Reminder: Trying to Outsmart the Stock Market Is Not a Helpful Game to Play

Academics from as early as the 1930s and 1940s have suggested that predicting stock prices is incredibly challenging, and a vast body of empirical research published since has continued to add weight to that view.

Nobel Laureate, Eugene Fama, known best for his work on the efficient market hypothesis and asset pricing is one such contributor. And the late Jack Bogle, founder of Vanguard (one of the largest funds managers in the world), who is credited with starting the first index fund also strongly believed that to be true.

The recent results from the annually updated SPIVA U.S. Scorecard published by S&P Dow Jones Indices, confirm again over the 20 years that it has been running, the majority of actively managed funds underperform the indices that they are trying to beat, and the few that do, cannot do it consistently over time. In fact, no fund in the study could stay in the top 25% for 5 consecutive years.

Add to that us, investors, making our own decisions on when to buy or sell those funds in response to what we think is going on in the economic and financial climate and our personal outcomes are likely to be even worse.

Why does this happen?

The reasons behind these findings are quite logical.

  • Markets are efficient enough

The prices that we see stocks trade on the market are, on balance, reasonable prices based on the expectations of millions, if not billions, of investors worldwide. This means that new positive or negative information is incorporated into those prices extremely quickly. So, it is nearly impossible to get the jump on everyone else who is participating in the markets and make large, consistent profits.

Even where inefficiencies do exist, the competition to profit from those is so stiff that they do not persist for long, and are unlikely to benefit the same person, or group repeatedly.

  • Active management comes at significant cost

Hiring plenty of analysts and other fund management staff, as well as incurring repeated trading costs in attempts to exploit market mispricing really adds up. So, even if it was helpful, it raises the bar for the returns needed to perform better than the indices.

Imagine starting a marathon an hour behind everyone else. If you were a good runner, could you finish better than average? Maybe. Would it be difficult? Absolutely.

What does this mean for us?

Well, if we accept the reasoning (and the empirical evidence) behind the disappointing results that active management has produced, then we should consider a better approach—one that trusts market prices to be reasonable, that keeps our costs (read: handicap) low, and that does not lean heavily on unreliable forecasts or guesswork.

That is why our clients are in stock-bond portfolios built with funds that are low-cost, diversified broadly, and with managers who share the right philosophy and who understand how the wrong approach can very well harm their investors.

This is an original article written by Bryan ChanClient Adviser at Providend, Singapore’s First Fee-Only Wealth Advisory Firm.

For more related resources, check out:
1. Principles for Successful Investing
2. Evidence-based Investing – Why Is It Important?
3. Providend’s Money Wisdom Podcast Episode 24: What Has Investing Got to Do with Football?


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