Can You Beat the Index?

Let’s take a pause on the more technical aspects of financial planning, and instead explore the basics of building a Coffeehouse portfolio. When it comes to investing in the stock market, you have three choices:

1. Pick stocks yourself.
2. Hire a professional stock picker to pick them for you.
3. Purchase all the stocks through a “Total Stock Market” index fund.

On the surface, purchasing all the stocks runs counter to our common sense and the way we live our lives. 

When it comes to making meaningful life decisions, just like when choosing a dentist, we want to engage with someone who has “done their homework,” and has a thorough understanding of their profession. 

Applying that same logic to stocks doesn’t work. In the world of picking stocks, there is no such thing as a “professional.” In fact, you could argue that the harder one tries to pick the top stocks, the more they will underperform. 

Remember, stock prices are not set by the Board of Directors of a publicly traded company. They are set by you and me, the countless number of investors who buy and sell stocks throughout the day. 

As a result, if a company is expected to have earnings that consistently increase over time, that glowing forecast is likely to be built into today’s stock price.  

Don’t take my word for it. Let’s look at the numbers. S&P Dow Jones Indices LLC keeps a running tally of actively managed funds’ performance versus benchmark indices. The data shows that while it is possible to beat an index through active stock picking, your chances are slim, and the price you pay is prohibitively high; proof enough that markets are efficient.    

Does that mean your best choice is to purchase one “Total Market” index fund for your common stock allocation and leave it at that?

THAT is a juicy topic we will cover next week. Stay tuned.

Invest for the Long Term

If your portfolio has become complicated and you are looking for a long-term approach to investing and building a financial plan, let's connect on a strategy call. We can discuss your strategy to accumulate wealth if you are still working and your tax strategy on withdrawals during retirement.