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The biggest reason why many investors don’t outperform the FTSE 100

Beating the FTSE 100 is an aim for many investors. Doing so would enable a portfolio to increase in value at a fast pace, with the large-cap index expected to deliver high-single-digit percentage returns per year in the long run. As such, outperforming the UK’s biggest listed companies could make a real difference to an investor’s retirement prospects and their quality of life from a financial standpoint.

However, many investors fail to achieve their goal of beating the FTSE 100. Here’s one reason which seems to be relatively common, but fairly straightforward to overcome.

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Timing

Timing the stock market is notoriously difficult. In fact, it seems to be near-impossible for anyone to buy shares at their lowest point and then sell them at their highest level on a consistent basis. As a result, there are very likely to be times when an investor is ‘on the wrong side of the market’. In other words, they mistime their purchases and sales to some extent on a regular basis.

But this does not mean investors should give up on trying to time the market. Certainly, they may experience paper losses from time-to-time, but by using the economic cycle to their advantage, they can improve their overall returns in the long run.

Buying and selling

For example, history shows that a recession is likely to take place on a regular basis. Sometimes there is a gap of just a few years between recessions, while at other times investors must wait over a decade for the next one to occur. As such, for investors who are trying to time the market, simply waiting for the next recession before buying shares could be a good strategy. A recession may mean that high-quality companies are available at low prices, which more than makes up for the relatively low returns associated with holding cash reserves in the boom years between recessions.

Just as recessions come and go, so too do bull markets. This means that when valuations reach a point at which they appear to offer narrow margins of safety, it may be a sound idea to sell and move into other assets such as bonds or cash. Bull markets can run for extended periods of time, and bubbles can form. But history shows that they always burst – eventually – and so taking profit on overvalued shares could be a sound move.

Beating the market

While buying during recessions and selling during overheated bull markets may sound like an obvious strategy, it seems as though few investors follow it. Instead, they become increasingly optimistic during bull markets, and more fearful during bear markets. The end result is that the cycle works against them, rather than for them. This means that they constantly face a headwind, rather than a tailwind.

By focusing on valuations, the economic outlook and going against the majority of investors’ viewpoints, it is possible to beat the FTSE 100 on a consistent basis. Clearly, it requires patience and discipline. But the rewards from doing so could be worth it.

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Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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