Outperforming the S&P 500 is not Easy. Don’t Be Fooled Otherwise.

I was browsing MarketWatch and noticed this article titled “Beating the market is easy”.  It’s a catchy title and I like to beat the market so I clicked on the link.  The article outlines 10 ways you can beat the market.  The market, in this case is the S&P 500.   The author outlines a few different strategies:

  • Implementing leverage (strategy 1).
  • Substituting different indices (strategies 2-9).
  • Indexing & Reducing fees (strategy 10).

These are not ways to “beat the market”.  First of all, the S&P 500 is a global index made up of 500 of the greatest corporations in the entire world.  Keep in mind, there are millions of corporations in the world.  Wall Street has sold this phony story to everyone that you’re a sucker if you can’t outperform the 500 best corporations in the world.  That’s like telling your kid he’s a loser if he doesn’t grow up to be a better basketball player than everyone on the NBA all-start team.  That’s nonsense.  “The market” is an incredible group of companies.  Being able to pick the companies that will outperform these 500 companies (on a risk adjusted basis) is not easy to do.  And it’s not surprising that most money manager can’t do it.

Anyhow, strategy 1 is the equivalent of taking on more risk.  If you increase the leverage in your portfolio you’re likely to increase the risk in your portfolio.  Especially if you’re simply buying one index.  Leveraging the S&P 500 is not a way to produce superior risk adjusted returns.  Now, there are clever ways to implement leverage so that it generates higher risk adjusted returns (like some risk-parity approaches), but simply leveraging the S&P 500 is not one of them.  The author fails to correctly assess risk adjusted returns and makes an apples to oranges comparison as a result.

Strategies 2-9 are all apples to oranges comparisons.  If you buy the Russell 2,000 Index and then compare your returns to the S&P 500 you are not making an apples to apples comparison.  You are comparing two different indices.  Buying the Russell 2,000 doesn’t mean you’re “beating the market”.  It means you’re achieving the exact return of the small cap market.  And in doing so, you’re taking on a bit more risk to achieve a bit higher return than comparable indices like the S&P 500.  Again, none of these strategies account for risk adjusted returns and again compare apples to oranges.

The final approach is, by definition, matching the market.  John Bogle has been selling low fee index funds for years.  They match their correctly correlated market because that’s the index they’re tied to!

Beating the market isn’t easy.  Don’t be fooled otherwise.

 

 

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Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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