Chippenham, Wiltshire -- The answer is quite simply YES!
I almost feel like stopping right there. After all, it seems obvious to me that any Fool has the ability to beat the market over the long term. Fools are intelligent and sensible people, and they can apply their intelligence and their good sense to beating the market over the long term.
But we must have all seen the often reported fact that most professional fund managers fail to beat the market average. If they can't do it with all the resources that they have at their disposal then how can we, mere Fools, ever hope to beat the market?
How many old people do you know who have beaten the market?
It is really hard to beat the market -- especially after all costs, the bid-offer spread and taxes are taken into account. This fact is proved by the distinct lack of large numbers of rich "old" Fools who are now living out their retirements on the market-beating funds that they have accumulated over their lives.
We often hear the name Warren Buffett as an example of an investor who could consistently beat the market, but if beating the market were easy we would know a whole host of other famous and rich people who have made their money through investing in the stock market. The fact is most investors fail to beat the market either in the short term or the long term, and so it can be said that for MOST investors the best investment they can make is to buy an index tracking unit trust.
But resorting to buying an index tracker because "most people do not beat the market" is quite an admission of defeat. We are Fools, and we CAN beat the market! But you cannot expect to achieve market-beating long-term returns without making a market-beating effort to achieve them. It is very hard to make money, and in investing (as with everything else in life) you don't get something without putting in the hard work.
So why should you try?
If it is so hard to beat the market, why should you try? Well, we all want to be able to do better than average. While I would encourage everyone to consider investing directly in individual shares, you should only do this if you're willing to take the time and effort to do it properly. If you put in the work then you too can beat the market.
How do you beat the market?
What is the key element to successfully beating the market over the long term? It is quite simply to buy shares in high-quality businesses that you understand, and to buy them at attractive prices. Simple, isn't it?
Some of the best writing I have read on investing comes from Whitney Tilson and can be found over at our sister site at Fool USA writing in the now discontinued Boring Portfolio series. The following factors on developing a market-beating portfolio have been influenced strongly by his work.
To beat the market in the long term you should:
1. Make Long-Term Investments
Your time horizon should be at least five years -- and ideally a lifetime -- on your investments. But, according to this study by Barber and Odean the average individual investor in the USA turned over 80% of their portfolio every single year. Churning your portfolio is going to give you poor long-term returns and you will incur massive charges for the privilege.
By making long-term investments you will give yourself the benefit of keeping trading costs low (yes, trading costs have fallen dramatically, but any cost reduces your return and don't forget about the bid-offer spread). While the cost of trading shares can now seem very cheap, these small costs matter a great deal in the long run.
Investors sell one share and buy another because they think the stock they're buying will outperform the one they're selling. But another study by Odean shows that precisely the opposite is the case: the shares investors bought underperformed those they sold in the following year.
Odean's research showed there was a strong correlation between the amount of trading investors did and their returns. More trading resulted in poorer returns. Not surprisingly, Barber and Odean concluded: "Our central message is that trading is hazardous to your wealth."
2. Only Invest When You REALLY Believe the Odds Are Heavily in Your Favour
The future is very difficult to predict. Even when you are very confident about an investment, you will still have to contend with a lot of uncertainty. Therefore, only invest when you are super confident, when you are as sure as you can possibly be that you are onto a long-term winner. That doesn't mean you should never take any sort of risk -- investing is a risky business, after all -- but only invest when you believe the risk of an investment is more than balanced by the potential return.
This means that you should make relatively few investments. Why dilute your best ideas with inferior ones? The average investor will hold many different companies in their portfolio, I don't know what the average number is but I bet it is near to 20. Why hold so many?
3. Hold a Concentrated Portfolio
An obvious consequence of making few investments is making big ones. To invest successfully, you have to find shares that the market is "mispricing", which doesn't happen very often. It's hard to find good companies trading at a bargain price, or great companies trading at a reasonable price. So when you find an attractive situation where you are highly confident of a favourable outcome, you should invest a meaningful amount. If you are confident of your investments then why hold any more than 10 individual investments at any one time? If you are REALLY confident then why hold any more than 5 investments? And if you are not really confident in an investment, then why invest in that company at all?
Conclusion and a Word of Caution
Be careful, though. While having a concentrated portfolio will increase your chances of beating the market, it is almost certain to lead to more short-term volatility and can result in large losses. If you aren't certain that you know what you're doing, then you are better off with an index tracker.
We Fools have some competitive advantages as individual investors: we should use them. We can be patient and focused on the long run, we can do the required hard work in trying to understand and value a company, and can make relatively few but relatively big investments when we believe the odds are stacked heavily in our favour.
So Fools, can we beat the market? Vote yes!
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