When talking with friends or colleagues about your investment portfolio, do you ever hear them, or maybe yourself, mention how their portfolio is doing relative to the Nasdaq or S&P 500? Should you worry if your investments are beating the market? Well, not really. You shouldn’t worry about how your individual investments are performing against the market as much as how your portfolio is performing against your financial goals.
What is “beating the market”?
The phrase “beating the market” means earning an investment return that exceeds the Standard & Poor’s 500 index (commonly called the S&P 500 or just S&P). This index is a market-capitalization-weighted group of the 500 largest publicly traded companies in the US. Essentially, is a group of huge US companies and if they are doing well, the market overall is doing well since their performance usually reflects the performance of the overall US stock market. So if the S&P is earning a 21% rate of return for a given year and your investment portfolio, in whatever index funds or other vehicles you choose, is earning at or above 21% then bravo, you are beating the market.
Is it realistic to beat the market?
Unless you are Warren Buffet, you are not likely to be able to consistently beat the market over any large amount of time. I assume you are not likely an investment megamind (because otherwise, why would you be reading this article?) and you would fall into the majority of people who have some boom years where their portfolio beats the market, maybe even several in a row, and a few tight tears that fall short. Even most professional fund managers fall short of beating the market. Overall, your best bet is to look for a market mirroring strategy over time. If over a 20 year period your rate of return on your investments is at or above the market average, then you have done well. As with the tortoise and the hare, investing for the long run and slow, steady growth wins.
So should I try to beat the market?
Instead of focusing intently on your investments’ rate of return, focus on making sure your investments are allocated into vehicles that meet your current and long term financial needs. Your risk-tolerance with your money should be based not only on your personal view of risk and volatility, but on your needs for the money. If you are investing funds for 3 years while you save to put a downpayment on a house, you should select a less risky investment since a $20,000 loss in market value would make a huge difference in your ability to purchase and you may not have the time to wait to let your money sit in the market to recover from a loss. Alternatively, if you have 20 years until you retire, allocating your investments into riskier vehicles may give you the market-beating returns you are looking for with the added benefit of time to allow the money to sit and grow.
In order to get market-beating returns, you may opt to be invested in riskier investments with higher returns such as international stocks, mortgage-backed securities, emerging markets, IPOs, forex, etc. High risk equals potentially a high reward, but it could also equal disaster for your portfolio. The volatility of riskier investments are better for risk-tolerant investors who have time and money to allow their investment to sit and recover from any negative backsliding.
If you are planning to retire soon or otherwise have a need to tap into your nest egg in the next 5 years, you should be looking to invest in more low-risk vehicles, like savings bonds, certificates of deposit (CDs), or an interest-bearing savings account. If the market has a large dip (perhaps due to an election, new policy decisions, scandal, poor earnings reports from major corporations, a worldwide virus epidemic, natural disasters…almost anything could cause a market dip nowadays), you want to be able to stay in the market to watch your investments recover. You don’t want to be stuck in the unenviable position where the market plummets and takes your hard earned nest egg with it leaving you with little choice but to sell stocks at a loss because you need the money now and cannot afford to leave it invested while you wait for the stock price to recover.
So no, you should not try to beat the market just for bragging rights. There is no real benefit to being able to say that this year your investments beat the market if next year they fall far short and you are stuck selling at a loss because you need the money. I always remind my clients that personal finance is personal. Financial planning is planning for you, not anyone else. Investing should be done with you and your individual needs in mind, not merely looking to get a certain market-beating return at any cost.
