more badly this future cemetery dweller would beat the pros. As mentioned, nobody who understands how the stock market works can argue against that.
Strange But True
Most investors who react to changes in the stock market, the economy, and their investments (ie. most traders) underperform most investors who could lay around in hammocks all day, without ever watching financial news or following anything financially related.
Sure, there are going to be people who watch their investments like hawks, and do reasonably well, but most investors who monitor the markets and the economy do worse than investors who just sit on their diversified portfolios of index funds and never touch them.
Investing is a pretty bizarre game—unlike virtually anything else.
For instance, if you want to be a good soccer player, you have to study the game, refine your skills, and practice, practice, practice.
If you want to be a good writer, a good dancer, a good speaker…the same rules apply. You have to practice and refine your abilities.
But investing is different. And there’s a compelling reason for that:
If you own a representation of the world’s stocks through an index fund, and just hold it, you’ll beat the vast majority of the professionals over your lifetime. There are highly paid and highly trained professionals who will follow the economy, follow the markets, and buy and sell strategically, but the vast majority of them will lose to a soccer mom who buys a basket of global indexes, and never even opens her account statements.
The soccer mom’s investment returns will be exactly the same as the average, professional global stock market trader. That’s how the markets work. If you own a total U.S. stock market index fund, for example, and if the U.S. stock market makes 5% this year, it means that the average dollar invested in the U.S. market that year made 5%. And because the average invested dollar made 5% that year, it would mean that the average professional investor, with money in the market, made 5%…because most of the money that’s in the market is directed there by professional investors.
Because you own a representation of that entire market (through an index fund) you would earn a 5% return.
Just by owning a stock market index fund, you can make a return equalling the average of all professional investors. Most of the market’s investors are professionals, trying to gain an edge. But the soccer mom would beat half of them, before fees.
After fees, she would beat more than half of them because professional investors would incur more fees than she would. Buying and selling stocks costs money, as does the research associated with the decisions professional investors make.
Some of those professionals would beat the soccer mom. But they won’t be able to do it every year. Sometimes, a lucky/talented professional could beat the soccer mom for a few years in a row, but ultimately, the odds are that the “skilled” professional will end up losing to the market average. In many cases, they would end up giving back their advantage. Studies show that high-performance levels, among professional investors, are rarely sustainable.
Now, these professionals are trying really hard. They all follow the economy, sometimes keeping money out of the markets, sometimes putting larger sums in.
But the markets can move quickly. Those who have cash on the sidelines never get an announcement from the ever-humbling market, informing them when it’s going to rise. In fact, nobody knows what direction the markets are ever going to go. It’s hard to believe, but it’s true. So when the markets do make a jump, many of these professionals (who kept money out of the stock market) scramble to get money in. And those who try this market-timing game lose a step or two to the soccer mom who keeps her money in the markets, rather than trying to second-guess its direction. When you don’t have money in the markets, and they rise, you have lost the opportunity to profit from the jumping market. These “losses” are called “opportunity costs”.
Then there are the amateurs. These people are competing with the professionals, trying to out-think the pros, trying to out-think the markets, and trying to busily move their investments from fund to fund, stock to stock, or cash to bonds. But they don’t generally beat the pros.
That said, the soccer mom does beat most of the professionals…if she resigns herself to more important past-times, while ignoring the stock market, interest rates, and the economy.
If you’re curious as to why I chose a soccer mom and not a soccer dad, there’s a reason. Women’s investment accounts generally outperform men’s accounts.
More men think they can guess where the economy or the stock markets are headed. And of course, their overconfidence generally hurts their returns.
If you read an online blog or news article that outlines, in great academic detail, where the markets or the stock markets are generally headed, just smile.
Then go to the park with your kids, leaving others to second-guess the markets and the economy.
If you have a diversified investment account that you never touch (especially if it’s comprised of index funds) you’ll beat the vast majority silly…without even trying.
It has to be one of the world’s greatest paradoxes.