So how do you beat the market you ask? Well, the correct answer is you do not. You match it at best but rarely will you be able to beat the actual markets. Why? Because they are random in nature and no matter what you do it is not possible to predict them with consistent accuracy. Which leads us to the two basic types of returns found in the markets, alpha and beta. We will take a brief look at each and what they mean for you the average investor.
First, we will look at the alpha returns. These returns occur when an investor actively manages their portfolio to try and beat the market returns. This can be done through a variety of means, and one is not necessarily better than the other. And in the end, the method you decide to use may not matter anyway.
You can hire a financial planner to advise you on what to invest in be that individual stocks or some form of mutual funds. In these instances, the planner will actively try to beat the markets by investing in certain assets that they think will outperform the general market. This is a similar approach to investing in actively managed mutual funds that also try to outperform the markets. While some people find brief success in doing this beating the markets over the long haul is nearly impossible. I have read several books and articles that state plainly that at least 93% and as high as 97% of all fund managers fail to beat the markets from year to year. Now remember, these are well compensated financial managers whose job it is, is to beat the markets and they are unable to do so on a consistent basis.
Which leads me to the other part of the alpha return seeking individuals, the average investor. Now let me be frank here. If the professionals only beat the markets at best 7% of the time and more likely 3% of the time how do you expect to beat them? Do you have an army of analysts working for you? Do you have eight plus hours a day to research investments in which to place your funds? Do you have access to massive amounts of information that needs to be analyzed before making any investment? I did not think so and neither should you. And again, let’s be honest here. Are you in a position to diversify your portfolio in such a manner that you increase returns while decreasing risk? Well here is the good news, you can be if you go after the beta returns and avoid alpha returns altogether.
So what is the beta return you ask? Well, simply put it is the average returns of the market. Nothing more and nothing less. In searching for beta returns, all you need to do is average what the market does and not actively try to beat it. So how do you do this? Well, that answer is fairly simple and straight forward in nature. With the use of low-cost Exchange Traded Funds or ETF’s. These are much like mutual funds, but they tend to follow and index of some sort, trade throughout the day like a stock, are passively managed and have lower fees associated with them. These reasons make them the perfect instrument for the average investor to use to get at least a market return on their investments.
As an investor, you want to own certain assets and own them in the cheapest possible way. That is why I am such a fan of the ETF. Take for example an index mutual fund and its fees, which on average are about 1.2%. Compare that to an indexed ETF with fees of about 0.1%. While it may not seem like a lot a 1.0% difference in fees means you are earning more on your investments and are compounding more money year over year as well. These lower fees are also a reason why it is easier to match the markets as you save a percentage point right off the bat meaning you are that much closer to earning the market average.
Also, there are ETF’s for just about everything imaginable. Do you want to own real estate? There are Real Estate Investment Trust ETF’s for you to own. Want to own commodities? There are ETS’s that invest in physical assets as well as those that invest in companies that deal with the commodities. Emerging markets more your cup of tea? Well, there are many ETF’s that specialize in that area and those sectors as well. If there is an area that people want to invest in the chances are that there is an ETF that you can own. All you do is search the thousands of ETF’s and find the ones that fit your investment plan and strategy. And then pick the ones that have the most liquidity and lowest fees.
By using ETF’s, you can match the markets to achieve beta returns without much effort. And with proper diversification strategies you can lower risk and possibly increase potential returns. There are many models that are available for the do it yourself investor to use if you look for them. There are robo advisors that will tell you what ETF’s to own and in what percentage. If you want to use them, they will charge you a small fee, or you can do the investing yourself. That is a decision that only you can truly make. But when considering all things, you need to take into account trading fees and if you will rebalance on a regular basis. If you are investing in smaller amounts, trading fees can eat a larger portion of your returns so a robo advisor may be a good alternative for you. Some that I am aware of and know a little about are www.acorns.com, www.betterment.com, and www.wealthfront.com. All are trusted and tested to be stable platforms.
So my advice to you is do not try to chase the alpha returns and simply take the beta. Why? The beta returns are not that shabby as the markets have averaged about a 9% return annually for the last 100 years. I know I would take less risk and take those returns in a minute. And why should you be any different? Use the tools available to you and others and look for a comfortable level of risk and go after the beta returns that are not bad. A 9% return over 30 or 40 years will mean a lot more money for you in the end so forget alpha and think beta.
If you have any questions or need any additional information, please feel free to contact me.
