The phrase “beating the market” means earning an investment return that exceeds the performance of the Standard & Poor’s 500 index. Commonly called the S&P 500, it’s one of the most popular benchmarks of the overall U.S. stock market performance.
Everybody tries to do beat it, but few succeed.
The Barriers
Investment fees are one major barrier to beating the market. If you take the popular advice to invest in an S&P 500 index fund rather than on individual stocks, your fund’s performance should be identical to the performance of the S&P 500, for better or worse. But investment fees will be subtracted from those returns, so you won’t quite match it, never mind beat it. Look for index funds with ultra-low fees of 0.05% to 0.2% a year, and you’ll get close to equaling the market, though you won’t beat it.
Taxes are another major barrier to beating the market. When you pay tax on your investment returns, you lose a significant percentage of your profit. The capital gains tax rate is 15% to 20%, unless your income is very low. And that’s the tax on investments held for at least one year. Stocks held for a shorter-term are taxed as ordinary income.
Investor psychology presents a third barrier to beating the market. Perversely, most people have a tendency to buy high and sell low because they’re inclined to buy when the market is performing well and sell out of fear when the market starts to drop. This one at least is within your control. Learn how to analyze a stock and consider the company’s potential for future gains. It’s not foolproof, but at least you’ll be buying for sound reasons.
Risk Is Key
One way to try to beat the market is to take on more risk, but while greater risk can bring greater returns it can also bring greater losses.
You might also be able to outperform the market if you have superior information. There are few ways that an individual investor can possess superior information unless they are company insiders, and trading on nonpublic information is a serious crime called insider trading.
Defined more broadly, though, you may have superior information based on your expertise in an industry or a product. There’s no crime in investing in what you know.
Some investors have made fortunes through what appear to be superior analytical skills. Household names like Peter Lynch and Warren Buffett achieved their successes by picking individual stocks. Many individuals you’ve never heard of have attempted similar strategies and failed. Even most professional mutual fund managers can’t beat the market.
Sometimes It’s Just Luck
Meaning no disrespect, Lynch and Buffett may have just been exceptionally lucky, even if they are financial whizzes. Highly regarded economists have shown that a portfolio of randomly chosen stocks can perform as well as a carefully assembled one.
Yes, you may be able to beat the market, but with investment fees, taxes, and human emotion working against you, you’re more likely to do so through luck than skill. If you can merely match the S&P 500, minus a small fee, you’ll be doing better than most investors.