The Myth of Beating The Market

Supposed I wanted to buy the S&P 500 Index on January 2, 2013.
For argument sakes, let’s say I had $10,000 and could buy 68 shares of SPDR S&P 500 ETFs at the closing price of $146.06.
Suppose I had fat fingers and typed 98 shares instead, and having a margin account, the order went through. The total trade would be 98 x $146.06 = $14,313.88. $10,000 would be paid with my own money; $4,313.88 would be money borrowed on margin.
As of April 16, each share was valued (note, I don’t use the word “worth”) at $157.41.
98 shares X $157.41 = $15,426.18
Repay $4,313.88 margin loan
Less $10,000.00 capital
Profit on 98 shares = $1,112.30 before commission and margin interest, an 11.123% gain on $10,000.
Had I bought the 68 shares I actually intended to buy,
68 X $157.41 = $10,703.88
Less $9,932.08 cost
Profit on 68 shares = $771.80, a 7.7708% gain on $9,932.
The S&P 500 Index (using SPY as a proxy) was up ($157.41/$146.06)-1 = 7.7708%. Buying SPY with cash resulted in the same gain, but Mr. Fat finger ended up with an 11.123% gain.
Does this mean Mr. Fat Finger “beat the market”?

A Big Lie from the marketing department

This is the part we share another fundamental truth with you. Everyone in the industry plays a line-drawing game. Investment book author Dan Solin recently took Jim Cramer to the woodshed for telling people that they can “beat the market”. He then heaped praise on Bill Sharpe for “exposing” the fact that “beating the market” was a low-probability event.
I say they are all giving investors a load of bullsh*t. The truth is this: by definition, NOBODY can “beat the market”. Everyone in the business knows it, but it’s in nobody’s interest to let the investors know. This way, each salesman can draw the line where they want to, say they know better than the other guy and sell their fund/books/trading system. Collectively, the industry rakes in the fees. It’s all good.
THINK ABOUT IT: You will get the return (and all other metrics such as volatility, and ironically, the Sharpe ratio) of the index by buying the index. If you try to time the market, or use margin, or over/underweight some of the stocks, YOU NO LONGER OWN THE INDEX in the same way.
Everything has changed, so why should you compare the results to the index?

Investing in The Titanic

What are we trying to beat? If we are just talking about percent return, you just saw Mr. Fat Finger “beat” the S&P by using margin. He is a genius, right?
risk-is-an-icebergSo, when Dan Solin and every other guy who has something to sell talks about “beating the index”, they are talking about RETURNS only. They are not referring to the RISK.
Even worse, most strategies that “beat the market” are like icebergs. You see the top line returns, but the risk grew exponentially, hidden below the water.
By the time you find out, it’s too late. Just ask those who invested with Ken “Best Stock Fund of the Decade” Heebner or Bill “I beat the S&P for 15 years” Miller.
Do we want high returns? NOT if it comes with even higher risk!

Most Bang for the Buck

When people write to us and ask “Where can I see the past performance results?” I cringe because I know the industry has trained them to only look at the percent RETURN, not the RISK.
Mutual funds and managers only ever talk price, because if investors really knew what lurked beneath, they would freak out. Since consistency is king, they would figure out in one second that the risk of the fund makes is very difficult to reach their investment goals.
Instead, they are left to experience risk the hard way with every crash. Somehow, they never learn about risk as THE most important measure of performance, and because of this, parents are unable to teach kids what they need to know about investing.
Looking at percentage returns as the only indicator of performance is like …

  • counting reward, but not risk
  • looking at income, but not expense
  • shopping by price, ignoring quality
  • counting home runs, but not strike outs
  • calculating miles, but not gallons
  • counting calories, ignoring portion size

There IS a way to truly level the playing field. It is so simple you will be stunned, but it is in nobody’s interest to show investors because it would mean all funds and managers would be judged by a single, objective, clean and unequivocal yard stick.
No more line drawing games means no more smoke and mirrors. And that, would be bad for business.