Fight the Crowd or Go with the Flow?

There are basically two types of people in the world; those who challenge conventional wisdom, and those who go with the crowd. In the investment world, the former are called value investors, and the latter momentum investors. Value investors believe that because people, and investors, are often wildly irrational, and get caught up in the fads of the moment, many things can be purchased at a price lower than their long term value. Momentum investors like to ride current trends; "the trend is your friend" is their motto. We are value investors; in fact, we've built a philosophy of life based on the thesis that the most important thing we do is to use our minds to independently value people, investments, art, philosophies; just about everything. We call this approach Valuism.

Trying to Beat the Market?

There are all sorts of different types of investments; real estate, hedge funds, bonds, commodities, collectibles, private companies, and more. But when discussing "investments" most people think of the stock market first. So we'll frame the following discussion in terms of the stock market, although what we say applies to many different kinds of investments.

As a long term investor, you face a basic strategic choice: do you just want to accept whatever gains the market averages provide, or do you want to beat the market? It may sound like a no-brainer; of course you want to beat the market. Over the last century, the stock market, including both dividends and capital appreciation, has generated an average annual return of about 9.4%. Of course, many stocks have done far better in any given year, doubling or tripling. Most investors don't want to accept "average" returns; they want to pick the best stocks! But as in so many things, the obvious answer is the wrong answer.

Even most professional investment managers do not beat the market averages over the long term; in fact, once fees and trading costs are taken into account, very few investors beat the market over a long period of time. One of the most predictable things is that a smart person, who spends a lot of time and energy doing research using the most sophisticated tools, will not, over the long term, beat the market averages. So it's very important to make a distinction between being smart and being wise. You may be smart, but if you're wise you'll realize that trying to beat the market is probably not the best use of your intelligence. And if you invest, say, $100,000 over 10 years and average an annual return of 9.4%, you'll end up with over $245,000. Over 20 years at that rate the $100,000 would become over $600,000. Is that so bad?

Investing is a particular challenge because it runs counter to most of our experience. In most things in life, if you work hard, gain experience, and think carefully, you can do well. As the saying goes, the more you put into it, the more you'll get out of it. That is not true in investing, an area in which feverish activity is correlated with under performance, and where a passive strategy tends to have better results than an energetic approach.