Investing in the stock market is all about making money. While there are plenty of investors who are happy with average market returns that can be easily achieved with index funds and mutual funds, there’s a vast audience of investors that are more interested in beating the average returns seen among benchmark stock market indexes.
In an effort to beat the market, investors research and implement the investing strategies they believe will be the most profitable. However, the vast majority of investors simply miss the mark. Even Warren Buffett has warned that it’s difficult for stock pickers to outperform index funds and broad-market exchange-traded funds (ETFs).
Nonetheless, the allure of the riches that can be made with a single, well-placed trade has many investors accepting the heightened risks associated with an attempt to beat the average market return. So naturally, a common question is born: “Why aren’t my portfolio returns beating the market?”
Why Most Investment Portfolios Don’t Beat the Market
If you’re actively working to beat the average returns of the S&P 500 or another benchmark stock market index and you’re not reaching that goal, there are several potential causes. Some of the most common reasons investment portfolios fail to meet or beat average market returns include:
1. Your Expense Ratio Is Too High
The term expense ratio is most commonly used to describe expenses associated with mutual funds, ETFs, and other managed funds. The fund manager decides what expenses are necessary, and they are taken out of the profits of these funds. An ETF with an expense ratio of 1% uses 1% of its total assets to cover annual expenses.
Expense ratios can be applied to anything designed to create a profit. For example, a business that has a total value of $10 million and spends $1 million on expenses each year has an expense ratio of 10%.
This same concept can be applied to your investment portfolio as a whole. If you have $100,000 in a mix of individual stocks, ETFs, bonds, and other investments, and your total annual cost of investing comes to $1,000, your portfolio’s expense ratio is 1%.
Any expense ratio of 1.5% or greater is considered to be high and can seriously cut into your investment returns, ultimately making your portfolio underperform when compared to benchmark stock market indexes.
If this is the case, it’s time to dive in and see where your expenses are coming from. Most commonly, high expense ratios are caused by:
High Broker Fees
There are plenty of discount brokers like Robinhood that allow individual investors access to the U.S. stock market with zero trade commissions. However, if you work with a traditional brokerage, you may be paying high fees that were common years ago.
If this is the case, it’s time to change your broker to cut down costs.
Investment Advisor Costs
Investment advisors make a lot of money. Some advisors make millions of dollars per year. Where does that money come from? Their customers.
According to Forbes, financial advisors typically charge about 1.5% of the total value of a portfolio on smaller investment accounts. That percentage goes down when the value of a portfolio climbs.
For example, an investment account with $5 million would generally be charged around 0.5% in annual fees. Unfortunately, the average investor doesn’t have enough money to make it worth consistently having a financial advisor involved.
Many, including Warren Buffett, believe the best route for most investors is an investment strategy surrounding ETFs rather than paying the exorbitant fees charged by investment advisors and other professionals on Wall Street.
Too Much Activity
Every trade will come with fees. Even if you aren’t paying commissions, you will pay regulatory fees. Ultimately, the more active you are, the higher your investment portfolio’s expense ratio will be.
Of course, it’s important to keep an eye on your investments and make necessary adjustments, but active trading and portfolio balancing are two different topics.
2. You Can’t Beat the Market if You Mirror the Market
Several experts point to low-cost ETFs as the way to go for the average investor. All in all, when comparing ETF returns to returns created through stock picking, ETFs often do better. According to ETFOptimize, many retail investors are moving toward an ETF-driven investment strategy.
For most, that’s great news. ETFs are the picture of diversification, and they provide exposure to the stock market on a grand scale while protecting you from volatility. However, if your ultimate goal is to generate better returns than indexes like the Nasdaq, S&P 500, or Dow Jones Industrial Average, ETFs aren’t going to be the way to go.
After all, if you can’t beat ’em, join ’em — but if you’ve already joined ’em, you’re surely not going to beat ’em.
Investing in an ETF is like joining the market. You become the market and your investment returns will likely mirror the very benchmark you’ve set the goal to beat. So, if beating the market is your goal, you’re going to need to pick individual stocks that you believe will generate higher returns than the overall market.
When picking individual stocks for your investment portfolio, it is important to practice diversification to protect your portfolio against volatility. However, diversification is a double-edged sword. Too much diversification and you will simply mirror the market; too little, and you will have to accept significant risks. A general rule of thumb for those who live on the wild side and are willing to accept the inherent risks associated with trying to beat average stock market returns is to try to maintain a portfolio with as close to 20 stocks as possible.
3. Inadequate Research
Keep in mind, tracking 20 stocks closely is a full-time job. So, if you’re working toward an investment portfolio that generates higher returns than the overall market, make sure that you have the time and willingness to do the research required to make that happen.
Due diligence is a term that’s often heard but generally misunderstood. Due diligence is essentially the research that investors should take part in before making an investment. There’s quite a bit to research involved to get a real understanding of the risks and rewards associated with an investment, and the majority of investors simply don’t put in the time needed to do this research.
When diving into a stock, you should:
- Look Into the Last Four Earnings Releases. Publicly traded companies release financial results on a quarterly basis. By reading through the last four of these reports and comparing them sequentially, you’ll get a good understanding of the financial stability of the company and the growth, or lack thereof, it has experienced over the past year.
- Look Into the Last Year of SEC Filings. When publicly traded companies make material changes, the U.S. Securities and Exchange Commission (SEC) requires them to file documents and make information surrounding these changes publicly available. Reading through the past year of SEC filings will give you an idea of major accomplishments and roadblocks the company has faced. Moreover, if the company takes part in dilutive transactions ultimately costing investors by robbing them of the value of their shares, these transactions will be outlined in SEC filings.
- Read the Company’s Website. Go to the company’s website to get an understanding of what it does and how its products and services are superior to other products and services within its market.
- Consider Analyst Opinions and Money Managers. While it’s never a good idea to blindly follow the opinions of investment analysts, money managers, professional investors, or other experts, it is a good idea to look into expert opinions as a way to validate your own opinion of a publicly traded company before adding a new investment to your stock portfolio. Companies like Atom Finance give you access to analyst estimates and recommendations.
- Dive Into Market Performance. Finally, a company can be doing all the right things, but for some reason fly under the radar of Wall Street participants. Even if the stars seem to be aligning, market performance doesn’t always match fundamental perception. It’s rarely a good idea to buy into a downtrend, regardless of how strong you believe the company is.
4. Blindly Following the Experts
Beginner investors often find the process of researching and stock picking to be daunting, but aren’t willing to accept returns that are at par with the overall market. As such, many reject the idea of investing in ETFs or with robo-advisors like Betterment or Acorns.
With either little time to do research or an unwillingness to devote the time necessary to adequately research a stock, many of these beginners make the decision to blindly follow the moves made by money managers, take advice from TV personalities, or even accept the claims of random posts on message boards.
Blindly following experts or other market participants is a dangerous endeavor. The fact is anyone can put anything they want on the Internet. You never know, the information you’re reading may have been written by someone who has never made a single investment decision in their lives.
Don’t bet your hard-earned money on the opinions of others. Instead, if you can’t do the research to make informed investment decisions, you’re better off not picking individual stocks at all; take a more passive investing approach by either investing in trusted, low-cost ETFs or working with a robo-advisor. If you must take an active approach to investing, it’s important to take the time necessary to do your own detailed research before making any investment decisions.
5. Allowing Emotion to Take Hold of Your Investment Strategy
The stock market is a constant battle waged between the bulls who believe valuations will rise and the bears who believe valuations will fall. This battle is an emotional one, often driven by fear and greed.
Emotional decisions are known to lead to devastating losses in investment portfolios.
Oftentimes, newcomers to the market will hold onto falling stocks for too long, hoping that a reversal is ahead, but ultimately ending in further losses. Moreover, many fail to sell a stock when prices are high because they allow greed to take over their investment strategy. This leads to smaller returns or losses.
Instead of allowing your emotions to make your investment decisions, it’s best to follow your investment strategy to the letter. Keep in mind, you will have to accept losses sometimes. Other times, prices may rise more after you’ve sold. Nonetheless, your investment strategy is designed to both improve your potential for gains and minimize risk of loss. Sticking to that strategy is your best path to stock market profits.
6. Allocating Too Much Money to a Single Investment
It happens all the time. You hear about an investment that’s a “sure thing.” It has nowhere to go but up, so you pump money in and get ready for a ride to the top.
There’s only one problem: Things didn’t go as planned. That product didn’t launch as expected, or demand wasn’t there, and soon enough the “sure thing” is filing for bankruptcy.
There are several unexpected events that can lead to devastating losses in the value of any single stock. Even the largest companies in the world aren’t immune. Just take a look at Enron.
Putting too much of your money into a single investment can prove to be a major mistake. Should things go wrong, all of your eggs will have been in a basket that fell apart.
It’s best to make sure that no more than 5% of your investment portfolio is invested in any single stock. However, some experts suggest that those willing to accept more risk should cap themselves at between 10% and 15% of their investment portfolio in any stock they have a strong belief will rise. However, when deciding on allocation caps, keep in mind that larger allocations directly equate to larger levels of risk.
7. Timing the Market Is Nearly Impossible
Generating higher returns than those experienced by the overall market requires nearly perfect timing when it comes to entrances into and exits out of investments. However, timing the market is no easy task.
Even with the best technical indicators, most expensive education, intuitive trading tools, and extensive understanding of the inner workings of the stock market, investors often make costly mistakes when attempting to time price movements in the stock market.
HartfordFunds has even published documentation stating that it’s “impossible” to time the market.
Although somehow famous investors like Warren Buffett, George Soros, and Carl Icahn seem to have a knack for timing the market, even they have made extremely costly mistakes. For the average investor with a much smaller investment portfolio than these moguls, the risks involved in timing the market are far too great to consider.
8. Failing to Adjust Your Investment Portfolio Over the Long Term
When investors do their due diligence and come to the conclusion that a stock is likely to generate higher returns than the major stock market benchmarks, they make the decision to buy it. Once this decision is made, they’re often emotionally attached.
Many investors trust their due diligence so much that they don’t even look at the investment again for the next year or two, but that’s never a good idea. No matter how good an investment is, anything can happen. Changes are commonplace in the stock market, especially in uncertain times. Moreover, it’s never a good idea to trust that anyone’s judgments about an investment — even your own — will remain true in perpetuity.
The best investment opportunity you’ve ever seen could become a flop overnight. As a result, even passive investors should be somewhat active by checking in and rebalancing periodically. Make a point of performing detailed due diligence quarterly or monthly to catch falling stocks before they cause too much pain to your investment portfolio.
9. Overallocation to Low-Risk Asset Classes
Diversification is an important part of just about any investment portfolio. It is the process of spreading your money over several investments in order to balance risk and shield your investment dollars from stock market volatility.
Low-risk asset classes like bonds and other fixed-income securities are an important part of most diversification strategies. However, low-risk asset classes also generally come with the lowest potential reward.
If you’re working to produce higher returns than the overall market, it’s important to keep allocation in low-risk asset classes to a minimum. However, it’s also important to remember that by giving up larger allocations to lower risk asset classes, you will increase your risk of loss.
10. Your Idea of Investing Is All Wrong
It is possible to beat the market; that has been proven time and time again. However, beginner investors often start to invest under the impression that the stock market will provide overwhelming riches in a short period of time. When those overwhelming riches aren’t realized immediately, many investors make adjustments, buying and selling stocks at the wrong times, and realizing losses.
When you start building an investment portfolio, it’s important to go into it with realistic expectations. Depending on the benchmark you follow, the average returns in the overall market will come in at between 8% and 10% annually. That’s a strong return, especially when compounded over time, and beating it is going to be difficult.
Instead of striving for the goal of beating the market, it’s better to break down your goals and make them more personal. Are you investing in order to pay for college, buy a car, go on a vacation, build wealth, create a comfortable retirement, or a number of other reasons? Use these goals to guide your investment decisions rather than tying yourself to unrealistic expectations of getting rich quickly as a beginner and making a living day trading.
The idea of beating the market is exciting. The allure of somehow going from Kia to Bentley overnight is incredibly hard to ignore. Although it is possible to beat the market, it’s extremely difficult. The more important gauge of your success is whether your investment decisions are getting you closer to your financial goals.
Nonetheless, paying close attention to expenses, taking the time to research your investments, avoiding emotional investing, and keeping a level head will help you expand your stock market profits and ultimately reach your goals through long-term investing activities.