Money Management and the Economy

Thursday, January 24, 2008

You are NOT smarter than the market

You are not smarter than the market. Accepting this basic fact is the first step toward successful investing. That is counterintuitive to some people. There are lots of people out there who want to "beat the market". They hire financial advisers who claim that they will help them accomplish this allusive goal. There are also people out there who want to win the lottery, they buy lottery tickets. In both cases, you hear a lot about the "winners". What you don't hear is that there are a lot more losers and the odds are you will be one of them.

Now, financial advisers will argue that what they do is not really gambling because they can control the outcome. They claim that by being "smarter" they give you a leg up on the typical investor. That isn't really true because the market price of stocks in not set by the "typical investor". Prices are set by the collective wisdom of market professionals, many of whom manage billions of dollars each. Your financial adviser is one of them, albeit not likely one of the billion dollar managers. And, on average, they collectively lose money for their clients.

We know that they lose money for their clients because for every stock sold, there is a buyer and a transaction cost. So while the financial advisers will have made money, that money came out of some poor dumb investor's pocket. Don't be the that dumb investor. Take a deep breath and admit you aren't smarter than the market.

The positive side of this is you don't need to be smarter than the market. Because the market,in general, is pretty smart and you will make money if you can just match it rather than beat it. So your goal as an investor is to match the market, not beat it.

Of course, people go to Vegas because they like to gamble. They want to win, but many of them accept losing as part of the excitement. Just don't gamble with your house payment, the kids college tuition or your retirement funds. If you have extra money and want to play in the stock market, go for it.

But you won't find much help or wisdom here for doing that. Except to understand is you win, it proves you were lucky, not that you were smart.