How to Consistently Beat the Market

Say that investment results are distributed normally around a mean of 10%, with a standard deviation of 2%. The mean return is equal to the "market" return. This distribution is depicted in the chart below.

As we can see, an most of the returns fall between the green lines, within +/-1 standard deviation (+/-2%) of the mean for our fictitious market's results, which are normally distributed. Keep in mind that many people will perform outside of the green lines. Some will outperform the market by a standard deviation of more than 1, while others will underperform the market by a standard deviation of less than 1.

Those who outperform are grabbing their excess performance from those who underperform. Whether it is as a result of bad timing or poor decision-making, underperformers exist. Investment professionals are hoping that individuals are the underperformers, because they are trying to sell their out performance and receive a fee for it.

There is nothing wrong with that. In fact, as a professional money manager, I seek to perform my services for individuals who cannot do as well for themselves. If a professional consistently underperforms, then he or she will lose assets and might not survive as an investment manager. Thus, over long periods of time, natural selection will weed out poor professionals and allow the consistent outperformers to dominate.

How Can You Overperform?

I contend that too much time is being spent on stock selection. Not enough time is spent on stock rejection. As investors, we are expected to select stocks that will outperform the market, and we spend far too much time and effort on doing so. Our time is better spent on eliminating or rejecting stocks that will underperform.