Not too long ago, I was wondering on the internet, going from one blog to another until I get to this very interesting article telling me that I can’t beat the market… that nobody can: Why I can’t pick winning stocks, and you can’t either by Mr. Collins. While the article is dated 2011, the author makes some valid points. Academic studies across ages prove that you can’t beat the house. Still, I’m standing with my flag in the air claiming my righteous right to fail beat the market. If you are reading my blog, you and I are probably part of the same army. Can you beat the market? And is it that relevant to beat it?
A few points from Mr. Collins’ article to start with
Collin’s article is very interesting as it highlights the main reason why you could not technically beat the street as an individual (and SMALL) investor.
First, where do you come from? Do you think you can beat CFA’s and MBA’s at their game? Chances are that most DIY investors are not coming from a financial background. Therefore, how could this be possible to invest better than a team of well-trained CFA’s? That totally makes sense; I wouldn’t try to be a better mechanic than a professional garage either.
Second, predicting the market is impossible. I totally agree with him on this point. He discusses a funny story about how a company goes back and down in their job ladder to make-up sales guidance that would make sense for them and for investors as well. In the end, if a company can’t really predict their own sales, how could you possibly analyze the business and make your own assumptions and predict where the stock is heading?
Third, if pro’s can’t beat the market (most of the time), how could you? When you think about it, professional fund managers have a hard time beating the market. They have all the money and the manpower in the world to cover any companies. They are so plugged in some companies that they know everybody there from the CEO down to the receptionist. Yet, they can’t find a way to predict the future, how could you?
Why pro’s have a hard time to beat the street
You can pull out pretty much any research about active vs passive investments and most of them will tell you that most portfolio managers are… well…. Human! CNBC claims in a recent article that over 90% of portfolio managers don’t beat their benchmark over a 15 year period (including a full economic cycle).
“But the latest report on active management performance, in the closely watched SPIVA U.S. Scorecard from S&P, paints an even bleaker picture over the long term.
For the first time, the scorecard tracked 15-year performance to capture what it considers a “complete market cycle.”
In that period, 92.2 percent of large-cap managers missed their marks, while the number was 95.4 percent for mid-caps and 93.2 percent for small-caps. It’s probably no wonder, then, that more than 58 percent of U.S. equity funds either folded or merged during the 15-year time frame.”
I will not argue with facts here; portfolio managers don’t do their job… or do they? Most shocking articles telling you how you should sell everything you have in your portfolio and put it in an index fund often miss several obvious points. Here are the real reasons why pro’s can beat the market, but can’t make it happen for you:
First, there are fees. I know, this is the obvious reason, but trust me; it’s not the only one. Still, asking a guy you pay 2% (from the money invested) to beat the market is like asking Usain Bolt to win a 100m race, but he must start 2 meters behind everybody else. Chances are that he will lose even if he is the best sprinter in the world.
Second, the size of the fund. You are comfortably sitting by the window with a coffee in hand and you finish your thoughts about buying Apple (AAPL) as it is a wonderful company (really, it is). You place your order, click the “confirm” button and then, BAM! You just purchase 100 shares of AAPL at $157.50 each for a total volume transaction of $15.75K. Now, imagine if you had to purchase 834,854 shares of AAPL for $131.5M total volume transaction. This is a relatively small amount for the largest mutual funds. in fact, this is just one of the transactions Berkshire Hathaway Inc. (BRK.B) did over the latest quarter. But you can imagine that moving larger sums of money like this make it harder to beat the market.
Third, the index obsession. Many fund managers are required to almost replicate an index and then beat it. The logic from a sales perspective is simple; when the market goes down and you go down, nobody is going to blame you. Same thing when you go up along the rest of investors. What hurts mutual fund sales is when you go down when the market goes up. Therefore, many funds are required to follow an index (e.g. having a similar asset allocation) and then, beat it through superior stock picking skills (minus the fees and minus the large amount to trade).
Fourth, portfolio managers are humans. We rarely discuss this matter in the financial world where everybody should be efficient and trade without bias, but this is BS. How do you think most portfolio managers handled the last crisis in 2008? Most of them traded “not to lose more money” instead of following their course of action. They wanted to keep their job and the best way to do it was to finish at -20% where others were at -25%. Then, it doesn’t matter if they lag during the recovery of 2009, they were heroes who saved money to investors last year. The others got fired and the “safe guy” kept his job. However, the only way to make a solid investment return is to keep being invested and stick to your plan.
Unfortunately, the industry has been built in a way that most portfolio managers can beat the market, but won’t do it for the shareholders. However, you can now see that you weren’t that dumb to think you beat the market… it is probably easier for smaller investors to do it than for professionals!
Where am I standing over the past 5 years?
After reading Collins’ article, I thought; “oh… it’s been a while I didn’t check my own performance!.” I seldom do spot checks on my performance from time to time, but I thought it was a good opportunity to look at the past 5 years. I took this period because my broker gives me the numbers with all the calculations, not because it gives me an edge in the comparison game. For the past 5 years, I show a total annualized return of 12.80%. This return includes dividend payment and also convert my USD investments into CAD. Therefore, depending on the timing I look at my return, it may be greatly influenced. For example, you can imagine how my return was better in May, before the Bank of Canada increased their rate!
Unfortunately, comparing my return with indexes isn’t easy. Depending on the time I invest over the past 5 years, my geographic asset allocation changed from about 40%-60% (CDN-US) to 25%-75% now (including my latest trade of selling a Canadian company (SNC.TO) to buy a U.S. company (AMZN)). For the time being, I’ve used a 35%-65% comparison. I also calculated an exchange rate of 27.95% as follow:
However, it is obvious I didn’t put all my money in 2013 and enjoyed a nearly +30% ride on my US money. In fact, over the past 5 years, I’ve added $12,000 in contribution and $8,000 was added through dividend payments. This portfolio worth about $70,000 CAD today, $20K of it (28.5%) was added at various exchange rates during that time. Nonetheless, I rather pick the worst exchange rate (higher value of CAD) for my comparison with the markets.
So here are the results after 5 years (source Ycharts):
XDV: 7.71% CAGR
VIG: 11.90% CAGR, in CAD = 14.47%
SP 500: 14.07% CAGR, in CAD = 16.99%
TSX: 4.80% CAGR
If I use the combination of 35% CAD and 65% USD, I get total annualized returned of:
ETF Benchmark: 12.10%
Stock Market: 12.72%
My portfolio: 12.80%
Yeah! I win both against the dividend ETFs and against the market in general. Plus, if I use a currency exchange movement of 20% instead of 27.95% (which would be closer to the reality), the ETF benchmarks show 10.87% and the markets 12.20%.
It’s obviously not an incredible win, but still, it shows that it’s worth it for me to manage my own money instead of buying ETFs. I must also consider that I was building my portfolio during this period and most of my successful holdings weren’t even there back in 2012 (my portfolio worth about $27,700 back then). Therefore, I expect my return in the next 5 years a lot better compared to the index if I continue to post such performance.
Here’s my secret recipe
Now, I think the reason I beat the market over the past 5 years is related to two factors.
#1 I’ve built a solid investing strategy (read my 7 dividend growth investing rules).
#2 I never moved away from my strategy
While I think it is very important to have a solid investing process to pick the right companies, it’s even more important to not go from one strategy to another or try to time the market thinking a crash is imminent (thinking of any moment in particular?). This is the real secret of a successful investors.
This recipe has been applied to all Dividend Stocks Rock portfolios. Here’s my latest performance as at August 17th 2017:
Click here if you want to trade without worrying about where the market goes
In the end is it that relevant to beat the market? Hum…. Hell YEAH!
Some will tell you that it’s not relevant as long as you meet your financial goals. I partly agree with this statement. It is true the most important thing about your investment is to reach your goal. It doesn’t matter if you invest your money in CD’s paying 1.50% if in the end, you retire wealthy due to their high saving capacity or if your invest in penny stocks making 200% return each year (ok…I doubt you can achieve this). In the end, what matters is to reach your financial goal.
However, if you spend lots of time on your portfolio, this must be rewarded by something. I personally manage my portfolio as I really enjoy it. This is a hobby where I’m getting paid to have fun. Now that I have my own investing membership, I’m actually living to manage my portfolio and research the market. That’s the perfect life for me! However, my past 5 years would have shown a 8-9% annualized returned, I would have been better off investing my money in a few ETFs. All the time and energy wasted to not even meet markets’ return… this doesn’t make sense to me. It’s like doing repairs on my car and eventually having to hand it over to the garage to repair what I did.
Readers, do you track your returns? Are you satisfied with them?
Dividend Growth Investor
Actually, beating a benchmark is irrelevant to me as a dividend growth investor.
What truly matters to me is focusing on my goals, and working my way towards reaching them.
I focus on my goals, by focusing on things within my control. Includes focusing on your savings rate, what you invest in, how much costs you have and keeping your behavior intact.
If I fail to beat all your benchmarks, but hit my goals I am a happy camper.
If I beat all of your benchmarks, but I miss hitting my goals, I will not be happy
On a side note, you do not need to beat a benchmark to reach your goals.
Dividend Growth Investor
I totally agree with you the most important thing is to achieve your goal. But imagine that you do everything under your control and make a 3% investment return while you could have made 6% with less risk and fluctuation since both the market and benchmark made such return. You achieve your goal at the age of 50… but you could have achieved it faster if you would have not spent time managing your investment.
The point is not obsessing about stock market returns (if not, you might end-up making bad trades), but if you can get close to a benchmark or the market over 5, 7 or 10 years, you are definitely hurting your financial plan for nothing. Many investors are better off simply doing index investing and not trade single stocks.
Congratz on beating the market. Not a lot of people can do that. I look forward to your reports the coming years.
I like part 2 of the title: is that relevant. A lo depends on your goals (see comment above) and also on the time (sweat equity) you want to put in. I know myself: I have not the discipline to research stock and wait for the good entry. therefore, indexing is good for me. I will thus have a little lower than the market return. At least, when I can keep my system of buying every month with our salary surplus. Not easy…
oh yeah, meeting your goals is by far the most important part 🙂
Anybody that claims to beat the market is not a real investor. Possibly, he is a visitor who is fortunate to come around when market is booming and then quickly sell off his stocks and never returns. Even still with that, he must have lost some potential some potential gains
Hum… I’m sorry but I buy and hold most of my holdings and will never get out of the market in one shot. My numbers are real. I’m not a genius (I’m beating the market over the past 5 years by 1 or 2 %, it’s not much), but getting behind the market by 2% wouldn’t worth it either. You are better off with index investing in that case.
I have been comparing my portfolio to indexes and I simulate my purchases against indexes (US and CAD). Canadian indexes usually lag the US indexes to start with … so that’s not a hard one to beat.
What I have discovered is that my portfolio beats the US index since 2009 but no one in their right mind would turn around and put 500K in just one index. While my portfolio is balanced and performs, switching to indexing would spread my portfolio across multiple indexes and really lower the performance.
Since I have all my contributions tracked, it’s easy to adjust the calculations and I will assess how a split CAD and US would look like. In the end, the benchmark is not ONE index but the blend of multiple indexes reflecting the reality of investing at a specific point in time (like buying in today’s high markets). All of it lowers the performance of the portfolio, more so once you add bonds.
In the end, anyone comparing to an index is not even comparing apples to apples as you actually need to simulate the purchase at the same time and establish the end value with a formula like XIRR. It’s like tracking multiple portfolios at the same time.
What really has me curious in the active vs passive investing debate is the actual results of a portfolio and not hypothetical against specific indexes.
Also, to support your points about portfolio managers, they work based on their performance evaluation for the year, not 20 years down the road. Short term sell products … and that’s their business. The study should be to compare what the portfolio managers have for their own money vs the products they sell. That would be an eye opener.
You bring very good points.
I think that if we see how portfolio managers do with their own money, we would have a similar result than when we look at Real Estate Agents selling their own property; strategies and results aren’t the same.
Plus, professional portfolio managers make so much money from their job that their aren’t likely to invest most of their money in equities. When you make over 500K per year, what good it gives to take additional risk in the market? your job is already 100% dependable of the market. You are better off investing in real estate or simply pay off your debt and pile up in a savings account (especially if you make over 1M$ per year).
I have been beating the market using dividend stocks. I occasionally trade when a stock may be overvalued. I may have been lucky as dividend stocks have done well in the low interest environment. I concentrate on my dividend income -that is my goal.
Sidenote – My benchmark is the weighted averages of tsw, spx, xin and bonds which used to be shown in the national post. Perhaps I am also benefitting from the previous falling dollar
WELL, I HAVE BEEN PLAYING AROUND WITH TECHNICAL ANALYSIS FOR SOME TIME. I THINK YES IT IS POSSIBLE TO BEAT THE MARKET USING SOLELY TECHNICAL ANALYSIS.
OF COURSE I HAVE YET TO PUT MONEY INTO THIS IDEA BUT THE PRELIMINARIES LOOK GOOD!
Thanks for sharing your thoughts on this topic and being genuine about it. I personally know that it is possible to beat the market and to beat most fund managers because of the same points that you made:
1. Fund managers charge fees (and these fees might seem small, but over a lifetime, they can end taking away 60% or more of your compounded wealth.)
2. Small-time investors have the advantage over fund managers because we don’t have to move so much capital in and out of investments. We can zip in and out of a stock in seconds, whereas the fund managers might take 6 weeks to get fully in or out of a stock.
Hi Dividend Guy!
Nice to know you are doing well and so am I. All I know is for the last 10 years that is when I first started I have not lost anything. My portfolio is made up of ETFs and Div. stocks only and a few like apple although apple had started giving dividends. I would never go into Index funds as they have so many companies that are useless. Pick great companies and stick with them and you will always come out a winner if you are patient enough to do that.
good investing= cookie
The two main reasons the sophisticated money managers fail to beat the index:
They have too much Money.
They charge management fees.