How To Beat Hedge Funds and Wall Street Pros

What’s Wrong

Most of the investing world is bent on trying to maximize returns from the stock market. This is great and all, but what if the thing we wanted to accomplish required us not to do anything?

The vast majority of people confuse action with effectiveness. Sometimes it takes non-action to get the results we want. Many of us humans can’t help but to mess around with things.

Why do people do this? There’s a lot of reasons, all of them stemming from basic human psychology. The biggest reason is arrogance, or the Dunning Kreuger Effect.

Our confidence is extremely high when we just start in any endeavor, while it crashes quickly during the early learning stage. The thing is, this can be a crucial couple years in the start of anyone’s investing journey. (link to compounding)

If you ask 100 people if they are better than the average driver, almost all of them will say yes. We humans tend to think we are special, but we are not. How can every individual beat every other individual? It cannot happen.

The thing is, finding out that we underperformed in investing after doing it for 30 years is a final mistake. You don’t get another 30 years to try again.

What keeps us on “Mount Stupid”

I call these talking heads: the Jim Cramers, Cathie Woods, and Ray Dalios of the investing industry. (Yes, I’m naming names). When these knuckleheads speak, there is no learning. You will find no underlying process, only marketing.

You can’t blame them though, they are only following their incentives:

Pay attention to incentives and you’ll stay off of Mount Stupid.

Action vs Non-Action

Guess who outperformed the market in these two pictures:

Repeat after me: action does not correlate to success. Investing might be the only discipline I can think of where hustle does not equate to success. The lowest IQ person on the planet can buy stocks without ever looking at a chart or a report, then outperform most hedge funds.

Bull Markets, Inflation, and Geniuses Everywhere

A bull market is when the overall market trends upward. It’s easy to gain confidence in what we’re doing when we pick stocks, they go up, and we attribute it to our skill and not the overall rising market.

This is like running a garden hose into the ocean while the tide is coming in, then claiming we are responsible for the extra water. Silly, right?

The real pain comes when the inevitable bull market ends, the tide goes out, and our system doesn’t work anymore. Our confidence crushed, we enter the valley of despair.

A most costly mistake. This is time we don’t get back.

“Just buy whatever is going to go up”

20 years ago, back in 2002, IBM was the safe bet.

“The revival of I.B.M. over the last nine years is most tellingly measured not in numbers but by its return to pre-eminence as the industry leader. Once again, I.B.M. is the model others follow.” NYT, 2002.

In the below graph there’s 3 businesses and the S&P500 (Ticker: SPY).

Can you guess which is IBM?

It’s the yellow! A 130% return over 20 years (4.25% CAGR). Sad!

Just above that we have the S&P500 at 481% (9.19% CAGR). That’s really good!

Now purple and blue, here’s the real test. One of these you use almost every day.

Purple is Amazon, one of the best performing stocks of all time, and waaaaay above that is Monster Beverage at a whopping 92,000% return (40.6% CAGR). That’s a ridiculous amount of growth.

Here’s the point:
Nobody knows what stocks are going to perform extremely well in the future. Hedge funds and pros are clamoring about “safe bets” but the fact is they can’t outperform the market to save their lives.

Out of the thousands of stocks to choose from, roughly 7% generate almost all the returns in the market. And the road is extremely bumpy. From ’95 to 2015 Monster Beverage was below 30% or more below previous two-year highs 44% of the time. (That’s like riding a bucking bronco stock for 20 years. Don’t get bucked off if you want those returns!)
So much must line up:

Picking the right stock
Portfolio management
Riding the storm

Or you could buy an index ETF and focus on other things.
I like the Vanguard ETFs VOO (the S&P 500), and VTI (the United States total stock market). It captures the good, the bad, and the next Amazons and Monster Beverages.
“But it indexing averages only 8-12% returns!”
Yeah, and that is GREAT.
There’s two different thoughts going on here:

Index returns are bad
The Index routinely outperforms majority of hedge funds, professionals, and retail investors across the board.
When we zoom out, look at history and the mix of humans with markets, we find that it’s the humans that are responsible for most blunders in the stock market. (Yet another reason to index and take the human element out of it).

If You Must Invest

The best thing about investing is the fact that anyone, anywhere, can invest in any public company. Even kids are starting to invest! (A net positive).
The worst thing is the grifters. People will tell you “We expect a 50% annual return going forward” and then make money off of fees while their investors lose everything.
If you must invest you must weigh your incoming information wisely. The thing is, not everybody can spend all day every day weighing information. In my opinion, that’s what the real professionals do. It’s not the letters after their names, or the schools they went to, but their ability to weigh information independently and free from skewed incentives.
My incentives are to provide the best research for real people, like you and me, so we can create financial freedom.