Beating the odds
A few weeks ago I came across an article written by Wesley Gray. He holds both an MBA and a PhD in finance and I was very curious as to what he had to say.
The article titled "Mission Impossible: Beating the Market Forever" caught my eye and took my mind on an adventure while reading.
To put it simply, beating the market means ……earning a greater return than an index.
"The remarkable fact is that nobody can beat the market forever - not even Warren Buffett."
Now this is such an interesting concept because if no financial manager can consistently beat the market forever then why are their so many financial managers? And why is it my goal to become one?
Well forever is a long time. A very long time. So although it's impossible to beat the market forever, it is very possible to beat the market over the long term and many fund managers have proved their skills showing they can in fact outperform the market. However, a successful financial manager who is able to beat the market has to do so at another managers' expense. I'll explain this a little more below.
To understand this theory, you must first understand the power of compound interest. Interest on top of interest. This is such a powerful concept.
For example, let's say you invest $1,000 at an interest rate of 5% per year. After the first year, you would earn $50 in interest, for a total of $1,050. In the second year, you would earn 5% on $1,050, which is $52.50, for a total of $1,102.50. In the third year, you would earn 5% on $1,102.50, which is $55.13, for a total of $1,157.63. And so on.
As this pattern continues and you invest more money you slowly gain a greater percentage of the market. Now I'll save you the complicated math, but basically if this same pattern continues forever, you will keep gaining a greater percentage of the market until eventually you will just own the entire market and at that point you become the market therefore, you can no longer outperform it. This is also where we can see how one managers success must be at the expense of another. This is because if one financial manager continuously outperforms and owns a greater amount of the market, someone else's market share must be declining.
So as interesting as an article as this is, it is unrealistic for a financial manager to own the entire market. However, as fund managers grow, they start to own a greater share of the market and as we just saw it becomes increasingly difficult to outperform the market as you own a greater share of it.
So contrary to what many investors may think, as fund size grows, performance actually suffers. Another reason that performance tends to suffer as companies grow is due to the level of bureaucracy. It is more likely that funds will be managed by a larger team "resulting in more expensive and less-timely decisions." (Chen et al., 2005). Overall, smaller managed funds perform better than larger team-managed funds.
Here at Doyenne, we are able to curate models that act like your own fund, by taking into account your risk tolerance we can make a model that fits all your needs.