Can anyone consistently beat the index?

“I am not happy with my broker and I am not good in math,” says reader H. T. “What are the secrets of investing gurus? Is it really possible to always beat the stock market?”

In “Why we invest poorly” (May 20, 2016), I cited psychology research on why it is extremely difficult for humans to always make the best decisions in the stock market. Like many people, I invest in stocks and other things, but ethics prevents me from recommending specific advisers.

You do not have to be a math genius, but study the basics, such as price-earnings ratios and research in detail the company’s performance. Getting rich is not easy and often due to luck rather than skill, so you cannot rely merely on professionals and blame them when expectations are not met.

Bill Miller, who manages Legg Mason’s fund in the United States, was dubbed by Money Magazine as the “Greatest Money Manager of the 1990s.” Miller beat the S&P 500 index not just five or 10 times, but for 15 consecutive years, from 1991 to 2005.

The chances that Miller (or one specific person) could do this are indeed small, and this is where math comes in. We are not very rational; our emotions lead us astray when it comes to focusing on alleged winning streaks. So how do mathematicians view the issue?

“There are thousands of managers and dozens of 15-year periods,” says HEC Paris professor Olivier Sibony in his book “You’re About to Make a Terrible Mistake!”

“Assuming that markets are completely efficient … what is the probability that we would observe [Miller’s] result at least one time, for one manager, over one 15-year period?”

The answer is astounding: 75 percent, says physicist Leonard Mlodinow in his book “The Drunkard’s Walk.” Math says that we should expect the existence of a Miller at any one time!

While the odds are minuscule that any one person (such as your broker) can consistently beat the index, the chances are big that there is someone on this planet doing it at any one time.

Miller knows this: “We’ve been lucky. Maybe it’s not 100-percent luck. Maybe 95-percent luck.”

He does due diligence and some mathematicians know more about derivatives and their ilk (Fischer Black and Myron Scholes won the Nobel for modeling options prices).

But ultimately, for most of us mortals, stock market investing is often nothing more than what Burton Malkiel entitled his book half a century ago: “A random walk down Wall Street.”

Manage your expectations. Even if you are not happy with your advisers, math predicts that they will have successes, too.

Tell them to examine these and learn from them, the same way French commandos debrief after successful sorties.

“If the mission succeeded merely because of good luck, there may be a lot to learn from it—perhaps more than from some failures,” says Sibony. “By the time they discover that their success was largely a function of good luck rather than superior talent or strategic advantage, it is often too late.”

Do not be too emotionally attached to your decisions. Immediately selling shares when the market plunges may not always be best, since holding on for the long run is often wise.

But the opposite is also true: Holding on when things clearly will not pick up is also foolhardy.

In 1983, General Motors (GM) created the Saturn division to compete against Japanese cars. Twenty years later, Saturn already wasted more than $15 billion with nothing much to show.

GM should have shut it down. But enamored of its initial decision, it added another $3 billion to prop it up. When the 2008 crisis hit, GM had to be bailed out by the US government and Saturn was finally shelved in 2010.

Follow my fellow columnists in the Inquirer Business section when they write about investing, set realistic expectations, talk openly with your financial advisers, diversify your portfolio, check out mutual funds, use common sense and reason, and you should do creditably.

* * * 

Queena N. Lee-Chua is with the board of directors of Ateneo’s Family Business Center. Get her print book “All in the Family Business” via Lazada, or the ebook version on Amazon, Google Play, Apple iBooks. Contact the author at [email protected].