I recently came back from an ETF conference in Florida where I participated in two panel discussions and sat in on various others. One recurring phrase during the conference was: "You can't consistently beat the market."I think this statement needs some qualification. It's too limited, and the definition of "the market" is very subjective. And who is the statement referring to? Who's the "you"? I believe that the market is and can be beaten on a consistent basis. The problem is identifying how and by whom. What Is the Market? Everyone has his or her own definition of "the market." Most people over the age of 50 are likely to see the market through the perspective of the Dow Jones Industrial Average. Younger investors might be inclined to gauge the market from the returns of the S&P 500, Nasdaq 100 or perhaps the Russell 200. Some global money managers will target their returns vs. a global index such as the Morgan Stanley Cap International World Index, which is a product of MSCI Barra ( MXB) Even market participants investing in the same asset class won't necessarily target the same benchmark. At the end of the day, whether you're an individual investor or a professional money manager, we should all find a benchmark to measure our performance against. There is one caveat: For a given portfolio or strategy, one should consistently target the same index. Who Are You? When market commentators say you can't beat the market, sometimes this is their way of telling the individual investor that they might be better off having their money professionally managed. Sure, there are plenty of how-to books on investing, but at the end of the day, ask yourself this series of questions: Would you remove your own appendix if you had appendicitis? Would you drill your own tooth and fill a cavity? Would you represent yourself in criminal court? Chances are you wouldn't. So do you want to manage your own investments?
- Type I: Statistically speaking, this is a rejection of the null hypothesis when the null hypothesis is true. In layman's terms, this is what we call a false positive. We accept something that is incorrect. A type I error occurs in investing when we accept an investment that will perform poorly. This is a more costly error to investors. Clearly, we want to avoid Type I errors.
- Type II: Statistically speaking, this is a failure to reject the null hypothesis when the null hypothesis is false. In layman's terms, this is what we call a false negative. We reject something that is correct. A type I error occurs in investing when we reject an investment that will outperform the market. Type II errors are more difficult to avoid and tend to be less costly. Nevertheless, we want to avoid type II errors if possible.
- Carefully define your benchmark and asset class when developing an investment strategy. Manage that portfolio within the context of the benchmark selected.
- If you cannot on a consistent basis outperform the market, then you might be best served by hiring a professional to do so for you.
- Try to deselect underperforming investments and avoid type I errors.