Can YOU Beat the Market?
Published on December 07, 2004

But first

But first . . .

 

VEGAS

Derek Deer: “You missed a fine, fairly cheap, Las Vegas tourist draw.  I have been a fish fan for many years and the aquarium exhibit at Mandalay Bay compares favorably with Mystic, CT and Boston.”

 

Deborah Peifer: “Your tale reminded me of a friend’s story several years ago. She and another friend were driving from Chicago to LA and decided, since neither had ever been, to stop in Las Vegas. My friend returned very upset. She had discovered, she confessed to me in solemn tones, that she had a serious gambling problem. “What happened?” I asked, fearing that she had gambled away the car. “In the two hours I spent at a nickel slot machine, I lost two dollars and forty-five cents – snap, like it was nothing!”

 

Gray Chang: “Congratulations on your $1 win in Las Vegas! You did better than 95% of the visitors to Nevada. If you want to maximize your chances of winning there, take the entire amount you are willing to risk for your entire trip, and place it on a single even-money bet, and either double your money or lose it all on that single bet. Your chance of coming back a winner will be very good (49% for betting on Pass at craps, or 47% for betting on Red in roulette.)  For great advice about gambling, go to wizardofodds.com.”

 

F Even better advice: don’t.

 

And now . . .

 

WALL STREET

Name Withheld to Spare His Mother:  “After this election I am going to be very disappointed if my investment returns do not exceed the average investor's by a substantial margin.  The way I came to this thought is that my beloved mother (really) has turned into a right-wing hack (agh!) and has at the same time started making statements about her finances and investment ‘strategy’ that are so nonsensical it’s painful.  I'll bet that most Bush supporters would do better with an index fund.  (I am leaving out people who truly understand finance but are voting for Bush on religious principle.  I respect that because it is internally consistent.)  Now the real question is:  say you supported Kerry based on logic.  Should you dare to forego the index fund and invest on your own?  And how should you decide whether you have the smarts to do so?”

 

F Some very smart people voted for Bush, obviously – Karl Rove and Bill Gates come to mind – but you raise an interesting point.  Politics aside, if you tend to be more logical than the average Jane or Joe, can you beat the market?  And by enough, over the long run, to justify all the time it would take you to select stocks on your own and absorb all the extra taxes that even a relatively active investment strategy is likely to require?

 

The answer for some, obviously, is yes.  Don’t tell me Warren Buffett and Peter Lynch, to take two well known examples, are just lucky.  There is a lot to the “random walk” theory of the stock market, which holds that you can’t beat the market because all available information about a stock is all but instantly “discounted” in its price (and what do you know about Procter & Gamble or Krispy Kreme that the market doesn’t know?).  But like Burton Malkiel, author of A Random Walk Down Wall Street, I am a “random walker with a crutch.”  I.e., I believe it is largely true that you can’t outsmart the market, but not entirely.  Which brings us back to your question.

 

Yes, you are likely smarter than most people (you were too modest to put it this way).  But you’re not competing with the 98% who may not have your gifts, but, in the main, with the 2% who do – and especially with a small subset of that group who have a lot of information at their disposal and perhaps more time and training than you.  (And still they – too – tend not to be able to beat the market.)

 

Plus, the dumbness of the crowd, when it manifests itself, generally makes more for crazy overvaluations than for crazy undervaluations, so to take advantage of the stupidity (unfailingly evident with the benefit of hindsight), you have to short stocks (or at least buy puts), which as I have suggested previously is particularly hard to do successfully over the long run.

 

Indeed, this is one reason why the dumbness of the crowd, when it manifests itself, generally makes more for crazy overvaluations than for crazy undervaluations:  smart guys will rush to buy the undervaluations, limiting the extremity of their plunge; but the same smart guys will, correctly, think long and hard about shorting the overvaluations, because shorting overvalued stocks has special perils that buying undervalued stocks does not.

 

So . . . what I have long suggested is to do much of your stock market investing via index funds, but – for the fascination and tax benefits of it – carve out, say, $30,000 or $50,000 of a $250,000 stock market portfolio to invest on your own through a deep discount broker.  You will have winners or losers, but will be able to sell the losers to take up to $3,000 in tax-lowering losses each year (excess losses carry over to lower future years’ income); and use the winners (once held for a year and a day) to fund the charitable giving you would have done anyway (easiest: via the Fidelity or Schwab or Vanguard charitable gift fund).

 

THE ROYALTIES ROLL IN

Leslie Rosenbaum: “I ordered your book a couple of weeks ago from Amazon and just got an e-mail from them informing me that it shipped.”

 

F Buy three or more and you can select free shipping, too. Surely you have three friends or relatives who like money?  Three colleagues or employees looking to save $1,000 a year to stretch their paychecks?  What about the grocer who serves you all year long?  And the guy with three fingers in the butcher department? How about your kids’ teachers?  Shouldn’t you buy copies for them?  And that nice man who drills your teeth?  Dentists love investing.  Buy one for him.



© 1998, 1999, 2000, 2001, 2002, 2003, 2004 Andrew Tobias