{"id":83,"date":"2008-03-03T06:49:22","date_gmt":"2008-03-03T14:49:22","guid":{"rendered":"http:\/\/marketriders\/weblog\/?p=83"},"modified":"2016-12-21T07:33:06","modified_gmt":"2016-12-21T15:33:06","slug":"can-you-beat-the-market-its-a-100-billion-question","status":"publish","type":"post","link":"https:\/\/www.marketriders.com\/investing\/can-you-beat-the-market-its-a-100-billion-question\/","title":{"rendered":"Can You Beat the Market? It’s a $100 Billion Question"},"content":{"rendered":"

By MARK HULBERT<\/span><\/strong><\/p>\n

Published: March 9,
\n2008 in the New York Times<\/span><\/strong><\/p>\n

INVESTORS collectively spend around
\n$100 billion a year trying to beat the stock market. That\u2019s the finding of a
\nrigorous effort to measure the total costs of Americans\u2019 efforts to surpass the
\nreturns they would have received by simply holding a stock index fund. The huge
\nprice tag helps explain why beating a buy-and-hold strategy is so difficult.<\/p>\n

The study, \u201cThe Cost of Active Investing,\u201d began
\ncirculating earlier this year as an academic working paper. Its author is
\nKenneth R. French, a finance professor at Dartmouth; he is known for his
\ncollaboration with Eugene F. Fama, a finance professor at the University of Chicago<\/span><\/a>, in creating the
\nFama-French model that is widely used to calculate risk-adjusted performance.<\/p>\n

In his new study, Professor French tried to make
\nhis estimate of investment costs as comprehensive as possible. He took into
\naccount the fees and expenses of domestic equity<\/p>\n

mutual funds (both open- and
\nclosed-end, including exchange-traded funds), the investment management costs
\npaid by institutions (both public and private), the fees paid to hedge funds,
\nand the transactions costs paid by all traders (including commissions and
\nbid-asked spreads). If a fund or institution was only partly allocated to the domestic
\nequity market, he counted only that portion in computing its investment costs.<\/p>\n

Professor French then deducted what domestic
\nequity investors collectively would have paid if they instead had simply bought
\nand held an index fund benchmarked to the overall stock market, like the
\nVanguard Total Stock Market Index fund, whose retail version currently has an
\nannual expense ratio of 0.19 percent.<\/p>\n

The difference between those amounts, Professor
\nFrench says, is what investors as a group pay to try to beat the market.<\/p>\n

In 2006, the last year for which he has
\ncomprehensive data, this total came to $99.2 billion. Assuming that it grew in
\n2007 at the average rate of the last two decades, the amount for last year was
\nmore than $100 billion. Such a total is noteworthy for its sheer size and its
\ngrowth over the years \u2014 in 1980, for example, the comparable total was just $7
\nbillion, according to Professor French.<\/p>\n

The growth occurred despite many developments
\nthat greatly reduced the cost of trading, like deeply discounted brokerage
\ncommissions, a narrowing in bid-asked spreads, and a big reduction in front-end
\nloads, or sales charges, paid to mutual fund companies.<\/p>\n

These factors notwithstanding, Professor French
\nfound that the portion of stocks\u2019 aggregate market capitalization spent on
\ntrying to beat the market has stayed remarkably constant, near 0.67 percent.
\nThat means the investment industry has found new revenue sources in direct
\nproportion to the reductions caused by these factors.<\/p>\n

What are the investment implications of his
\nfindings? One is that a typical investor can increase his annual return by just
\nshifting to an index fund and eliminating the expenses involved in trying to
\nbeat the market. Professor French emphasizes that this typical investor is an
\naverage of everyone aiming to outperform the market \u2014 including the supposedly
\nbest and brightest who run hedge funds.<\/p>\n

Professor French\u2019s study can also be used to show
\njust how different the investment arena is from a so-called zero-sum game. In
\nsuch a game, of course, any one individual\u2019s gains must be matched by equal
\nlosses by other players, and vice versa. Investing would be a zero-sum game if
\nno costs were associated with trying to beat the market. But with the costs of
\nthat effort totaling around $100 billion a year, active investing is a
\nsignificantly negative-sum game. The very act of playing reduces the size of
\nthe pie that is divided among the various players.<\/p>\n

Even that, however, underestimates the
\ndifficulties of beating an index fund. Professor French notes that while the
\ntotal cost of trying to beat the market has grown over the years, the
\npercentage of individuals who bear this cost has declined \u2014 precisely because
\nof the growing popularity of index funds.<\/p>\n

From 1986 to 2006, according to his calculations,
\nthe proportion of the aggregate market cap that is invested in index funds more
\nthan doubled, to 17.9 percent. As a result, the negative-sum game played by
\nactive investors has grown ever more negative.<\/p>\n

The bottom line is this: The best course for the
\naverage investor is to buy and hold an index fund for the long term. Even if
\nyou think you have compelling reasons to believe a particular trade could beat
\nthe market, the odds are still probably against you.<\/p>\n

\n

 <\/p>\n

Mark Hulbert is editor of The
\nHulbert Financial Digest, a service of MarketWatch. E-mail:
\nstrategy@nytimes.com.<\/p>\n","protected":false},"excerpt":{"rendered":"

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