If 95% of the people whose job it is to beat the market fail, what chance do the rest of us have?

This is according to SPIVA (S&P Indices Vs. Active) who keeps a scorecard of the performance of professionally managed funds vs. the S&P 500. According to its 2019 year-end report, over the past 15 years, 95% of professional funds have failed to beat the S&P 500.

With all their analysts and economists on staff along with their fancy computer algorithms, why is it that no professional investor can ever beat the market?

It’s because nobody can predict the future. And you would have to be able to predict the future to beat the market.

When you’re dealing with efficient markets everyone is presumably going to have all the information available on a company at the same time so it’s hard to gain an information advantage over the rest of the market – unless you have insider information. And that’s illegal.

Trying to predict when a stock is going to peak or bottom out is a fool’s errand. 

You never know when disaster is going to strike or when a fortuitous event is going to happen, so what investors do is they’ll buy stock in a couple of sectors, maybe mix in an international company, throw in some tech stock for good measure. Without realizing it, they’re hedging their bets, which is exactly the purpose of an S&P index fund.

Why waste that time and energy doing exactly what an index fund was designed to do?

The most common rebuttal I get when I tell investors they can’t beat the market is well, Warren Buffett beats the market.

My response is, well, Warren Buffett plays by different rules and he’s playing with a lot more money than anybody else is playing with.

Warren Buffett is an activist investor. He purchases large numbers of shares (usually preferred shares with preferential distributions and voting) to obtain seats on the company’s board to influence the direction of the company. It’s not your typical investing so it’s not a fair comparison.

What Warren Buffet does is more comparable to an investor that buys companies and turns them around, so it’s not an apples to apples comparison.

From the title, you might be concluding that I’m advocating for index funds. The truth is I’m not a cheerleader for index funds because I’m not satisfied with average returns and when you invest in index funds, average is exactly what you’ll get.

My point is that if professional investors can’t beat the market, why bother with the stock market at all?

This is why ultra-wealthy investors avoid Wall Street and allocate more than half of their investable assets in cash flowing alternative investments found in the private markets. It’s because these assets beat the market – with less volatility.

Main Street investors stick with Wall Street because they either don’t have access or have heard that they’re high risk. Private investments often get tagged with the “high risk” label because all private investments get lumped together.

High risk alternatives such as hedge funds and venture capital get lumped with lower risk, less market-correlated assets like private equity/debt and commercial real estate.

The ultra-wealthy know better. They know the distinctions between all the different alternative assets. They also know how to reduce risk by using various mitigating strategies to generate above-market returns at less risk.

The principal mitigating strategy the ultra-wealth use is to allocate large portions of their assets towards income-producing assets. Income-producing investments backed by hard assets have intrinsic value.

Intrinsic value is productive value. These assets produce products or services that generate income. They don’t just sit there like stocks waiting to be bought and sold. They’re more valuable than that and that’s why the wealthy covet these assets. They pay back their investors now and because they become more valuable over time from revenue they generate, they will pay back their investors in the future as well from appreciation.

The ultra-wealthy protect their cash flowing golden geese with multi-level diversification.

The problem with public equities is while diversification is achieved through acquiring multiple stocks across multiple industries to minimize risk in good times, no amount of diversification will save your portfolio in a market crash.

While diversification on Wall Street typically comes at the cost of returns as risk is reduced, diversification in the world of income-producing alternatives doesn’t necessarily mean sacrificing returns. It is possible to beat the market and do it with less risk.

The wealthy gravitate to income-producing alternatives because these assets lend themselves to diversification across a variety of factors including:​

All of these factors serve to preserve one thing – income – essential for growing and maintaining wealth even in downturns.

The one gripe I hear about private investments is illiquidity. I consider illiquidity a benefit.

Wouldn’t you give up liquidity to achieve:​

Why mess with the stock market? If you seek above-market returns, you won’t find it on Wall Street. 

The wealthy avoid Wall Street because they’re not satisfied with average returns and they know that it is very difficult to beat the market. Professionals can’t do it so why try?

That’s why they look to alternative assets in the private markets.

It’s in these markets that they can find and invest in passive income-producing tangible assets like commercial real estate.