This is part three of my 10 things every beginning investor should know post.

#3: Even active investors find it hard to beat the market

Alternatively, this should be titled “Even the pros (probably) can’t do it”. We touched a little on this in part one but this post will be a full exposition to convince readers that even the pros find it tough to beat the market. Do note that this is a blog post so being a blog post, this is by no means an academic thesis on why the pros can’t do it. But the evidence I shall present is quite damning.

The Stats

There are people out there who actively look for managers that can beat the market and in a given year, there ARE managers who can beat the market. However, the problem is that a star today almost invariably turns out to be a dog the next year or within the next three. Check out John Paulson’s record for a perfectly textbook example of this. Even managers that have done well for decades can see their records erode over a single event (think Bill Miller).

Studies have also shown that over the long-run, hardly anyone beats the market. So, if you’re a beginning investor and have no clue as to what things like indexed funds, synthetic ETFs, MTNs, Structured Products, Accelerators or Dual-Currency products are or how they work, why take the moonshot chance that things will turn out good?

Behavioural factors lead to closet indexing

The reason for the lack of outperformance among professionals can also be attributed to some behavioural factors. As famous economist and investor, John Maynard Keynes once said, “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”

Studies have shown that active fund managers, despite being paid to beat their benchmarks, often end up mirroring their benchmarks so that they don’t do too badly in a given year.

So, the question is, if there is a good chance that your active fund manager is going to end up putting together a portfolio that basically mirrors the index or benchmark he/she is being compared against, then why pay those higher fees at all?

As a beginning investor, it honestly isn’t worth the trouble on taking that bet that things will pay off handsomely when the odds show otherwise.