You may have heard people talking about “beating (or outperforming) the market.” What does that mean? And what is the market? Usually, when people talk about “the market,” they’re talking about U.S. stocks, as best represented by an index called the S&P 500 or the S&P.
For all intents and purposes, the S&P 500 is an index of 500 of the largest companies in the U.S., including stocks from many different sectors, financial companies, utility companies, consumer goods companies etc. On the surface, it sounds like a good idea — if you can outperform the overall market, that must be an indicator you’re doing something right.
But there’s more than meets the eye here. Below, let’s take a closer look at what it would take to beat the market consistently and if it’s even a worthwhile goal for individual investors.
What does it mean to “beat the market?”
To beat the market, you’re aiming to produce a better compound annual return on your investments than that of an index like the S&P 500. This has become such a common goal that there’s an entire industry devoted to helping investors try to beat the market. Countless professional money managers are paid millions of dollars per year to attempt to do just that, but very, very few can on a consistent basis.
Why is that? Financial markets are highly efficient, and within mere nanoseconds, stock prices immediately reflect all available public information. And all money managers — from the most successful to the greenest — have access to the same public information (acting on non-public information could lead to insider trading).
Prices are determined by supply and demand, with professionals buying with certainty that their purchases will go up in value — and sellers doing just the opposite.
In fact, the market is so competitive and so efficient, that a decade-long study recently found that only 15% of professional money managers outperformed the S&P 500. The law of large numbers suggests that at least some would — the question is, can they repeat that consistently, year-over-year, over the course of a 30-40 investing career? The answer is, very rarely.
Which is why — knowing that we, along with the smartest investors on earth, can’t repeatedly predict the movements of the market enough to outperform them consistently — there’s a better benchmark to focus on.
Be your own benchmark
Do you really care if you beat the market? I mean deep down, does it really matter? Or do you care about achieving a level of financial independence that affords you the ability to live your life and retirement years on your terms? We’re conditioned to feel like if we do something like ‘beat the S&P,’ we must be doing well, and thus on track to achieve that goal of financial independence.
But the S&P doesn’t know anything about your situation or your goals and dreams; it doesn’t know how many dollars you need to save in order to reach financial independence. So the goal of outperforming the market is a potentially misleading investing benchmark. There are many more factors that go into developing your own financial plan, factors that are personal to you.
With all of my clients, we examine the resources they have accumulated, forecast additional resources they will have, and identify what their goals and dreams are — then integrate all of that knowledge to develop an investment plan that gives them the best chance to achieve those goals and dreams.
Based on resources, goals, risk tolerance, and other factors, some clients need to shoot to earn a percentage return that may end up being more than the S&P, while still others may shoot for a lower number (and corresponding lower amount of volatility) in order to give themselves the best chance of success.
In zero cases does it matter whether they beat the S&P — or any other arbitrary index. The benchmark my clients compare themselves to is whether they are on track to reach their goals and increasing the degree of confidence in that pursuit.