Why you don't need to "beat the market" to be rich

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humphreytalks, humphrey yang, personal finance, investing, budgeting, wealth, cryptocurrency, stocks

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00:00It seems like everyone wants to beat the market, and in fact, there are entire industries dedicated

00:04to the pursuit of above market returns. The S&P 500 averages an 8% to 10% return per year,

00:11yet that's not enough of a return for some people, and if you want to get rich fast,

00:15people say you have to make more than 10% every single year. Think about when you turn on the TV

00:20and you go to CNBC, you might have the Jim Cramers of the world selling you stock picks.

00:24Then you turn on the computer and you might see a Motley Fool type of publication trying to sell

00:29you a subscription service for their premium stock analysis. Then there's a subreddit community of

00:34WallStreetBets where people are posting their gains and losses, all in the attempt to try to beat the

00:39market and YOLO their way into higher net worth. And it seems like no matter where you look, you

00:43could find some confirmation for any stock idea that you have, and so many people are just obsessed

00:48with this notion of beating the market. In this video, I'm going to share with you psychological

00:52biases that are hardwired into every investor's brain, which not only explain why we keep trying

00:58to beat the market, but why we're actually destined to fail at it. I'm going to share with you some

01:03case studies on how professionals can't even beat the market, and we'll discuss why you don't need

01:07to try beating the market, and that's actually the better way to live. To begin, let's look at the

01:11SP IVA scorecard. This is essentially a report card that grades professional fund managers and is

01:17published by the S&P Global Company, which is the same company behind the S&P 500 itself. In this

01:22scorecard, they take thousands of actively managed mutual funds and compare the funds returns to the

01:27market index like the S&P 500, and they also track this over different time periods. If we look at

01:32this column chart, even in a relatively good period, like the first half of this year of 2025,

01:3754% of active funds still couldn't beat the S&P 500. That's actually kind of on the lower end as

01:43well. As you can see, most of the time, it is over 50% that funds will underperform the S&P 500.

01:48You have some outlier years here and there, like in 2007, when 45% of large cap funds underperformed the

01:54S&P 500, but still 45% is quite a lot. But that's not the glaring problem. If you actually scroll down

02:00in the report, which I will link down below in the description, you can actually look at the

02:04performance of all of these funds across different time periods. As the time horizon gets longer,

02:09you'll notice that after one year, three years, five years, even up to 20 years, the percentage of

02:14US funds underperforming their benchmarks gets worse and worse every time. For all large cap funds

02:19compared to the S&P 500, you'll notice that by the time the 10-year timeframe rolls around,

02:2485.98% of large cap funds underperformed the benchmark. By the 20-year mark, that is now 91%

02:31of funds underperforming their corresponding benchmark. So these are professionals too,

02:36with a lot of resources. Like think of your active fund manager who has access to a Bloomberg terminal,

02:41which costs $30,000 per year, or has access to advanced insights and just industry knowledge of

02:47what's going on in the market 24-7. So 9 out of 10 professional fund managers can't beat the index,

02:52and Warren Buffett was so confident in this reality that he made a public $1 million bet against some

02:57of the world's most elite hedge funds. He bet that they couldn't beat a simple index fund over a 10-year

03:02period. This bet ran from 2008 to 2017, with Buffett wagering that the S&P 500 would outperform a

03:09selection of hedge funds over those same 10 years. And you guessed it, the results weren't even close at all.

03:15According to the article, as of the end of the bet, quote,

03:18Buffett's S&P 500 index fund had compounded a 7.1% annual gain over that period of 10 years.

03:25The basket of funds selected by Protégé Partners, the managers with whom he had made the bet,

03:29had gained 2.1%. You can see that in this chart, the hedge funds underperformed the S&P 500 every

03:35single year, with the exception of 2008, where the hedge fund was just down a lot less than the S&P 500

03:40was for that year itself. What's also funny is that while hedge funds can be down in performance,

03:45the hedge fund itself can be doing well financially because it charges annual fees to its investors.

03:50Quote, in conceding defeat, Sades, the hedge fund manager who wagered the bet with Buffett,

03:55said the high investor fees charged by hedge funds was a critical factor. Hedge funds tend to be a good

04:01deal for the people who run the funds who pass on the big bills to their investors. So hedge funds tend

04:06to charge a 2 in 20 model, which means they charge a 2% management fee on your assets under management

04:11and a 20% fee on the profits every year. And just to illustrate how big of a fee a 2% fee is,

04:17we can look at this chart from Investopedia, which details the small differences of expense ratio fees.

04:22While these aren't exactly hedge fund fees per se, what you'll notice is that even seemingly

04:27small percentages will make a big difference at the end of the day when it comes to your returns

04:32over a long period of time. I hope that this drives home the point that yes,

04:36even professionals can't beat the market. So if that's the case where elite hedge funds can't

04:41beat a simple index, why do people keep trying? The answer isn't a rational one. It's actually

04:46psychological. There are powerful cognitive biases that make us believe we can be the exception,

04:51even when the data proves otherwise. The first of these cognitive biases is what's known as the

04:56disposition effect. This is where investors will consistently sell winning stocks too early

05:01and they will hold losing stocks for way too long. Studies have shown that winning stocks sold too

05:06early went on to outperform the market by 2.4% while the losing stocks held by these same investors

05:12kept underperforming by 1% or more. This disposition effect is basically a combination of regret avoidance

05:19and loss aversion. Both are psychological biases that play into our behavior around investment decisions.

05:26With regret avoidance, you don't want to regret not taking profits. So you might sell a stock in order

05:31to lock in the profit that you have already. When it comes to loss aversion, you may be unwilling to

05:35realize a stock that is losing. So you don't want those realized gains. So you hold onto that stock,

05:40hoping that it'll come back from being down, let's say 20% or maybe even 50%. And you hold onto it way

05:46longer than you should. Macro Synergy, a London-based macroeconomic research firm, also found that this

05:51effect is super amplified during market crashes. When markets are doing poorly, people become even more

05:57likely to panic and sell their winners while holding their losers for just way too long.

06:01So this chart right here illustrates how strong the disposition effect is when compared to the

06:05market's returns. You can see that when the market is in a bear market or a period where it crashes,

06:11the disposition effect is at its peak. Emotions then are just causing us to make exactly the wrong

06:17decisions at all the wrong times. The next case study shows how emotions can actually drive market

06:22behavior and lead to poor investment decisions, especially if you're a retail investor. Earlier

06:27this year, three researchers from Ireland and Australia studied the GameStop situation that

06:32unfolded back in 2021, and they actually made a discovery. They could actually predict the stock's

06:37price movements by analyzing the emotions and sentiment expressed in Reddit posts. This wasn't

06:43really about fundamentals, earnings, or business strategy. It was pure psychology driving a stock worth

06:49billions of dollars. According to them, there were three phases of emotions when it came to the

06:53GameStop saga. The first was the joy phase. When they analyzed the Reddit comments, they noticed that

06:58when the users expressed joy and excitement, GameStop's price tended to go up in the five-minute period

07:03afterwards. This would then cause the eventual run-up of GameStop stock all the way up to around the

07:08300s or even the low 400s during that time. But then when the stock hit its very peak, the emotion of fear

07:14started to set in, and once fear became the dominant emotion in these Reddit posts, prices would drop

07:20within the corresponding hour. After GameStop eventually crashed, investors would become more

07:24angry, and in the angry phase, the researchers noticed that investors started to double down and

07:29buy more, briefly causing the price of GameStop to increase by a little bit. Now, it's important to note

07:34here that this really only applied to GameStop stock. At some point, the stock itself started to trade away

07:40from company fundamentals. GameStop started to trade on just pure mania of the public, and I think it

07:45just shows you that modern retail investing amplified by social media can be very dangerous because it

07:50kind of creates this feedback loop where the emotions can actually drive the stock price. You might

07:55actually see this in certain stocks these days. Like right now, there's a lot of buzz about Palantir,

08:00quantum computing, nuclear energy, robotic stocks, certain meme stocks that trend on Twitter, etc. The problem

08:05is, while some people make tens of thousands or maybe even hundreds of thousands, for every one of those

08:11people that makes a lot of money, there are probably 99 losers in that bunch. The third psychological

08:16tendency that people have when it comes to buying and selling stocks on their own is that they are often

08:20too overconfident, or this is known as overconfidence bias. A study of 66,000 brokerage accounts found that

08:27the most active traders who are the most confident underperformed the market by 6.5% annually. This research

08:33paper was famous for its time because it examined the household's behavior over a five-year period,

08:38and it came to the conclusion that number one, the average household underperformed the market by 1.5%

08:43annually, and number two, that the average household turned over 75% of their portfolio each year, which

08:49was 25% more turnover than the overall market. And if you factor in fees and commissions, those were

08:55eventually killing all of their returns. People trade too much because they're overconfident in their

09:00stock picking abilities. And even if they can technically beat the market, they still have to

09:03beat the fees and the cost of actively trading. And that might be, that just might prove very

09:08difficult. So everything I just told you about, the failing fund managers, the psychological biases,

09:13and the emotions in trading, this is actually good news. It means that we can stop playing that game

09:19altogether and just stick to a strategy that actually works to build wealth. Look at this chart of

09:24the S&P 500 over the past century. Through the Great Depression, World War II, the dot-com crash, the 2008

09:30financial crisis, and COVID-19, every single catastrophe that you can imagine, the market has delivered

09:36consistent wealth to patient investors. The average annual return still sits at around 10% over the long

09:42term, and it's even more in the past five years. The truth is, is that the more simple your life can be,

09:46the better. When you stop trying to beat the market, you actually have more time to yourself because

09:51you're probably not watching Jim Cramer screaming about different buy or sell signals. You're not

09:56checking your portfolio every five minutes, and you know you're not being emotional with investing

10:00because you hopefully aren't even paying attention. Think about all the time and peace of mind that

10:04you're going to get back, and paradoxically, you'll also get better returns than 90% of people who are

10:09trying to outsmart or beat the market. So what does this actually look like practically? Of course,

10:14you can do what we have said on this channel, which is just to buy a low-cost index fund like VTI or VOO,

10:19and just set it and forget it. You could invest in something like a three-fund portfolio that's

10:24going to be a combination of a U.S. stock market index fund, an international stock market index

10:28fund, and a bond market fund. Or if you really feel like tweaking your financial optimizations

10:33and being in the weeds, perhaps instead, I would suggest focusing on where your money is going and

10:38optimizing where you're allocating your money in general. You could start putting some money into

10:42your Roth IRA or 401k. You could buy some alternative assets that could help you diversify your

10:47portfolio, for example, commodities or real estate. And if you really want to own individual stocks,

10:53I would just say limit it to a very few great companies and possibly within a retirement account

10:58if you can do that. The way I like to think about this is that essentially you're profiting off of

11:02other people's psychological mistakes. Every time somebody panic sells and every time a fund manager

11:07makes some sort of emotional decision, or every time someone tries to time the market,

11:12their loss is technically becoming your gain because you don't even play that game.

11:16The best investors are usually the most boring ones, and it is my opinion that your energy is

11:21just best spent on focusing how to grow your main source of income and increasing that.

11:25Because doing that will be the path to greater wealth rather than trying to buy options on certain

11:30stocks that are hot that week and trying to time the market. So let me know if you're susceptible to

11:34any of these biases. I personally think I'm susceptible to the first one, which is the disposition effect.

11:39If you enjoyed this video and you're interested in knowing whether or not you're doing well

11:42financially, you might want to check out my next video right here on the signs you're doing well

11:47financially, even if it doesn't feel like it. Again, this video was maybe a tough message or tough

11:52pill to swallow, but I think it would benefit majority of investors out there. So I will see you guys in

11:57that video or a future one on the channel. Let me know what you think. All right.

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