10/12/2014 04:06 EDT | Updated 12/12/2014 05:59 EST

Outperforming the Market Is Simple

In a culture of pursuit, "average" is a negative word. It's the tide of mediocrity to swim against, if not a failure to avoid at all costs. Beat the market! Out-performance is the only way to win. "You should see what I made on the last stock I bought!"

Yet, the word "average" is simply a mathematical definition to describe the middle of the pack. Not only is it just the mid-point between the high and low but it's also the most likely result, statistically speaking.

So, when it comes to your investment returns, is middle of the pack good enough when it's measured by the stock market index? More importantly, what if you are in the 49.9 per cent of investors who don't even make the halfway cut?

The study of how people behave around financial decisions illustrates, over and over, that we are hardwired to make mistakes with money. Driven by fear and greed, we overwhelmingly follow emotion and rely on faulty intuition as the basis for everything from ill-timed investments, buying and holding onto stocks that we shouldn't, and speculating or averting losses irrationally, all at exactly wrong time. We have an overwhelming predisposition to get in our own way, ensuring that we under-perform by applying these ingrained jungle-survival techniques.

The same intuition that we hold such confidence in is the one that causes us to permanently lose money, time and time again.

Certainly professional portfolio managers are immune to these human frailties! Unfortunately, evidence shows that professionals don't outperform the market for very long stretches of time either.

If we agree that outperforming is tough and most people are unlikely to do so for very long, what makes us think that we should beat the market? Why isn't the market return satisfactory?

Well, if you can beat the market you should and we all believe that we have a cutting edge that is better than average. For a few of us, that's true. You thought that referred to you when you read that statement, didn't you? That's why we all invest this way. "There must be a smarter way" is a survival technique.

The truth is that emotion inappropriately gets in the way of complex financial decisions, compelling us to sell when we feel fear and buy when we feel exuberance. That's normal. That isn't profitable, however.

How did you feel knowing that the S&P/TSX ended this week at 14,227.36, down 9.29 per cent from the high of 15,685.13, roughly a month ago? If your inclination is to sell or buy, consider that you are subject to normal human emotion, especially if your inclination is only based on the up or down movement of share prices -- we had significant amounts of both in one trading day on Friday alone.

Back to our original question: if average means that you outperform 49 per cent of investors, isn't "average" good?

This information should not be construed as investment advice, nor can it take into account your own specific circumstances. The opinions formulated within this article are based on sources believed to be reliable and may not reflect the opinions of any organizations that I am affiliated with.


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