Get used to mental discomfort if you want to beat the market

• By Scott Phillips, www.watoday.com.au
• View Original
• December 21st, 2017

Investing can be uncomfortable. Unless you're the sort of person who enjoys (financial) roller coasters, the seemingly endless jumps and dives can be stressful. And that's when they're actually happening. In between, owning shares can feel like watching a horror movie with that ominous music playing in the background … you know the fright is coming, you're just not sure when.

Which is why there's a booming market for those who promise you "certainty" or that you'll "make money in up and down markets". There's no such thing as either certainty or a cast-iron promise in finance, of course, but we're hardwired to want such things, so there's money to be made in selling them. I'm going to suggest to you a better way. One that is more, well, honest, but also one that has delivered for investors time and time again.

If you can't beat the market, just buy an index fund or ETF and go fishing.

There are three outcomes when you invest: you either beat the market, you match the market, or the market beats you.

As I've written before, there's no excuse for letting the market beat you in the long term – if you're not cut out to be a stock-picking investor, you can simply buy an exchange-traded fund (ETF), which offers you the market return (less a tiny clip in fees). So, over time, the worst any of us should be doing is matching the market's return. And that's precisely what many of us should do.

However, let's say you're the sort of person who wants to beat the market. You like the challenge, you have the time and the interest, and you reckon you can do it. Here's the uncomfortable truth: not only is the market a roller coaster ride, you need to – deliberately – add some more mental discomfort.

You see, if you do what everyone else does, you'll get what everyone else gets. That is, the market return. Which is perfectly fine, as I say. But let's say you want to beat it. The only way you can do that – by definition – is to take a different view. Make a different call. Zig when the market zags.

If everyone thinks Woolies is worth $25 a share, and you think it's worth $25 per share, you'll get the market's return. You have to believe Woolies is worth more than $25 a share – and be right – to beat the market, as those shares keep climbing past $25. As people say "sell", and tell you you're mad for holding.

Or take another example. Back in 2013, Cochlear shares traded for $80. Then, it announced a recall and a lost a contract in China. Some investors decided to sell, figuring the company was now worth materially less. Others believed it was just a short-term problem.

The shares subsequently hit $55, for a 30 per cent fall in less than six months. So who was right? Well, the shares now trade at $181 a piece. The "price" of that five-year, 125 per cent gain was holding your nerve for two years as the price fell then slowly recovered. Then you had to continue to back your judgment as they continued to rise from there.

That is, you had to endure both seeing your position cut by almost one-third, as well as the market at large telling you that you were obviously wrong.

Foolish takeaway

Investing to beat the market is hard, because of the combination of skills and mental toughness you need to stay strong when the times require it. If that feels too hard, buy an ETF and happily go fishing or shopping. But if you're going to try your hand at beating the market, get used to holding unpopular opinions – it's the only way to earn superior returns.

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