Retirement: Second Place Wins The Race

Posted on December 3, 2014 at 10:45 AM PST by

Can you beat the market these days? Should you even try? Increasingly, the resounding answer for retirement investors is “no” and “save your money.”

Wall Street blows a lot of cash on the idea that everyone should somehow beat the market. Try $600 billion a year in fees. Yet the financial research theory, now decades old, has finally proven true. Your odds of getting a better return than the overall market are now vanishing small — less than one manager in 100 can do it.

Could you pick that manager? Does he or she even take clients with your level of retirement savings to grow? Probably not.


Could you do it yourself instead and save the money? Only if you believe that you have the skill and the stamina to outlast all of Wall Street and beat them and the market consistently, year after year. The data shows it’s just not true, for them or for you.

The University of Maryland took a look at what’s called “true alpha,” that is, a market-beating return that cannot be attributed to chance. You know the old story of the stock-pickers who use a dartboard. Every few years, someone sponsors a contest with 5th-graders, or a cat pawing at toys or something utterly random, like coin flipping.

The resulting “nonprofessional” portfolio inevitably wipes the floor against highly paid managers, making the point quite clear: The managers are in the business of packaging sheer chance wholesale and marking it up to sell retail.

It wasn’t always so. Before 1990, there was a pretty good opportunity to beat the market. Then, 14 out of 100 managers could do it consistently. Soon, though, index funds and ETFs really took hold. Computerized information became more widely shared and constant. Many more mutual funds entered the market.

The result was the rapid destruction of the ability of talent to win over coin-flipping. Yet the “talent” is still in business, still charging high markups and still maintaining the faulty argument that investments must be picked and managed.

Are managers necessary? Not when just 0.6% of managers can pull off a true win. Think of it this way: If that tiny minority of traders is able to beat the market, by how much will they do so? Not much, it turns out, once you subtract their fees.

Retirement photo finish

Why not just own the market, get second place in a photo finish and keep those fees in your portfolio, where they can do you some good by compounding? That, in essence, is the argument of index funds.

Unsurprisingly, index funds and index-style exchange-traded funds (ETFs) have exploded in popularity since. What’s more, price competition has set in, driving down the cost of holding an index ETF to well under one-tenth of 1%.

That move represents the savings of hundreds of billions of dollars, money that remains in the accounts of investors themselves. And that’s how retirement is reached these days by prudent, long-term investors.