Can you beat the market?
Can you beat the market?
or: why you better not try to / #5
Dear Reader,
Are you wealthy?
I am, and I am not.
I live in Germany, a pretty wealthy country (number 17 in global comparison), so I live quite a prosperous life. But within this country, my personal wealth is, I guess, below average.
My modest financial abundance consists of this: income from my daily work, claims to the statutory pension insurance, an endowment insurance (which is a form of life insurance that pays an interest-bearing investment either at the end of the contract period or upon the insured's death), and an investment in so-called ETS (more on this later).
As you might see by these assets, when it comes to financial activities, I tend to be a lazy person. No risks, no shifts, no trading. I only look at my monthly bank statement and see the money going into investment.
This laziness goes well with my knowledge as an economist. Because in economics, there is the so-called efficient market hypothesis.
Eugen Fama, a Nobel Prize in Economics winner, now in his eighties, is considered the father of this idea. It says that over a long period of time, it is very difficult to beat the market. That means no matter how clever your trading is, you will not outperform the overall performance of a stock market.
Why is it so?
A share's price rises when many want to buy that share, and it falls when many want to sell it. The price of a share is, therefore, always the result of all people involved in trading. And since each trader's decision whether to buy or sell is based on their knowledge, it can be said that the knowledge of all traders is contained in the price of a share.
Because of Fama's findings, investing in so-called ETFs is nowadays widespread. An ETF (for exchange-traded fund) holds the same securities in the same proportions as a certain index of a stock or bond market. As a result, the value of an ETF develops in the same way as a stock market.
Therefore, an ETF does not try to beat the market but to go with the market. And as most stock markets grow over the long term, so do the values of ETFs.
Another advantage is that the costs of such ETFs are low since the effort to manage such funds tends towards zero because traders aren't required to reassemble the portfolio continually.
Because of the costs and because of the efficient market hypothesis, actively managed funds – where portfolio managers take care of constant optimization, buy and sell assets based on the latest information about the economy, industries, and companies – regularly perform worse than those passively managed index funds.
Nevertheless, there are still actively managed funds. And more than that, more and more people are trading on stocks themselves. Digital progress, especially trading apps, has triggered a new boom.
Based on the previous considerations, one must conclude that it's a strange boom. If the professionals can't do better than an index and can't beat the market, how can an amateur hope so?
So how does the trading app boom fit with the efficient markets hypothesis?
It fits quite well. As said, the efficient markets hypothesis refers to the long term. In the short term, the market can very well be beaten. It requires superior information (which most people don't have) or luck. And since stock markets rise more often than they fall, being lucky isn't all that difficult (however, I am afraid most traders do not consider their success to be luck but rather the result of their alleged knowledge.)
To sum it up: If you want to invest your money in the long term, you better not rely on your knowledge, not even on the knowledge of some experts, but on the knowledge of all market participants. Link your wealth accumulation to an index! Only if you have money to spare and if gambling is a pleasure for you, you should trade with shares and bonds. – I am not that type of guy. I prefer to let others do the work. This sometimes feels like taking an exam without studying for it even one minute, and still be as good as the average; without forgetting, that in the world of finance, "just" being average is pretty good.
Onwards,
Johannes Eber
sources:
https://en.wikipedia.org/wiki/Efficient-market_hypothesis
https://en.wikipedia.org/wiki/Eugene_Fama
https://www.investopedia.com/terms/e/etf.asp#toc-what-was-the-first-exchange-traded-fund-etf
https://www.worlddata.info/richest-countries.php