7 Reasons Your Investments Are Not Beating The Market
Dear Rich Lifer,
A recent report found nearly 90% of actively managed investment funds failed to beat the market.
Across all domestic actively managed equity funds, 88.4% underperformed their respective benchmark over the last 15 years, according to an analysis of the S&P SPIVA report.
While this number might sound high, if you’ve been following the performance of actively managed funds against the markets at all, you’re probably not surprised.
Even Warren Buffett acknowledges most pros can’t beat the market.
In his 2013 letter to Berkshire Hathaway shareholders, Buffett explained how he has advised trustees to manage the money he plans to leave his wife:
“Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.”
If it’s so hard to beat the market, then why even try?
Passive investing in index funds and other ETFs may be the best strategy for the majority of investors. Last year, passive funds reached a higher asset total than active funds.
Evidence that more people understand passive funds are the right place for the bulk of their assets.
But there’s absolutely nothing wrong with picking stocks, too.
Not only is stock picking fun, but it can lead to big rewards if you pick a few stocks that perform exceedingly well.
For example, if you had invested even a small sum of your portfolio in stocks like Apple (AAPL) or Amazon (AMZN) a decade ago, you would have made a lot of money.
But the question remains: How can you beat the market?
Where Most Investment Portfolios Fall Short
If you’ve tried to beat the average returns of the S&P 500 or another benchmark stock market index and failed, there are a number of reasons you keep coming up short.
Here are seven of the most common reasons most portfolios fail to beat market average returns:
- Your Expense Ratio Is Too High
Let’s say you have $100,000 invested in a mix of individual stocks, ETFs, bonds, and other investments. If your total cost of investing comes to $1,000, your portfolio’s expense ratio is 1% (1,000/100,000).
Expense ratios of 1.5% or more are considered high and will eat into your returns. If this is the case for you, here’s where you need to look:
If you work with a traditional brokerage, chances are you’re still paying high fees that were common years ago.
Nowadays, discount brokers like Robinhood allow investors to trade with zero commissions. Consider changing brokers or negotiating a discount on trading fees and you’ll lower your expense ratio.
Annual Advisor Fees
Some financial advisors take home millions of dollars per year. How is that possible?
From the exorbitant fees they charge. According to Forbes, financial advisors typically charge about 1.5% of the total value of a portfolio on smaller investment accounts.
That percentage drops as the value of your portfolio climbs. For example, an investment account with $4 million would only be charged around 0.5% in annual advisor fees.
You can see why hiring a financial advisor may not be the right move early on if you’re trying to grow your portfolio and beat market averages.
Too Much Account Activity
Whether you’re paying commissions or not, you’ll still be charged regulatory fees. And every trade comes at a cost. The more active you are, the higher your portfolio’s expense ratio will be.
While there’s nothing wrong with rebalancing your portfolio, try not to get in the habit of trading too often.
- Not Doing Your Due Diligence
Tracking 20 or more stocks is a full-time job. So, if you’re struggling to beat market average returns, it could be you simply don’t have the time to do enough research or the research you’re doing is not thorough.
Here’s a quick checklist for what you should be looking at before investing:
- Read the last four earnings releases
- Check the last year of SEC filings
- Review the company’s website
- Listen to what analysts and money managers have to say (keyword: listen)
- Review market performance
This is the bare minimum. But, if you dive into each of these points, you’ll be lightyears ahead of the average investor.
- Stop Mirroring the Market
Like we said earlier, investing in low-cost index funds is probably the best route for most people. However, if you invest in broad-market funds, don’t expect above average returns.
You’re essentially mirroring the exact benchmark you are trying to beat. Instead, choose individual stocks you believe will deliver higher returns than the market average.
Also, remember to diversify your portfolio to lower your risk. Too much diversification and you end up back where you started – mirroring the market.
A general rule of thumb is try and maintain a portfolio with around 20 stocks. This seems to be the optimal number for above average returns.
- Not Taking Enough Risk
Another common problem we see is investors allocating too much capital in low-risk investments. Think bonds and other fixed-income securities.
If too much of your money is tied up in these low-risk, low-reward investments, your other investments will have to perform extremely well in order to pull your overall average up.
Diversification is a critical part of any smart investment strategy, however, don’t let your aversion to risk prevent you from being able to outperform the market.
- Following the “Experts”
New investors often find researching stocks to be a daunting task. But they are also not willing to accept average returns.
Their workaround is listen to what experts are saying and follow this advice. You probably already know how this ends.
Placing your hard-earned money in the opinions of some talking heads is a very risky move. Most of these personalities don’t even have skin in the game. If you’re too lazy to do the required research, it’s best to stick to low-cost index funds and be happy with average market returns.
- Going All-In On One Stock
Tell us if this sounds familiar…
A friend or colleague reaches out with an investment that’s a “sure thing.” There’s only one direction this stock is going…
So, you invest a small portion of your portfolio in this stock and sure enough, it goes up. You then decide to invest a larger sum. This time, however, it dips. Then it dips again, and again before you’re forced to sell at a loss.
Putting all your eggs in one basket is never a good idea. A good rule of thumb is to never put more than 5% of your portfolio in one stock.
If your tolerance for risk is high, 10-15% is acceptable. But the more you allocate, the higher your risk of losing those funds becomes.
Try to ignore any hot tips from friends and co-workers. Beating the market requires discipline and unwavering confidence in your plan.
- Stop Trying to Time the Market
The final piece of advice we’ll share with you is to stop trying to time the market. I know, it seems almost impossible to generate above average returns if you’re not able to sell at the top.
But the truth is timing the market is nearly impossible. In fact, investors who successfully time the market, often get lucky.
Instead leverage dollar-cost averaging so you mitigate the risk of buying high and having to sell low. This is the only reliable way to lock in better returns.
Beating the market is something few investors achieve consistently. But steering clear of these seven common pitfalls will tilt the odds in your favor.
To a richer life,
The Rich Life Roadmap Team