This is a guest post from author and former hedge fund manager Lars Kroijer. The piece reflects his own opinion and is not endorsed by Reuters. The views expressed do not constitute research, investment advice or trade recommendations.
Most literature or media on finance today tells us how to make money. We are bombarded with stock tips about the next Apple or Google, read articles on how India or biotech investing are the next hot thing, or told how some star investment manager’s outstanding performance is set to continue. The implicit message is that only the uninformed few fail to heed this advice and those that do end up poorer as a result. We wouldn’t want that to be us!
What if we started with a very different premise? The premise that markets are actually quite efficient. Even if some people are able to outperform the markets, most people are not among them. In financial jargon, most people do not have edge over the financial markets, which is to say that they can’t perform better than the financial market through active selection of investments different from that made by the market. Embracing and understanding this absence of edge as an investor is something I believe is critical for all investors to understand.
Consider these two investments portfolios:
A) S&P500 Index Tracker Portfolio like an ETF or index fund
B) A portfolio consisting of a number of stocks from the S&P 500 – any number of stocks from that index that you think will outperform the index. It could be one stock or 499 stocks, or anything in between, or even the 500 stocks weighted differently from the index (which is based on market value weighting).
If you can ensure the consistent outperformance of portfolio B over portfolio A, even after the higher fees and expenses associated with creating portfolio B, you have edge investing in the S&P 500. If you can’t, you don’t have edge.