If You Can’t Beat the Market, Own the Market

Very few investors manage to beat the market. But in an astonishing triumph of hope over experience, millions of investors keep trying.

— Jonathan Clements, Author

It isn’t easy to beat the stock market. In fact, most money managers typically underperform. And those who are able to beat the market one year struggle to stay on top in subsequent years.

Why? Turns out that outperforming the market may require more luck than skill. Imagine a baseball stadium filled with 20,000 fans. You give each fan a quarter and ask them to flip it at the same time. Heads they can stay, tails they must leave the stadium. Because the odds of heads or tails is 50/50, after the first flip about 10,000 fans will stay and 10,000 leave. The remaining fans flip again and 5,000 stay and 5,000 leave.

After a total of 14 flips, the odds are that only one person is left, having managed to flip 14 heads in a row. Now fill the arena back up. Would you expect the same person to flip 14 heads in a row? Probably not. A great stock picker is like a great quarter flipper —its mostly about luck. In fact, studies have found that active managers as a group do worse than random chance. Meaning they might actually improve their stock-picking performance if they used coin flips to make stock picks.

Since trying to beat the market leads to a high probability of underperformance, most investors would be better off simply just owning the market.