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Beat the Market? Fat Chance

edited February 2013 in Fund Discussions
Hi Guys,

It was a different investment community forty years ago. In that hazy past, the odds were that individual investors were mostly trading with each other.

In that yesteryear, private investors executed 70 % of the daily trading volume; institutions accounted for the remaining 30 %. The science or art of investing was very primitive; it was basically dumb, weak money exchanging stocks with equally dumb, weak money. There were remarkable exceptions; these exceptions quickly became rich (and sometimes poor again cyclically).

Today, that structure has been completely reversed and turned on its head. Now the bulk of the trading (like 70 %) is done by smart, strong institutional money. As an individual investor, it is highly likely that if you are trading some equity position, an institution is taking the other side of that gamble.

That trading partner poses a significant threat. Over time, he has become relatively and absolutely a more powerful opponent. His advantages are manifested by his composite unbounded financial resources, his unfettered timeline, his formal educational background dominated by top-tier MBA graduates, his mathematical sophistication especially in the statistical and operations research arenas, his unlimited research time commitment, his supercomputer access, and his sheer numbers.

The institutional participant is a daunting challenge to private investors. It is not a fair or a level playing field. It is something like the championship Baltimore Ravens professional football team competing against a ragtag group of tag football high school part-time players. The outcome is basically predetermined.

In the early 1990s, Peter Lynch published his blockbuster best seller “Beating the Street”. He projected that the “average Joe” could tame the excesses of Wall Street. Lynch ended that exceptional tutorial with 25 Golden Rules for superior investment outcomes. However, even at that earlier date, the private investor was becoming overmatched by the resources and skills of the institutional giants.

Even the legendary Peter Lynch magic was eroding. His major outsized performance was registered in the late-1970s to the mid-1980s. In that glorious period, his firm permitted him to participate in the inefficient small company and foreign company marketplaces. He invested so broadly and prolifically that it was said that Lynch never saw an investment opportunity that he did not like. But the times turned against him in the late-1980s, and he struggled to generate market-like rewards for his now excessively large client base. He salvaged his reputation by retiring in 1990 at age 46 after a few very mediocre years.

Interestingly, Jeff Vinik, Fidelity managements replacement for the departing Lynch, was soon summarily fired in 1996 when he attempted an ill-fated timing rotation to bond positions. Even as early as the 1990s, the major investment houses were clamping down on the freedom of choice prerogatives that were afforded earlier superstars like Peter Lynch. Vinik eventually recovered while launching and managing a highly profitable Hedge Fund operation. He currently owns a host of professional sports franchises around the world.

That’s spectacular success, even for a Jersey-boy. It does prove a major point. Rare as they likely are, active investing can have huge paydays.

But, there has been a sea change that has made the task far tougher for today’s amateurs, semi-pros, and even full time professionals. Everyone is substantially smarter, better informed, and can react with computer-like lightening speed.

The global statistics collected at places like Morningstar, Dalbar, and Standard and Poor’s demonstrate just how demanding it now is for the part-time investor to produce excess returns above market Index averages. When reviewed in total, these data sets are dismal for the individual investor. On average, we investors recover only about one-third of the returns that the mutual funds that service us deliver. We are pitiful in our entry-exit timing maneuvers. The marketplace is essentially a winning institutional game now.

I recognize there will always be a few highly skilled, insightful, and lucky souls who will outperform the dominating monoliths. They will be rare birds indeed. There are so many smart, informed, and talented financial outlets nowadays competing for the golden ring that they tend to neutralize one another.

They cancel each other out, quickly negating any momentary advantage, and deliver sub-par performance to their customers because of the continuous frictional cost to compete so energetically. Costs are like a hole in a water bucket; it’s a constant drain to wealth accumulation under all circumstances.

So, currently, my takeaway is that it is nearly impossible to “Beat the Street”. That’s just not going to happen for most of us.

But some segment of us will persistently try. Many current MFO members are in this camp. What is the game plan, the strategy, and most importantly, the prospects for this brave band of fearless warriors? Let me invent a likely generic profile to explore the issue for comparative purposes.

The committed private active investor is middle aged with a college degree. He is smart, dedicated, motivated, and industrious. He exchanges ideas on websites like MFO, accesses Morningstar for needed mutual fund data, and probably visits sites like Pony Express Bob to identify momentum attractive candidate funds for consideration. He likely deploys technical analyses using charts to guide perhaps a sector rotational strategy. It is a time-consuming struggle to access and absorb the mountainous pile of data available. Constant attention is necessary. Decision making is a lonely process.

Given the dominance of institutional investors these days, his competition is probably an institutional giant. Perhaps it’s a Boston behemoth, perhaps one of Chicago’s monsters of the midway, or perhaps it’s a team from the illustrious New York Genius network. Surviving against that cohort is hazardous duty. Given their many advantages, the odds of outwitting and outplaying these fierce and tireless opponents must approach zero. And adding the heavy burden of costs into the equation only deepens the challenge.

Given today’s environment and the lineup of market participants, what Peter Lynch interpreted as an individual investor advantage has morphed into a decided disadvantage. Currently, an active private investor is definitely playing a Loser’s game.

Why fight the tape? Since smart institutional investors engage to neutralize one another, an increasing number pf this elite club are joining the passive investment universe. Their numbers will swell in the future. It is doubtful that these numbers will ever penetrate the 50 % level, since institutional warriors enjoy the hunt and the profit incentives too much. That’s all goodness because active market participants are necessary to supply the requisite market pricing mechanism. Pricing competition keeps the marketplace roughly efficient.

Indexing is a reasonable solution to this dilemma for individual investors. It guarantees just short of market rewards if the low cost and low trading disciplines as advocated and practiced by outfits like Vanguard are followed. Even Warren Buffett has acknowledged the wisdom of this approach for most investors.

I encourage you to seriously consider the passive Index option for a more comfortable retirement. Although I currently own a mixed bag of actively managed and passively managed mutual funds/ETFs in my portfolio, I am slowly switching to more and more low cost passive holdings. Portfolio management need never be a overly simple either/or decision; compromise is a useful tool to reduce risk.

So it might well be time to step away, not to smell the roses, but to readdress your portfolio mix. The accumulating evidence overwhelmingly demonstrate a participant sea change and a slowly developing tsunami of institutional investors flooding towards the Index option. Recognize those perturbations and respond to your own special interpretations of those factoids. The institutions are making smarter decisions these days; just look at their profit margins

Certainly there will always be winning active investors who produce outsized market returns. Jeff Vinik is one such wizard. But there will also be lottery winners too. The key is to forecast these winners and their persistence. That’s a Herculean chore. Fat chance on accomplishing it.

Talk to you guys further down the road.

Best Regards.


  • MJG,

    Don't assume all of the committed active private investors are all men. Or that some of us don't index a portion of our portfolios. And that many of us to don't have advisors, and a game plan. Our goal is not always to beat the market, it's to make sure we have a well thought out approach and enough diversification so we get to keep and grow much of the money we want to spend in our retirement and leave to our heirs in many cases.
  • edited February 2013
    Masterful MJG.

    Only way to beat the market is having illegal access to information nobody else has or by superior analysis of available information (ref. Madin, Hagel).

    Your thesis reminds me of the cold war analogy, or better yet, the scene in War Games when the computer Joshua figures out that there is no way to win Tic-tac-toe...or, Global Thermonuclear War.

    The only way to win is to not play=).
  • edited February 2013
    Dear MJG,

    Since this a recurrent topic, I return to my question which remained unanswered last time we discussed it. I would be happy to get an answer since this issue is of very practical importance for me now, and I am sure it is equally important for many other investors following this debate.

    Let us start with bonds. Can you or anybody else give a convincing argument that one should invest in the Vanguard Total Bond Index fund VBTLX of Vanguard Total Bond ETF BND instead of the actively managed PIMCO Total Return PTTRX or its ETF version BOND? PIMCO funds beat the Vanguard funds, so it seems that investing in PTTRX of BOND is a clear-cut better choice than the investment in bond index funds such as VBTLX of BND. It seems that most people know it and vote with their feet: the AUM in PTTRX is 10 times greater than in VBTLX.

    If this is the case, it would mean that the indexing argument fails for bonds. I must be wrong here, so please correct me. But if I am right, this means that the indexing argument should be examined on a case by case basis, which is equivalent to active investment.

    For example, can you suggest an index fund that would beat Matthews funds in their investments in Asia? If not, the indexing ideology does not apply to investments in Asia.

    One possible lesson from this discussion: To have a better chance to beat the index, one should try to identify not just a manager, but a fund family with a good culture which gives them persistent advantage, like PIMCO in bonds or Matthews in Asia. Other fund families that come to mind are Oakmark and Artisan. So instead of betting on a single genius player, one may try to bet on the best professional teams and let them defend your interests.

    I do believe that indexing in general is more tax efficient (though not for bonds) and less expensive (though nor for some Vanguard active funds). But if it fails for investments in bonds and investments in Asia, shall we switch to a discussion on a case by case basis? This would help all of us recognize the areas where a detailed study of mutual funds (and mutual fund families) in the Mutual Fund Observer can be most helpful, and isolate the areas where indexing is a much better approach.


  • Reply to @andrei: Keep it coming Andrei!
  • Reply to @andrei: My answer would be Yes!, examine it on a case by case basis. I invite you to look at FCNTX (considered by many to be a proxy for the S&P 500) in a M* graph compared to VFINX and the S&P 500 over any time period but especially take a look at the maximum option. Which would you rather own?

    For the passive investor who doesn't wish to put the time and effort into their investments passive index investing is by far the best option. Many committed private investors, as described by MJG, can, and do, do better. We are not always in competition with the institutional investors, in fact I play right along side of them in many cases. It's often just a matter of choosing the right side. You're not always going to be right, just be right more than you're wrong.
  • Bravo MJG. This essay should appear in the WSJ.
  • edited February 2013
    Reply to @Mark: Well, to be honest, here we have a problem. From time to time I consider investing in FCNTX or its clone FNIAX. But during the last 3 years FCNTX does not beat VFINX, and in fact during the last year VFINX beats FCNTX. Thus one may ask whether it becomes too difficult to actively manage $105 billion in stocks in FCNTX and FNIAX. Perhaps it is (or was) a bit easier in bonds...

    This is an important argument in favor of indexing. If you want to set it and forget it, indexing is a much easier game, especially because over time it does not suffer from the manager risk and asset growth.

  • edited February 2013

    I have linked a performance graph of the S&P 500 Index vs. SPCEX, Alger Spectra Fund A vs. AGTHX, American Growth Fund of America A vs. VADAX, INVESCO Equal Weight S&P 500 Fund A (with quarterly rebalance) vs. IACLX, ING Corporate Leaders 100 Fund A (with quarterly rebalance) vs. PIXAX, Pimco Fundamental Index Plus A. Seems all five took the bogey.

    Click the expanded view for the ten year picture, then click compare and enter the tickers of the other funds.

    This graph speaks volumes concerning the discussion on active vs. passive. Funds that beat their respective indexes are not too hard to find if one knows how to prospect.

    Good Investing,
  • MJG
    edited February 2013
    Reply to @andrei:

    Hi Andrei,

    To this moment, no MFO member has chosen to answer your specific question. That, in itself, is an answer. There is no simple, clean, one-size-fits-all response. The most honest reply is that “It Depends”.

    It depends on many considerations, but one obvious factor that does apply to almost all individual investors is your risk tolerance or risk aversion. How much are you willing to gamble that your actively managed funds will outperform market returns and how much incremental risk are you willing to accept to achieve those superior rewards?

    Veteran MFO members understand these key tradeoffs. They exist for every investment choice you make.

    Going the active fund route suggests that you have completed assessing these tradeoffs, and have concluded that the odds are tilted in the active fund management direction. Having done a respectable analysis, the final decision is now determined. Just do it.

    Actively managed funds will always outperform Index products if you consistently and persistently guess correctly. But that’s a heavy burden since the odds do not favor that outcome.

    Let me illustrate with an example that is roughly statistically accurate. Say that 33 % of active mangers outperform their benchmarks annually. Let’s also say that by careful elimination of the bad actors, you can reasonably increase those odds to 60 %. Over time, the data show that the excess returns is merely of order 1 % annually. So your expected excess returns is only 0.6 %. If you double the excess returns level, the expected excess returns is still only 1.2 %.

    The other side of that coin is that you have a 67 % likelihood of selecting a loser fund. The fund industries cumulative returns distribution curve is very asymmetric; it is much steeper on its underperformance side. Trading and management costs are a major contributor to that asymmetry. Underperformance (relative to an Index) levels in excess of 4 % are not unusual. So even if you wisely enhance your selection process to cut the downside performers to about a 40 % probability, your expected excess returns are roughly -1.6 %. The risk-reward tradeoff is still unattractive.

    In any given year, actively managed funds will always top a category performance listing. But likewise, the bottom rungs on that listing will also be occupied by actively managed products. That’s the incremental risk you accept when you elect the active management approach. You accept that risk each and every year. Rankings are chaotic and unstable.

    Wall Street is littered with fallen heroes. The famed investor Jesse Livermore won and lost fortunes several times during his enigmatic Wall Street career. Legg Mason’s Bill Miller lost his magic touch a few years ago after generating excess returns for 15 consecutive years. Nobody can predict when the music will stop.

    I currently own both Vanguard and PIMCO bond products. I have become increasingly leery of the Bill Gross skill to keep the music flowing. Gross is no magician; he has made some sour calls lately. My arguments are statistically rooted. Some wizards will defy the odds.

    Outsized performance persistence is a goal that has eluded even the most talented management teams. Just check Standard and Poor’s SPIVA and Persistence scorecards for statistical verification of that assertion. Here is the Link to their most recent releases:

    Even in areas where one might expect active management to shine, there is disillusionment. In the Small Cap arena and in the Emerging Markets arena, annual performance and persistency are sub-par relative to expectations from luck alone.

    Are there exceptions? Yes.

    In my original post, Jeff Vinik is identified as an exception. Bill Miler was an exception until the markets moved away from his style. Bill Gross is an exception, but teetering just a little.

    If you feel that you have identified one of the rare exceptions, have the courage to follow your decision and your instincts. But understand the risks; reversals happen. The marketplace has a strong pull towards a regression-to-the-mean.

    The good news is that you get to make your own call, and therefore are totally responsible for that call. Note how MFO members have judiciously refrained from making that call for you. There are no silver bullets when investing; otherwise we would all be billionaires. Ironclad performance guarantees do not exist.

    Good luck.
  • edited February 2013
    Dear Skeeter,

    Thanks, a great ten years figure! But to be fair, the graph of SPECX since inception in 1969 shows a less optimistic picture.

    Until 2001, it was managed by David Alger and then by several other managers. During the first 5 years since inception, the fund was decimated, it lost 2/3 of its original NAV. Then it recovered and experienced an amazing stable growth for the next 25 years, until it was decimated again in 2000. During the last 10 years it performed great, but I doubt that many of its original investors could "stay the course" when it crashed in 1969-1974 and in 2000-2003.

    During nearly 44 years of its existence, $10 invested in this fund would grow to $742, whereas being invested in S&P 500 they would "only" grow to $536, but with a much smaller volatility. I can imagine that in 2000-2003 an average investor in this fund asked himself whether it makes any sense to entrust money to this fund after its original manager David Alger left in 2001, in the midst of the crisis, while his fund continued crushing down until 2003. I know how I would answer this question.

    Thus this fund does not necessarily present a convincing argument in favor of active management. I hope that a more convincing case can be made by studying families of funds (rather than particular funds) which have great culture of investing in the areas where they can achieve reproducible success. Examples of such families may include PIMCO, Matthews, Oakmark, Artisan - but maybe I am too optimistic about them?...

  • Reply to @Skeeter: The 1, 3, 5 etc. returns probably looked a lot different on March 9, 2009. Did you know it was going to do better or did you have expectation that it will continue to sink faster. It is only clear in retrospect what I should have invested. I probably would have invested in triple leveraged fund but doing it is another matter.

    Even with such return information about SPCEX is known, how much confidence do you have it will outperform going forward.

    Funds come and go. Persistence is exhibited by only a few and so-far the only statistically significant attribute for future out-performers is that they do have low costs.

    To justify lower returns we are getting we are looking at the risk adjusted returns. Yet, risk adjusted returns are not spendable. Only real returns are. Investing is as difficult as before.
  • edited February 2013
    Reply to @MJG:

    You noted to Andrei:
    To this moment, no MFO member has chosen to answer your specific question. That, in itself, is an answer. There is no simple, clean, one-size-fits-all response. The most honest reply is that “It Depends”.
    I am up to my arse in work; but will take a few moments here.

    Is there now a time frame to which a "no-reply" validates something? A silence is affirmation??? I think not. You have been in this investment racket long enough that I would have hoped you may have provided some type of input against Andrie's question regarding bond etf's/indexes versus active managed bond funds.
    I will presume you will rest with your write otherwise and skip the specifics. This is, of course; your option.

    And correct; every investor's choices depends on too many variables.

  • edited February 2013
    Howdy andrei:

    You noted:
    One possible lesson from this discussion: To have a better chance to beat the index, one should try to identify not just a manager, but a fund family with a good culture which gives them persistent advantage, like PIMCO in bonds or Matthews in Asia. the above. Gain as much knowledge and insight into the fund houses. Their gift may not last forever; but one may catch and ride the wave of their clear thinking for some time.

    As to your bond(s) question. My 2 cents worth.
    We have not and likely will not use a bond etf or index, unless it is a more narrow focused fund and we choose to invest in that area of bonds.

    As to BND, AGG, VBTLX, VBMPX, etc.; although their holdings mixes vary in some areas, funds in this "type" that lay claims to "total" are misleading. These indicated here have little or no exposure to anything outside of gov't (Treasury), investment grade corp and mortgage securities. So, they are "kinda" limited-total. All of these have a similar return for 1, 3 and 5 years at: 2.7%, 5.3% and 5.5%. These numbers compare against a fund as PTTRX, with: 7.2%, 7.1% and 7.7%.

    Many active managed funds that claim to be "total" or related wording; are or may be at some point in their life cycle more so total as to bond types within the fund. These could include any U.S. or other global bond, including muni's. Another large factor that separates the etf/index versus the active managed are the tools used inside the active funds. I note these as the "steriod" funds, regardless of the investment area.

    'Course, a new area is now open; being the active managed etf's. This brings forth a fund as: BOND. Surely more are on the way in all areas.

    Walking through a bond fund door today, would find me walking towards the active managed, "total" bond funds; unless a speciality bond area was desired; then perhaps an etf/index would also be a choice. BOND is ahead of PTTRX by 1/2% YTD, on a very small number.

    In this case, one would have to lean upon the previous track/return record for at least the last 5 years and 10, better yet; "IF" it is known that there have not been any major changes in manager(s) or management companies. I don't what else there would be to lean upon; as we sure as heck don't positively know the future directions.

    As to the start of this thread. MJG recycled numerous thoughts from the past 3 years from FundAlarm and MFO. Sure ain't the same market as from not too many years ago. The machines and big money houses are in command as never before; Washington D.C. and some of the folks in that town have serious "cranial/rectal inversion" with no medicine in sight. Several thousand folks are on track with inside info every day of the week, from any country of your choice. Many things that should be fundamentals for decisions with investments are no longer in place....yes, always a few exceptions here and there. Trade and/or currency wars in place??? Hey, why not. Recently the G-20 members apparently made it known that it is okay for Japan to operate its current policies regarding their economy and monetary programs. One would think that Japan stated under their breathe to "just buzz off" or worse. We'll do as we please....domo! Our country surely can't pressure/lecture Japan or anyone else about monetary policy, eh? And what about those central banks wanting some or all of their gold bullion housed on the mother land property? And why would it require Germany to wait for 7 years to have their request filled from the NY FED?

    As to etf's/indexes that is part of the starting thread. Well, I can look at the SP-500, if that is what I would want and buy any number of clones. Or perhaps, just buy VTI for U.S. exposure. We are Fidelity accts. holders; so our easiest in-house would be to use FSTVX (lg.cap) and FSEVX (mid/sm cap). We would have about 3,000 holdings with each index and would not have to care whether large cap or small cap or growth or value were the flavor of the day/week. We held FCNTX and VPMCX for many years prior to June of 2009. I don't find this house moving to those again for equity exposure. We also like and have held FLPSX, but would likely now travel to a mid/sm index fund.
    Our only binding event would be how much, when to buy, when to sell and why. Although each index does have a 90 short term holding/sell fee.

    Solely, as to etf's. Sadly, these are the playground areas of the hedge funds and big traders; which rip and tear apart what could or should be some "normal" path of travel; only to become a short term pleasure play for the big kids.

    So, for bonds; I lean to whatever one can determine to be a broad based, active managed fund operated by some folks we have proven themselves to date, if one is looking for a core holding.

    What a game we play !!!

    Ya'll take care, and back to work for me.

  • Reply to @andrei: I've given up on him- good luck to you!
  • FWIW, why should the goal be to "beat the market"? I don't get it. Every investor's goal is going to be somewhat different. My goal is to be able to have the cash flow I desire in retirement. What with Social Security, 401k, and (fortunately for me, part of a business ownership), I know what kind of return I need from my investments to achieve that income goal. And it has nothing to do with "the market". The same goes for our clients. Each has a different pot to work with, each has different cash flow targets, and specific risk tolerance.

    Frankly, I don't give a rat's patooie if my portfolio "beats the market" from one year to the next. I DO want my mix of managers to help me reach my retirement income goal. I can look back over the last 10, 15, 20 years and see that client accounts have done better than "the market" with less risk. What happens year-to-year is important, but not all that big of a deal. We are talking a marathon here, not a 100-meter dash. HOW each investor puts their truly diversified mix together is not nearly as important as is focusing on the big picture "at the end". The best thing investors can do for themselves is to create a TRULY diversified portfolio. In many cases, 401k plans have lousy investment options. But more and more we are seeing 401k plans offer self-directed brokerage accounts, which is something EVERY participant should consider. That should really open the door to a large number of investment options that are not found in hardly any traditional 401k, such as long-short, currency, EM bonds, bullion, and dynamic allocation strategies.

    The fact is that there are plenty of talented managers (men AND women) who have strong track records and who have beaten their benchmarks over 3, 5, 10 year periods. If an investor does not have the time or the inclination to do the work needed to find these people, there are plenty of other options. Just don't go to Raymond James, Edward Jones, Merrill Lynch, or the local bank and expect someone there to do anything holistic. Places like Mutual Fund Observer have great content and plenty of smart people to offer help and insight.

    My suggestion is to not spend time on "beating the market". Instead think about what your REAL goal should be, then create a portfolio that should get you there, no matter what happens to "the market". And remember that nothing helps like putting as much money away every pay period as you possibly can.
  • Morning BobC,

    Yes, sir.

    Individual investors must establish their own goals; and most importantly don't become trapped by personal emotions when a period of time exists with which one's portfolio does not measure against that goal, as had been planned.

    Continue to gain knowledge to the best of one's ability.

    Thank you and regards,


  • edited February 2013
    To say the least the question is flawed. Without a clearer proposition and set of terms all participants agree to, this donkey can't fly. Perhaps the OP laid out the relevant terms and definitions in his lengthy expose' --- don't know. Doesn't matter unless everybody agrees to them.

    Since all will have different perspectives on relevant terms like: market, investor, investing, active and passive management and the correct time-frame for consideration, little can be accomplished to resolve such a poorly worded proposition. That's not to say the comments on both sides aren't valid. They are - as each approaches the arena (meaning "combat zone" and not necessarily "circus") from a different perspective.

    The proposition - or something like it has been promulgated for years - John Bogle being a major proponent. Over very long periods (measured in multi-decades) it holds truth to this extent. (1) Since all things tend to "average-out" over the very long term, (2) And all else being equal, (3) Than financial contracts (Isn't that what ownership of an asset really constitutes?) which exact the lowest cost from the participants to construct and execute will over time prove the more profitable to the participants. The key qualifier is of course: "All else being equal." As the many responses demonstrate - they seldom are.
  • MJG
    edited February 2013
    Hi Guys,

    First and foremost, I want to thank each and every MFO member who visited my posting. The response was overwhelming and very satisfying to me since the goal of every single of my submittals is to educate, to inform our band of brothers.

    Secondly, and no less importantly, I particularly want to extend a thank you to those members who contributed excellent commentary. You prepared outstanding viewpoints that balanced the discussion. We all benefit from these divergent standpoints. No single person understands all the fascinating machinations and mechanisms of the marketplace. Your special perspectives are always welcomed and truly appreciated.

    It appears that my chosen title is somewhat controversial. Good. It was selected to capture the prospective audience’s attention, and by the readership count it performed exactly as designed. In addition, it closely and purposely mirrors the title of Peter Lynch’s famous book whose objective was to inspire individual investor participation, education, and potential profits.

    I partially concur with some contributors that specifically “Beating the Street” for that singular purpose is a shallow objective for most investors. It might satisfy some egos, but it will not necessarily enhance one’s retirement comfort. Please take note of my qualifier “necessarily”. I attach a deeper, embedded purpose to that common phrase. Let’s dive into the weeds now.

    I naturally anticipate that under normal circumstances a retiree with a several million dollar portfolio need not Beat the Street; he might not even need to beat inflation; his goal might just be wealth preservation. However, for most retirees a fair return in excess of inflation must be the target.

    Before constructing a portfolio, a target return is estimated based largely on projected annual withdrawal rate demands and expected timeframe. There are other factors too. During the construction of that portfolio, an asset allocation determination is made to satisfy that target goal with minimum risk. In many instances, risk is defined in terms of portfolio volatility.

    The commonsense logic is that only risk sufficient to meet the required portfolio drawdown rate is acceptable. I’m a total investment amateur, but a highly seasoned one; I have never earned a dime giving financial advice. But that’s how I developed my portfolio over two decades ago; I propose that some professional advisors that participate on this fine site do the same.

    A guiding principle that controls much thought in cobbling together a portfolio is broad product diversification, including international components. None of this is novel stuff. I do not invent these concepts: I do deploy them. Essential elements that go into that portfolio assembly are mutual fund statistical data sets like average annual return, return standard deviations, and correlation coefficients.

    The forecasted portfolio returns must be high enough to satisfy the clients projected drawdown schedule. If a client needs a 4 % drawdown rate above inflation, short term government bonds will simply not do the job. Historically these short term government bonds only generate about a 0.7 % annual reward above inflation rates. Therefore, to satisfy this hypothetical customers needs, more additional product risk (likely equities) must be introduced into his portfolio.

    How much of each asset class is required to resolve the allocation issue? That depends on the expected reward profiles of each investment class candidate. What are those levels? An excellent zeroth order point of departure is the historical returns (pick your own timeframe) registered in the past. These data are precisely the Index returns that represent the marketplace overall and for various subcomponents of it.

    So equaling or beating the Indices (Beating the Street) is a crucial part of both constructing and assessing (measuring) the current status of a portfolio. That portfolio was assembled with certain forward looking expectations; expectations that were basically grounded in Index returns. That portfolio is in trouble if those expectations are not realized. So Beating the Street is a measure, a benchmark of the health of a retirement portfolio.

    If a portfolio continuously fails to achieve street-like rewards, most advisors will eliminate the faltering elements and select replacements. If the advisor uses Morningstar as a data source, it is highly likely that the advisor will never select a one-star fund. Denials aside, most advisors base their initial selections on recent performance in general, and specifically contrasted against an Index reference standard.

    How do financial advisors gauge their success? One reasonable answer is to compare performance against a carefully constructed benchmark. Typically, the benchmarks are composed of Indices which are themselves a proxy for the marketplace. So “Beating the Street” is really just an alternate way of saying that the portfolio is doing its intended job.

    Since portfolios are built using Index returns as a likely returns pattern, a failure to achieve those forecasted returns implies dire consequences for the portfolio’s survival likelihood unless changes are implemented.

    Language has developed to facilitate communications. It is mostly successful, but since it has been around for so long, alternate meanings and interpretations sometimes interrupt or interfere with its goal. Such might be the case here. Language can be a tricky business.

    For me, “Beating the Street” is about equivalent to “Beating the Indices”. As a retiree, “Beating the Indices” means that my portfolio is keeping its head above water insofar as my planned withdrawal schedule is being preserved. It is an embedded performance measurement tool, not an ego adventure; it functions like a calibration device.

    It’s interesting to note that even Wall Street bankers did not use this simple measurement concept as late as the early 1960s. In Peter Bernstein’s superb book “Capital Ideas”, he relates a story from Bill Sharpe. When Sharpe lunched with these bankers, he questioned them about their performance relative to some relevant benchmarks. No banker could answer his question. In that period, these professional financers did not measure their performance against any reasonable standard. We have come a long way since those times.

    One final clarifying point is needed.

    For the record, when I use the term “guy”, I mean it as a gender neutral term. That’s the way it is used in our household; that’s the way it is in many households. Sorry if it offends some of you guys, but it makes writing much easier for me. In all ways, I respect women for their financial acumen. They run their households efficiently, and they invest wisely. I often reference studies that conclude that female investors outperform their male counterparts. That’s accomplished by trading less frequently. Good for them.

    Once again, thanks for your readership, and thanks for your informed contributions. I enjoy discussing these matters with you all.

    Best Wishes.
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