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I Bet You're Probably Losing: Try Something That Actually Works

Jason is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I read two articles today, that were both stark reminders that most of us are really bad at investing. From Foolish contributor Morgan Housel:

Most investors underperform the market. When that's the case, how to become a great investor isn't what's important; becoming a less-bad investor should be the goal. The difference is subtle, but important.

The article goes on to list more detail about the common mistakes that investors, especially less experienced ones, make, including things like getting caught up in overconfidence, which leads to any number of mistakes in our efforts to "outsmart" the market. Add in this from the Guardian's Heidi Moore:

Plenty of hedge-fund managers just aren't that good at what they do: the vast majority, for all their fancy strategies, don't beat the S&P 500 index. Last year – in a booming market – hedge funds returned, on average, only 8% – compared to 16% for the S&P 500, according to research from Goldman Sachs. This year, through May, hedge funds returned 5% "compared with 15% gains for both the S&P 500 and the average large-cap core mutual fund," the Goldman report revealed.

And if the individual investor can't do it, and even most hedge funds can't either, why even bother? Because there are some really easy tools to get out of our own way. 

It's about acting smarter, not being smarter

Housel goes on to discuss how there is evidence that as we become more experienced, we usually do become better investors. The interesting piece isn't that we get better, but how we do it. The evidence is that much of the improved returns is a product of trading less often. And while we can speculate whether this is more a product of making better investment choices, or realizing that timing the market doesn't work, I think it's fair to say that it's probably a combination of both. Factor in capital lost in trading fees and taxes, and it's a perfect storm of underperformance. 

The simple fact is that just plain trading less often (especially the selling) seems to help when we are new to investing. We think we have to get involved; be active in our investing, when the facts show that it's just plain not true. Add in that most of us just don't have the time, patience, and/or skills as new investors to make the best decisions, and the best thing to do for many of us is to avoid individual stocks altogether, at least to start.

Okay, so if I'm not buying stocks, how can I beat the market?

Well, start by stopping that thought process. Beating the market with zero experience or limited knowledge and time is just plain small "f" foolish. As Housel talked about in the article linked above, we should really focus on not losing. And that starts with eliminating our mistakes with bad stock picks. Index funds are the perfect starter investing tool that still give us the exposure to stocks, and I have a couple that you should consider:

I've written about Rydex Equal Weight S&P ETF (NYSEMKT: RSP) before- it's a fund that I personally invest in. This fund tracks the S&P 500 index, but instead of weighting the companies by market share, it weights all 500 equally. Historically this has paid off, as the fund has outperformed the S&P by nearly double since inception in 2003, gaining over 150% versus just over 81% for the S&P. Add in dividends, and you pick up another 35% gain on the index. 

Two other options to consider are the SPDR S&P 500 ETF (NYSEMKT: SPY) and Vanguard S&P 500 ETF (NYSEMKT: VOO)The former is one of the oldest S&P index funds, founded in 1993, while the Vanguard fund has only been around since late 2010. However, it's my opinion that the RSP Fund will continue to outperform. 

And since the market is much more than just the 500 components that make up the S&P, another ETF to give a serious look to is the Vanguard Total Stock Market ETF (NYSEMKT: VTI), increasing your exposure to a larger swath of the market. VTI has also performed well since inception, outperforming the S&P index handily over the past 13 years.

Okay, so when do I buy?

Early and often, to paraphrase the old Chicago voting saw. Seriously, this brings us to the final point I want to stress- market timing is a losing game. The best tool the individual investor has is time, and since most of us aren't starting out with a lot of cash, using a method like dollar cost averaging has shown to be incredibly effective over time. For example, if someone began investing in the RSP fund near its inception in 2003, and religiously invested the same dollar amount every monday, and reinvested every dividend, they would have gained a total return of over 176.9% today.

As an interesting aside, if that same investor invested once per month instead, they would still be up almost exactly the same amount, 176.2% Simply put, adding shares on a consistent, regular basis, versus trying to "get in" at the best price, really pays off.

And compared to the SPY fund, RSP has gained about 15% more. And if 15% doesn't sound like much, if that investor was putting $100 per week into the fund (close to the yearly max for an IRA,) we're talking about $8,500. Extrapolate that over 30 or 40 years, and it could be another couple years of retirement paid for...

Foolish bottom line

Investing in stocks can be very rewarding. The vast majority of my retirement and investment funds are in stocks, with less than 10% of my portfolio invested in Index funds. With that said, I recommend these same funds -- and the concept of dollar cost averaging -- to my family and friends, especially those just starting out.  As Warren Buffett said (stealing from Mr. Housel again, Fools) diversity is protection against ignorance, and Index Funds have bucketsfull of diversity while still keeping new investors exposed to the market. So start off small and smart, and build your wealth using a less dangerous tool. And when you actually know what you're doing, you'll have a lot more money to invest in those stocks!

What do you think? Share with me in the comments below.

 

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Jason Hall has owns shares of RSP and SPY. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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