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Can Hard Work Really Outguess the Market?

You and I read it and hear it everyday - pontifications on where to invest now -- what to buy, what to sell.  In fact, I'll regularly see more than one article next to another that completely contradict each other.  What are the odds of these prophets successfully outguessing their peers? According to the World Federation of Exchanges, the global market cap of equity markets (not even counting the bond and commodity markets) is about $51 trillion as of the end of August 2011.  That's $51,000,000,000,000.  $51 million million.  And the international bond markets are another $82,200,000,000,000!  How many millions of companies and investors do you think comprise the participants in the global marketplace? If we assume that a very large money manager would manage about $200 billion, that would make room for 665 of these very large managers.  So let's assume that this were the case, and these firms were competing for returns.  They're all trying to outguess each other and find the next hot trend.  And spending money on research and trading to do so.  First, just the act of their researching and trading gives them a cost to overcome.  So already they're behind the eight ball.  And obviously if there are winners, there must be losers - they can't all beat the average.  But which ones will emerge victorious?  Even Morningstar admits that long-term track records don't shine a bright light on who's going to outperform during the next period. 

One could say it's ego or hubris that makes people think they can beat the market (amateur and professional alike) but it's just the American way.  We want our team to win and we believe that hard work always pays off.  But this is a negative-sum game and the odds are not in your favor. So what to do?  Well the reason this game becomes negative-sum is due to the costs involved with trading and research.   So you can up your chances by paying attention to costs.  And if you want to maximize returns (with the appropriate level of risk) then allocate your investments to the ones that have been identified by academia as having the best long-term risk/return properties. The market is a behemoth.  Even the largest players in international finance are mere specks in comparison.  To think that any of these have the power to predict or outmaneuver "the market" is like thinking they could influence the path of a hurricane. 

Sometimes the market goes where you expect, but there's never anything you can do about it - and sometimes the personal consequences of misguessing are tragic.