Can market timers outperform the market?
One of the most watched bets in investment history just wound down. Ten years ago, billionaire stock investor Warren Buffett wagered that the S&P 500 Index would outperform five hedge funds over the next decade. The bet was a classic “passive investing” vs. “active investing” showdown.
What were the results of market timing? The S&P returned about 7% with dividends reinvested over the decade. That performance is a little below the S&P 500’s longer term record of a 9.7% average annual return over the past three decades, which included the market slides in 2000 and 2008. In any case, the S&P 500 outperformed the five hedge funds, which averaged a 2.2% return.
Active investing
Even though market timers frequently underperform the market over the long term, they nonetheless suffer from “overconfidence bias” – the subjective belief they are better traders than an objective evaluation of their trading performance would determine.
Interestingly, some active investors outperform in bear markets, but why? Is it because of superior trading skill? An information advantage? Well, it turns out, many of them really do buy useful information.
The real price of a trade
Even when investors correctly time the market, the price of doing so often erodes any performance gains. Here’s why:
* Trading fees –Buffett says $100 billion is wasted in fees for active management that fails to outperform the market. Indeed, higher-cost funds have been shown to underperform lower-cost funds.
* Investment research costs – Professional investors pay between $50,000 to over $500,000 for analysts’ research. Large institutional traders pay much, much more.
* Capital gains tax – Actively selling stocks subjects the investor to more taxes, since he is required to pay tax on capital gains from all the trades.
Some market timers can outperform the market, but the cost of doing so may be too high and significantly diminish returns.
Is there a way to improve investment returns without higher risk? Watch this six-minute video for the answer.
Douglas Goldstein, CFP®, is the Director of Profile Investment Service, Ltd., which specializes in helping people who live in Israel with their US dollar assets and American investment and retirement accounts. He helps olim meet their financial goals through asset allocation, financial planning, and using money managers.
Published February 12, 2018.