In the complex world of investing, the allure of generating “alpha”—the excess return over a benchmark index—has always been enticing. Many start their investment journeys aiming to achieve alpha, driven by the prospect of superior returns. While some remain committed to this path, others eventually shift their focus to accepting market-like returns, embracing a more measured, long-term approach.
In my previous article, ‘The Quest to Find a Trusted Financial Adviser,’ I shared my personal experience of searching for a client-centric adviser whom I could trust to guide me toward my financial goals. In this article, I shift focus to my investment journey, reflecting on the lessons I’ve learned both from my own experiences and the wisdom shared by my colleagues at Providend, as well as insights from established figures in the finance industry. My hope is that these reflections provide valuable insights as you continue your own investment path.
My Journey
I began my investment journey by investing a small sum into a unit trust on the advice of a financial adviser. At the time, I didn’t take the time to fully understand what I was getting myself into, and I wasn’t deeply involved in my investments. Over the years, I attended various courses on how to invest and started exploring the world of online brokerages.
Like many new investors, I was drawn in by stories on social media of people making significant gains. Eager to replicate their success, I subscribed to premium financial services like Seeking Alpha and began chasing the hottest stock picks. As someone who was married and planned to start a family, I was hopeful that investing could help secure a better financial future for my family. I thought, “If others can succeed, maybe I can too.”
However, this approach quickly became stressful. I found myself staying up late at night, constantly monitoring stock prices and anxiously evaluating whether my investments were profitable. The pressure to pick the right stocks and ensure profitability began to take a serious toll on my peace of mind.
The turning point came when a friend recommended ‘The Quest for Alpha’ by Larry Swedroe. Swedroe’s insights had a profound influence on my investment philosophy. The title of this article is a tribute to his book, as it helped me realise that while the pursuit of alpha—beating the market—is enticing, it is often an elusive and unsustainable goal for most investors.
1. Alpha Is Hard to Generate for Retail Investors
When I first restarted my investment journey, I was convinced that with enough research and timing, I could consistently outperform the market. But as I delved deeper—guided by Swedroe’s perspectives—I realised that generating alpha is not only difficult; it’s nearly impossible for the average retail investor.
Professional asset managers, equipped with vast resources and teams of analysts, struggle to consistently generate alpha. In fact, a 2023 study by S&P Dow Jones Indices found that over a 15-year period, 92% of large-cap mutual fund managers underperformed the S&P 500. If professionals with significant resources and expertise often fail to beat the market, it’s clear that retail investors face an even steeper uphill battle.
Even for those rare retail investors who do manage to generate alpha in the short term, sustaining that outperformance over the long run is extremely challenging. The markets are unpredictable, and even the most well-researched investments can be derailed by factors outside of our control—macroeconomic shifts, political events, or unforeseen market disruptions. Moreover, the costs associated with frequent trading can erode any gains made from outperforming the market. In the end, the pursuit of alpha can often lead to stress, overconfidence, and ultimately, underperformance relative to the broader market.
2. Alpha May Be Derived From Luck
One of the most critical lessons I learned is distinguishing between luck and skill. Often, when an investor outperforms the market, the question arises: was it due to genuine skill or mere chance? The Efficient Market Hypothesis by Eugene Fama and Kenneth French suggests that markets are generally efficient, meaning that excess returns are often the result of short-term fluctuations rather than consistent skill.
A 2008 study by Barras, Scaillet, and Wermers supports this, concluding that much of the alpha generated by mutual fund managers was due to luck, not skill. This realisation helped temper the overconfidence bias that many investors, including myself, experience. As renowned financial writer and behavioural finance expert Morgan Housel points out, overconfidence is one of the greatest risks in investing. Housel, known for his book ‘The Psychology of Money,’ emphasises the role of human behaviour in financial decisions and how it often drives investors toward unnecessary risk. Early short-term success can easily lead to misplaced confidence, but more often than not, this success is due to luck rather than skill. Recognising this has helped me adopt a more measured, long-term approach to investing.
Understanding the role of luck versus skill in investing has been crucial in reshaping my investment mindset. It’s easy to attribute short-term gains to personal expertise, but doing so can lead to dangerous overconfidence, pushing investors to take unnecessary risks. Over time, I’ve come to appreciate that consistently beating the market requires not only skill but also an ability to predict unpredictable variables—a nearly impossible feat. This shift in perspective helped me see the value of a more disciplined, globally diversified approach, relying on market returns rather than chasing elusive outperformance. By focusing on what I can control, like minimising fees and staying invested, I’ve found more peace in my investment strategy and greater confidence in long-term results.
3. Why Index Funds Are More Efficient
Given the challenges of generating alpha and the significant role of luck, index funds emerged as a far more efficient solution for me and for most retail investors. Index funds aim to replicate the performance of a market index, like the MSCI ACWI (All Country World Index), rather than trying to outperform it. This removes the stress of stock-picking and the temptation to chase elusive returns. Instead, index funds offer consistent market performance with minimal fees, and over time, these advantages compound into substantial wealth accumulation.
Studies like Morningstar’s Active/Passive Barometer consistently show that low-cost index funds outperform most actively managed funds across multiple asset classes. This realisation was a turning point for me. Instead of chasing every hot stock tip, I began focusing on the simplicity and reliability of index funds—a decision that has granted me far more peace of mind. As I emphasised in ‘The Quest to Find a Trusted Financial Adviser,’ finding trustworthy guidance and stability is key to long-term success.
4. What If You Still Want to Continue the Pursuit of Alpha?
Even with this knowledge, you may still decide to pursue alpha. However, I would like to raise some points to consider.
Prioritise Your Core Financial Goals First
Consider the extensive evidence supporting index funds, which suggests that they may provide a reliable way to secure your core financial goals. With their proven track record of delivering consistent, market-like returns and minimising risk through diversification, index funds offer a solid foundation for long-term financial security. If you believe that index funds are the right vehicle to fund your core goals, this means setting aside sufficient funds for retirement, your children’s education, and other essential life goals. For these critical objectives, it’s wise to choose the most reliable investment options available to ensure stability and growth.
Allocate a Portion You Can Afford to Lose
Once you’ve secured your primary financial goals, you might consider allocating a small portion of your portfolio—typically no more than 5-10%—towards pursuing alpha through individual stocks, cryptocurrencies, or other speculative investments. These assets can offer the potential for higher returns, but they also come with increased volatility. It’s important to invest only what you’re comfortable losing so that you can explore these opportunities without jeopardising your long-term financial health.
A Journey Shaped by Knowledge and Peace of Mind
The quest for alpha is not just about outperforming the market; it’s about understanding yourself as an investor. Through the resources I’ve explored—from Larry Swedroe’s ‘The Quest for Alpha’ to the writings of Morgan Housel and Andrew Hallam—I’ve learned that chasing alpha can lead to unnecessary risk and stress. Instead, I’ve shifted my focus to what I can control: minimising fees, staying diversified, and focusing on long-term goals.
This shift has brought me not only financial returns but also profound peace of mind. Embracing a simplified and reliable approach through index funds has freed me from the stress of monitoring volatile markets. It’s allowed me to focus on what truly matters—spending quality time with family, enjoying sports like pickleball, and living in the present without the emotional turmoil that comes with speculative investing.
Andrew Hallam, in his book ‘Balance: How to Invest and Spend for Happiness, Health, and Wealth,’ emphasises the importance of living in the present and aligning your financial strategies with broader life goals. This philosophy resonates deeply with me. By adopting a balanced approach, I’ve freed up mental space to concentrate on what truly makes me happy, rather than fixating on future gains.
Conclusion
The quest for alpha, much like the quest for a trusted financial adviser, is a journey of learning and self-reflection. For retail investors, generating alpha is extremely challenging, and in many cases, it’s more a product of luck than skill. While the allure of beating the market is strong, it’s often more efficient to accept market returns and invest in low-cost index funds like the MSCI ACWI. If the urge to speculate persists, it’s crucial to first secure your financial foundation and only allocate what you can afford to lose.
The lessons and insights I’ve gathered have profoundly shaped my investment approach, helping me to invest thoughtfully, cautiously, and with peace of mind. Investing isn’t just about accumulating wealth; it’s about ensuring a future where you feel secure, content, and able to enjoy the present.
Sources:
- S&P Dow Jones Indices, “SPIVA U.S. Scorecard 2023.”
- Barras, Laurent, Scaillet, Olivier, and Wermers, Russ. “False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas,” Journal of Finance, 2008.
- Morningstar, “Active/Passive Barometer 2023.”
- Fama, Eugene F., and French, Kenneth R. “The Cross-Section of Expected Stock Returns,” Journal of Finance, 1992.
- Housel, Morgan. The Psychology of Money. Harriman House, 2020.
- Hallam, Andrew. Balance: How to Invest and Spend for Happiness, Health, and Wealth. Wiley, 2022.
This is an original article written by Sean Tan, Associate Adviser at Providend, the first fee-only wealth advisory firm in Southeast Asia and a leading wealth advisory firm in Asia.
If you are interested in joining our Providend Associate Adviser Programme, find out more here.
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3. Why a Robust Estimate of Future Returns Is Important for Investment Planning
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