The Investment Scientist

Beat the market vs. capture the market

Posted on: February 4, 2012

Last month, I was approached by a plastic surgeon whose money was with Morgan Stanley Smith Barney. He was looking for someone who could beat the market: not just promise to beat the market, like his financial advisor, but actually deliver.

I told him that I can’t beat the market, I can only help him capture the market. I could see a wisp of disappointment flash across his face.

The market can be thought of as the collective wisdom of all participants. To beat the market I must be smarter than all of them combined. I know I am not that smart.

Capturing the market is nothing to sneeze at. Look at the table above (source: DALBAR, inc.)  that compares the 20-year returns of the S&P 500 and the average equity investor. You will find that the equity investor lags the market by a huge margin consistently.

Take the 2010 entry for example. From 1991 to 2010, the S&P 500 returned 9.14% annualized, while the average equity investor during the same period only earned 3.17% annualized. The average investor did that by timing the market, picking hot stocks, and chasing hot money managers, etc.; all the things that generally lead to “buy high, sell low”.

If those investors had been my clients, I would have made sure them think twice before they shot from the hip, and they would have captured most of the missing returns – 5.31% annualized. That is 170% more money in 20 years!

Get my white paper: The Informed Investor: 5 Key Concepts for Financial Success.

2 Responses to "Beat the market vs. capture the market"

The disappointing thing is that many people have to go through the experience of sub-par experience before they see the value of indexing. A 65% stock/35%bond portfolio has quadrupled your money over the past 20 years with reasonable volatility.
This message is kept secret by much of the financial services industry.


Right on.

Investing is quite simple: have a reasonable asset allocation plan and stick to it. However it’s hard for ordinary investors to carry it out:

1. The financial industry is constantly dangling the seduction of “beat the market.”
2. Our reptilian brains want us to “do something, just do something” whenever the market falls.

I figure if I can help my clients avoid these two pitfalls, I am probably worth more than the money they are paying me.


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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.


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