Reading about the stock market, you’ll quickly learn about two different sides of an interesting debate. Some claim to have the golden ticket to beating Wall Street averages. Others say doing so is impossible.
But what do they mean when they say “beat the market?” What’s the value in doing so? And is it even possible?
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What Does It Mean to Beat the Market?
In general, “beating the market” means having an investment profile that produces better returns than a benchmark. Dialing down exactly what that means depends on who you’re talking to.
There are several benchmarks out there that serve as indicators of overall market performance. The most common benchmarks include:
- S&P 500. The S&P 500 is a favorite among fund managers, considered to be the flagship benchmark index of the United States, and the basis of several popular exchange-traded funds (ETFs), index funds, and mutual funds. The index includes 500 large companies featured on U.S. stock exchanges. The diversity of sectors and market capitalization represented by the stocks in the index, along with the fact that the index is so large, are the major reasons that many consider the S&P 500 to be the most accurate indication of U.S. market conditions.
- Dow Jones Industrial Average. The Dow Jones Industrial Average is an index that only lists 30 companies. These companies are some of the largest publicly traded companies in the United States. Individual investors looking for more stable market returns from larger, blue chip companies often use the Dow Jones Industrial Average as a benchmark, as it is representative of a stable-returns-style investing profile.
- Nasdaq. Finally the Nasdaq is a tech-heavy stock market index, meaning that the technology sector accounts for a large percentage of the index’s components. Composed of more than 2,500 stocks, the Nasdaq has heavy diversification in terms of market capitalization. On the other hand, due to the tech-heavy nature of the index, it’s most commonly used as a benchmark for investors with an equally tech-heavy investment portfolio.
If you have a generally diverse investment portfolio, the S&P 500 is the benchmark to follow. If your annual returns outpace those of the S&P 500, you’ve beat the market. Long-term, stable-growth investors would compare their gains to the Dow Jones Industrial Average, while technology investors are better off using the Nasdaq as their benchmark. Beating the returns generated by any of these indexes means you’ve beaten the market.
Why Is Beating the Market So Exciting?
Experts who claim to have a way to beat the market are all over the place. Although they may or may not truly have the skills to fulfill this promise, one thing they almost universally have in common is charging a hefty fee to find out whether the system they tout actually works.
These fees aren’t pennies either. Services designed to help you beat the market cost hundreds or thousands of dollars, sometimes on a monthly recurring basis.
What’s so exciting that investors are willing to pay so much money to learn how to beat the market? The answer is simple: profits!
The S&P 500’s average long-term annualized return sits at about 9.8%. That means if you have $100,000 invested, you would expect to see a return on your investment of around $9,800 in an average year.
That’s not bad.
Then again, generating 15%, 20%, or 30% in a one-year period would make a big difference. Doing so would mean that you’ve expanded your average profits in the above examples by an additional $5,200, $10,200, or even $20,200, respectively.
When looking at a difference like that, spending a few hundred or even a few thousand dollars to learn how to beat the market would be an extremely fruitful endeavor. That is, if it works.
Can You Beat the Stock Market?
Is it possible? Absolutely. Investors beat the market all the time, but doing so isn’t always easy, and doing it consistently is even tougher. In order to beat the returns produced by the overall market, you’ll have to be pretty active in trading individual stocks, cashing in on gains when they happen and looking for lows to buy in at.
The good news is that it isn’t as hard as you may think. With a little bit of research on how the market works and strategies for beating the market, you have the ability to avoid paying exorbitant fees to join chat rooms or use the next big trading robot.
The idea is to use various indicators of market performance in order to make educated decisions on when to buy and sell stocks and other assets.
However, beating the market isn’t only about buying or selling at the right time. The ability to beat the market also has to do with being smart in terms of maintaining low costs of investing.
How to Beat the Market
If you’re looking to beat the market, there are a few tips that will help you along your way:
Pay Attention to Fees
Fee structures in the world of investing have changed quite a bit over the years. Decades ago, it was pretty expensive to make trades, as you could only do so by going through a professional broker.
Today, you have access to discount brokers that give you the ability to buy and sell securities with no commission fees, greatly reducing your costs and increasing your chances of beating the market.
When you’re on a mission to beat the market, make sure to look into the fees you’re paying when you make a trade and do some research to find out if there are better deals out there. You don’t want high fees cutting into your gains.
Don’t Go in Blind
In order to beat the market, you’ll need to have a strong investment strategy. Before you start to invest, take the time to do your research and define a trading strategy that you will use in the market.
It’s also a good idea to test that strategy using a simulated trading account, or an account using virtual money, designed to test your theories. Several online brokers, including TradeStation, TD Ameritrade, and WeBull, provide access to trading simulators.
Keep Emotions Under Control
Emotions are the enemy of investors. If you’re looking to beat the market, you must have the ability to check your emotions at the door. The most successful investors not only have a predetermined strategy, they also have the ability to avoid basic human emotions when investing and follow their strategy to the letter.
You can’t beat the market if you mirror the market. Most investors will heavily diversify their portfolios in an attempt to protect their investments from dramatic losses. However, if you want dramatic gains, you have to be willing to take some risks.
Instead of investing following the general principle that heavy diversification is necessary for long-term growth, it’s best to only pick a few high-momentum stocks that you believe have strong potential to see gains ahead.
This way, when the high-momentum stocks run, your gains won’t be limited by slower-moving income stocks also held in your portfolio. Of course, without diversification you run the risk that stocks that underperform will lead to significant losses.
If you plan on beating the market, you’ll want to be active in your portfolio management, constantly looking for opportunities to get in on stocks that are likely to make significant short-term runs. Usually buy-and-hold investing, a strategy that requires stocks to be held for long periods of time, simply won’t cut it for beating the market.
Consider Small-Cap Stocks
Historically speaking, small-cap stocks have outperformed their large-cap counterparts. Of course, small-cap investments come with higher levels of volatility and risk, but if your goal is to beat the market, you’ll have to take a few risks in your stock-picking activities.
Steer Clear of Heavy Safe Haven Allocation
Safe havens are used to balance drawdown risk should things turn south on Wall Street. However, they also largely limit your gains when things are going well.
After all, if 35% of your portfolio is held in low-return safe haven plays, the 65% held in equities would have to nearly double the average returns for you to come out ahead of the market. Limiting safe haven holdings is yet another risk that those looking to beat the market must be willing to take.
Although beating the market takes a bit of research, great timing, and a willingness to take on a higher level of risk, it’s far from impossible. In fact, using solid strategies to beat the market is how Warren Buffett, George Soros, and Carl Icahn made their billions.
If you’re going to try your hand at beating the market, there are a few things you should keep in mind:
- Nobody Is Right 100% of the Time. It would be great if you could guarantee gains when making investments. Unfortunately, that’s not the case. Losses are very real, and at some point they will happen. Never invest any amount of money that you cannot afford to lose in a risky play while trying to beat the market.
- Timing Is Everything. We’ve all heard the old adage that time is money. Nowhere is that more true than in the stock market. No matter what your strategy is, a keen focus on entrance and exit timing is one of the most important factors when trying to beat the market.
- Giving Up Diversification Adds to the Risk. In an attempt to beat the market, many give up diversification, essentially throwing their shield on the ground in a sword fight. Always remember that when you’re chasing fast money in the market, you’re taking on risk. Giving up diversification within your portfolio greatly expands this risk.