September 23, 2014

Be honest. Is one of your investing goals beating the market? Join the club of 50 million like-minded investors who share the same goal.

Beating the market is tough. Especially when you consider that 90% of the trading that takes place is done by institutions, not individuals. These big investors are all trying to beat the market, or at the very least not lose to the market (passive index funds.) Here’s the problem for a retail investor.

Institutions have resources at their disposal that individuals (most of them, anyway) can’t touch. Big pools of money. A full time staff of researchers (many of whom are math & physics wunderkinds from the top schools).

And they have contacts. This is important. Contacts inside the companies they invest in. Contacts in government. And contacts at the top Wall Street Banks who cover these companies. They have a huge competitive advantage over retail investors.

But don’t worry – it’s still possible for a regular individual with a 5-figure IRA to beat the market. But it’s not easy. Two of my favorite market-beating gurus are Seth Klarman and Charlie Munger. Here’s what they had to say on the subject.

“Investors operate within what is for the most part a zero-sum game. While it is true that the value of all companies usually increases over time with economic growth, market outperformance by one investor is necessarily offset by another’s underperformance.”
-Seth Klarman, 2005 Baupost Value Partners Letter

“The model I like—to sort of simplify the notion of what goes on in a market for common stocks—is the pari-mutuel system at the racetrack. If you stop to think about it, a pari-mutuel system is a market. Everybody goes there and bets and the odds change based on what’s bet. That’s what happens in the stock market. Any damn fool can see that a horse carrying a light weight with a wonderful win rate and a good post position etc., etc. is way more likely to win than a horse with a terrible record and extra weight and so on and so on. But if you look at the odds, the bad horse pays 100 to 1, whereas the good horse pays 3 to 2. Then it’s not clear which is statistically the best bet using the mathematics of Fermat and Pascal. The prices have changed in such a way that it’s very hard to beat the system. And then the track is taking 17% off the top. So not only do you have to outwit all the other betters, but you’ve got to outwit them by such a big margin that on average, you can afford to take 17% of your gross bets off the top and give it to the house before the rest of your money can be put to work.”
-Charles T. Munger, A Lesson on Elementary, Worldly Wisdom As It Relates To Investment Management & Business, USC Business School, 1994

So if you’re trying to beat the market, don’t get discouraged. It’s tough, but not impossible. Anyone can beat the market for a while, but very, very few can do it over time.

About the author 

Erik Conley

Former head of equity trading, Northern Trust Bank, Chicago. Teacher, trainer, mentor, market historian, and perpetual student of all things related to the stock market and excellence in investing.

{"email":"Email address invalid","url":"Website address invalid","required":"Required field missing"}