The Truth About Investing: The Market is Beatable

If you’re an investor in index funds, like I am, then you probably believe that it’s impossible to beat the market in the long run. You’ve had everyone from bloggers to Warren Buffett tell you the best thing for you is to invest in mutual funds indexed to the market. We do this because we believe the market is unbeatable. This is the belief in the so called “Efficient Market Hypothesis“. Basically we’re saying that stock prices already reflect all available information and it’s impossible to outperform the market return through stock-picking or market timing.

But that ain’t all true my friends. The actual truth is there are many people out there that can beat the market. Hundreds, perhaps thousands of them actually. The problem is you haven’t heard of most of them, and you never will. Why? Because that is what they want. You see, to beat the market on a regular basis you have to be small enough that no one pays attention to what you are doing. Otherwise people start to notice, and then they start copying. When you’re small you can do things that larger funds cannot. Fidelity Magellan is one of the largest mutual funds on the planet, any investment change they make is immediately noticed by the market, and the efficient market rules take over killing any potential returns.

Beat the Market by Investing in Alternative Investments

There are other ways to beat the market other than being small. You need to invest in securities that have nothing to do with the market though. Have you ever heard of cat bonds? Nope we aren’t talking lolcats my friends, cat is short for catastrophe. An insurer can issue cat bonds to investors that help the insurance company avoid some of the losses in the case of a big disaster, like hurricane or earthquake. To investors these bonds pay pretty well.

There are other investments too. Some hedge funds have been making a killing by purchasing up mortgages from struggling banks. Imagine buying a $400,000 mortgage on a house worth $250,000 for the small price of $100,000. This isn’t a joke. That is a killer return. Many of these investors are making returns above and beyond the S&P 500, and they do it every year consistently.


However most successful investors that regularly beat the market are not talking about a simple four-letter word we often forget to discuss. RISK. Many of these mortgages are very risky — cat bonds are too. Many of the stock investors that beat the market use borrowed money called leverage to increase their returns. However if they lose money they still have to pay back the borrowed funds. This has wiped out many investors over the last few years.

So what’s a small investor like you supposed to do? The market is beatable even without all of that fancy high-risk stuff. There are people out there that regularly beat the market. Should we find them and invest? Not a chance. It’s not worth your time. Index funds are simply good enough. For small investors there is no better vehicle than a quality low-fee index fund.

Just next time someone tells you it’s impossible to beat the market, just give them a wink and say you’re invested in hurricane cat bonds for the residents of Las Vegas and the coupon is 1% greater than the S&P 500 historical return. Watch their eyes go wide with confusion and walk away. I’m in index funds and you should be too.

About the Author

By , on Jul 1, 2009
Philip aka "The Weakonomist" is responsible for everything you read at . The anonymous blogger works in the banking industry and has personally watched its implosion over the last couple of years. A cynic and contrarian at heart, he seeks to shed light on the darkest corners of finance and economics. You can usually find him at the corner or Wall St. and Main St. throwing rocks at traffic. If you like this post feel free to check out his blog or subscribe to his RSS feed.

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Leave Your Comment (12 Comments)

  1. Matt SF says:

    Great post Philip! I think your thesis on alternative investments is one reason why those out of the norm ETFs have risen in popularity over the last year or two.

    Who would have thought 10 years ago we would have a “stock” that mimics the price action in U.S. Gasoline prices or Treasury Bonds.

  2. @weakonomist

    fair enough. Although perhaps we should object and inject some clarity into people’s framework for discussion. The mainstream media uses the S&P500 as their definition of the “market”. It is by statistical definition almost impossible to beat the S&P 500 (with a portfolio consisting of S&P500 type stocks) in the long run. Hence the argument why bother? Put it in an index fund or etf and save yourself the hassle of doing stock research.

    Perhaps what most folks should be taught to understand is that the S&P500 is just one of many markets. There is the small cap market, international market, commodities, private equity, distressed investing, etc..

  3. @mr credit card

    Allow me to clarify the point of the post. It’s true hedge funds should not compare returns to the S&P 500, however investment guides and finance media do so anyway. EMH proponents have argued that you simply cannot beat the market in the long term. My point is that you can, but not by traditional means. On a hedge fund blog or in an academic journal there is much more to discuss, but I focus on personal finance and merely want to share with Moolaonomy’s readers that though it is possible to beat the market, it isn’t worth the trouble for 99% of us.

    I completely agree that investors should not compare these returns to the S&P 500 and I hope your comment offers further clarity to the readers of this blog.

  4. Mr Credit Card says:

    You are comparing apples and oranges when you compare a hedge fund return and a S&P return. If you invest in a portfolio of large cap US stocks, yes, then the S&P 500 is the proper benchmark.

    You should compare a hedge fund return to a comparable index (likely a strategy index that compares returns of funds using the same strategy).

    Saying you beat the S&P 500 while investing in distressed assets is simply wrong. All it says is that distressed assets as an asset class outperformed large cap US stocks.

    Saying convert arb, long/shot, private equity or any other strategies that beats the S&P and hence inferring that you can outperform the S&P is simply WRONG!

    Mr Credit Card

  5. Mike Piper says:

    Mikael, here’s a clip of Warren Buffett’s thoughts on index funds and who should invest in them:

    About one minute into the clip, he says 98 or 99% of people should invest in index funds.

  6. Mikael says:

    Are you saying that Warren Buffet is telling people to invest in mutual funds? Or just that he says that IF you decide to invest in mutual funds then you should pick the ones indexed to the market? The reason I ask is that I have never seen anything that claimed that Warren thinks that is a wise choice. I would actually think that he would be never recommend it.

  7. Chiko says:

    Good post buddy, I totally agree. I’ve been beating the market ever since I started investing, I already up more than 4,000% in the last 6 months. Unbelievable right?

  8. Rob Bennett says:

    I don’t believe that it is necessary to take on extra risk to beat the market.

    Investors are not compensated for taking on Actual Risk. They are compensated for taking on Perceived Risk. You can beat the market easily (in the long term, not in the short term) by knowing the difference.

    When the market is wildly overpriced, Perceived Risk is low but Actual Risk is high. You beat the market by lowering your stock allocation until a day comes when Perceived Risk is high and Actual Risk is low.

    To beat the market, you need to be able to see when the market is wrong. That means being willing to look at valuations and being willing to stick with your rational position long enough for the market price to return to a reasonable place.


  9. Aaron says:

    Generally hilarious and true. There’s plenty of reason to follow you.

    And thanks for talking about risk of alternative investments like insurance cat bonds. Although some people are comfortable with more or less risk than an index fund can offer them. Know thyself as someone important once said.

  10. A great and honest presentation. Really well stated.

    As I (and my clients) age, I meet fewer people interested in “beating” the market. We all just want to keep from getting beat up by it.

  11. Mike Piper says:

    Thank you for bringing up risk. Many people seem to miss the fact that it’s perfectly consistent with the EMH that you can earn a return greater than avg. stock market return if you’re investing in investments that are higher risk than that of the stock market.

  12. JC says:

    “Index funds are simply good enough”

    – I’ll keep that in mind.

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