October 24

Mythbuster – You can’t beat the Market

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“You can’t beat the market” is a common stock trading myth. Most people are convinced it is practically impossible for individual traders to earn more than the stock market in general. Financial advisors and index fund salesmen will even tell you that you can’t trust anyone who claims otherwise.

How the Efficient Market Theory comes about

Let’s rewind and talk about some history for a while. The myth that you can’t beat the market was started in the 1970s by Professor Burton Malkiel of Princeton University, who did lots of research purporting to prove that nobody beats the market.

He influenced a generation of professors who together, give birth to a theory known as Efficient Market Theory (EMT). EMT says that markets in general are efficient – everything that can be known about a company is already, minute by minute, figured into the price of its stock. In other words, the price of the stock accurately reflects the value of the company at any one time.

I don’t wish to comment much about this beat-the-stock-marketEMT thing but I guess 99% of stock investors will say that this theory is completely rubbish. People who have experienced the spectacular bull-runs and horrific down-turns around every decade will know that stock markets work based on people’s emotions and their expectations of the markets.

Let me put it in much simpler terms. Have you played in any competition where everyone is equal? Of course not! You have seen teams who keep winning because they really put in their effort and desire to train and win the game.

So in relation to the stock market, the investors who are good enough will consistently outperform others no matter what the stock market condition is now! As simple as that!

A beautiful example is Warren Buffett’s Berkshire Hathaway. A mere $1,000 invested in the company in year 1964 would deliver $11,641,053 in year 2014, 50 years later. That translates into a compounded annual growth rate of 20.59%, handily beating the S&P 500 returns over the period no matter how you slice it.

Conclusion

If you had taken a look at the track records of legendary investors like Peter Lynch and George Soros, you would be convinced of the notion that everyone is able to outperform the stock market using their own methodology.

Peter Lynch focused on buying growth companies he understand and invests for the long run. On the other hand, George Soros uses his ‘reflexivity’ concept to win big whenever he is on a roll but cuts his losses small when he is on the wrong side of the bet.

Despite their investing strategies being poles apart, they are able to beat the market by dramatically shifting the odds of winning into their favor by enhancing their investment knowledge and practising their skills frequently. The money that keeps rolling into their pockets is actually a byproduct due to their diligence and massive knowledge on what works and what don’t.


Tags

beat the market, Efficient Market Theory, EMT, peter lynch, warren buffett


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