Can you beat the market? Four ways to improve your chances and one Way to Reduce your Investment Risk by 60%*

Can you beat the market? Is it even possible? On today’s morning commute you may have used an escalator. Did you stand patiently on the right or walk up on the left in a hurry? It can be infuriating standing on the right holding on tight looking for the right opportunity to join the other faster walkers coming up on the left-hand side of the escalator. It was proven by London Underground that it would be more efficient for everyone to stand 2 a side on the escalator. Like the markets we have a choice of passively tracking the ups and down or actively take an interest. This change to the escalators was never a success as too many people continued to walk up on the left even after being shown evidence that staying still would be more efficient, we humans don’t work like this.

We humans are not rational actors we are in fact emotional creatures. We all want to out do each other. Every day we are jostling with each other for position or status. We want to walk up on the left. It feels good to overtake people, we feel like we are getting somewhere. The efficient market hypothesis states that all information in markets are reflected in current prices. The theory goes the price of a company is always correct so there is no point timing the market. The market may be efficient, but we are not. We are humans and we are inefficient. The more we try to buy and sell to beat the market the more we pay in taxes, broker fees and the difference between the buy and sell price (the bid/offer spread).

No one can truly manage the markets. Adam Smith (the guy on your ￡20 note) is known as the grandfather of economics and his capitalist system is what our modern-day capitalism system was build from. In his book the Wealth of Nations written in 1750. His three main points were: 1) demand and supply, 2) specialization and 3) the invisible hand that guides the markets. We will be discussed all three ideas in this article.

Supply and demand

Markets are infinite. Markets were here before the Wealth of Nations book (which was written in the same time as the French revolution and the Independence of the United States of America). The market will be here after we have all died many years from today. You are not battling the market you are battling yourself and that’s the hard part. There is no perfect information as not one can know everything at anyone time. We don’t know what we don’t know and that’s often the danger. We can’t manage the markets but most importantly we can manage ourselves. We are finite. Over time the market will always win in the end. The good news is that to beat the markets we don’t need to be intelligent, work hard or be that knowledgeable. We just must do a few fairly simple things in the right order to be effective in investing. Effective investing can be learnt by following habits and even better can be automated by creating a system (or follow my simple 5 step Money Mindset Method eLearning course available now to pre-order). The market is efficient as there will always be a battle between demand and supply. Don’t do battle with the market, use the market as a tool. The market is like a piece of machinery that you can use to get what you want out of life. Investing can seem scary especially as you seem to spend money and then get nothing physically back except a few numbers on a screen. You don’t even get a share certificate these days arriving on your door mat like you have won something exciting. Maybe not the numbers from a lottery ticket but maybe something else just as exciting.

Efficiency is doing a task in the most economical way possible (whether important or not). Effectiveness is doing the things that get you closer to your goals. Why you are investing is much more important than how you're investing. Investing that gets you closer to your goals is much more important than getting a good return and then spending the lot on unimportant items. Investment returns is still important but not as important as getting the result of getting your goals in life. You could have enough money to fund your life after you stop working and then lose it all by taking more risk in the markets than you actually need to.

Specialization

Investing is no different from any other game. Winning is much more fun than losing. Luck and skill both play their part. Having specialised knowledge is a way to increase your luck when investing. Firstly education will increase your luck. For example reading a book or watching an online course about investments and educating yourself is much luckier than not reading a book about investment or at least setting personal goals each year. Secondly know the rules of the game. Luck is when preparation meets opportunity and you can help lady luck move in your favor by understanding the rules of the game. Think of the game Monopoly there are a few simple actions you can take to improve your chances to win like buying up the properties when you land on them rather than waiting until you have to pay rent to someone else after they have bought it. Investing is often not a science or an art but a practice. Like any life skill you only learn how it works when you experience the joy and the pain that investing can bring. Investing like any other game has rules and ways to win quicker putting money into a tax efficient wrapper like using your ￡20k ISA allowance or ￡40k annual pension allowance means your money will grow tax free and therefore faster than if it was outside the tax shelter. Thirdly knowing that switching from just investing in one company to investing in a fund of 50 or more companies (which can be done cheaply today) reduces by the risk you are taking by 60% due to reducing company risk*. Finally having a knowledge of asset allocation is the most powerful way to increase your luck. You can invest for your individual personal aims and objectives. Different assets behave differently and you can invest different allocations of your money depending on what you want out of life. (I explain this in more detail in my latest book and can forward you a copy if you request) These four factors help move you in the direction of travel that you would like and ultimately make you happier.

Adam Smith's Invisible hand

Doing the right things at the right time for you is like an invisible hand guiding you to your ideal future. Making little choices every day may that seem insignificant at the time add up over a lifetime. Every moment you have an active choice in the direction of your life is a bit like a voting machine that calculates your future life but counting up all the good decisions and bad decisions you have made during your life. The outcome will be your future self. Standing on the sidelines of the escalator may seem like the safe thing to do however you not only miss the opportunity cost of investing you also miss out on learning a life skill. Previous generation didn’t need to understand investing as your company pension would look after you after you stopped working or you would at least get a decent return on interest from the bank. Today we have to manage ourselves and need to understand the seemingly complex world of investing.

You can’t predict the future. It’s too unpredictable and complex. Learn what you can control not what you can’t control. Thrive no matter what happens in the economy. The only way things are going to change is when you change by making small choices every day between discipline and regret. Take that first step up the escalator of the market by educating yourself on how to invest effectively

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·        *This is called standard deviation and mathematicians much smarter than me have calculated that by investing in a portfolio with more than 35 companies in then due to counterparty risk being reduced your risk to reward also reduced. The best explaination is in the book ‘A Random Walk Down Wall Street’.