Smart People, Smarter Groups, Smartest Investing

I’ve been writing these posts for two-plus years, dancing around a subject that warrants its own discussion: Why is it so hard for individual investors to consistently “beat the market”?

It has to do with how stock prices are continuously set and re-set, all day, every day. Those prices, as well as the price of a stock index like the S&P 500, are determined by group intelligence, or the collective wisdom of all investors.

Then there’s you and me. If you decide you’d like to try outsmarting group intelligence, you must make your investment decisions based on what you, and maybe your stock-picking guru, happen to know. If you think an asset’s price will go up, you’re betting the group has underpriced it. If you think a price will go down, you believe the group has overpriced it. (By the way, trading on “insider information” is illegal. For example, if the public company you work for is about to announce a swell, but secret new product, you might be committing a felony if you traded on that tidbit.)

In short, to believe you can outsmart the market is to believe you are smarter than the collective wisdom of all other investors combined, and/or, you have public information the group does not. For example, you would not only have to know what Donald Trump’s next tweet will be, you’d have to know how all market participants will react to it. Now multiply that data point by the $400+ billion in global trades taking place daily, and that’s how smart you’d need to be to consistently profit from trying to “beat the market.”

Understanding group intelligence and how it governs market pricing is a first step in more consistently earning the returns any given market is expected to deliver. Instead of trying to beat the market’s group intelligence, you can take advantage of it by simply investing in index- or index-like funds and holding them long-term. That seems like a smart thing to do.

Written by John A. Frisch, CPA/PFS, CFP®, AIF®, PPC®