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Why Investors Will Almost Never Make It Big


To make the most money, do nothing.

There's considerable debate in academic circles about whether stock market investing is a "random walk," as described in Burton Malkiel's classic, A Random Walk Down Wall Street.

A similar debate rages on regarding whether and to what extent the stock market is "efficient," as claimed by exponents of the efficient markets hypothesis (EMH).

The upshot of both of these hypotheses is that it's virtually impossible over time to obtain returns that are significantly in excess of the total returns of the major stock market indices.

Whether or not you believe these hypotheses are correct, it's very important that investors understand that the outcome they predict is virtually inevitable, for it's an indisputable fact that the vast majority of stock market investors won't generate excess returns. By definition, the vast majority of investors will earn normal or average returns.

Thus, by definition, the vast majority of stock market investors are destined to earn mediocre returns. The only real debate is whether the results of the tiny minority at both ends of the statistical distribution are the product of skill (and/or anti-skill) or mere luck.

I won't resolve this debate in this article. However, I will offer a few key insights that I believe are absolutely critical to understand if you aspire to obtain better-than-average returns in your investing. I share this information with full consciousness that, almost by definition, such advice will be highly unlikely to make a difference to anybody.

Market Timing

Statistical tests, and plain common sense, show that excess index returns are generated in fairly short periods that represent less than 15% of all trading days. The key to successful market timing is to correctly foresee and be on the right side of the market during some of these periods.

Unless you're supernatural, you won't be able to foresee all of these periods in which there are major directional moves. The human creative process is such that you won't always have value-added ideas -- ideas that aren't already fully discounted in market prices. Most of the time, your ideas will already be accounted for in market prices. And many times you won't be able to correctly anticipate issues or trends that can generate excess returns.

To summarize: First, the market provides opportunities less than 15% of the time. Second, even if you're an unusually gifted investor, you'll only occasionally be capable of identifying such rare opportunities.

The key insight is this: If you want to be a successful market timer, you'll need to have the wisdom and discipline to be completely out of the market (long or short), more than 90% of the time.
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No positions in stocks mentioned.
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