The following is a guest post from Graham Clark at Moneystepper.com
We invest in the stock market because we think it “pays well”. Investing in the stock market (assuming we can earn the market returns of the S&P 500 since 1970) can earn us 15.79%. Alternatively, holding money in cash returns approximately 5%.
Investing in the stock market is therefore the equivalent of working at a legal firm instead of McDonalds – the wages are better.
Hourly wage of investing
Let’s say you have $10,000 invested in the Vanguard S&P 500 (with an annual TER of 0.1%). Therefore, your average annual return, after costs, is equal to $1,569. How much work did this take? To set up your Vanguard account and buy the fund, and then to completely forget about it for the year, probably takes about one hour.
So, you are earning an hourly basic wage of $1,569 per hour. Not bad. Well done you!
Now, I’m going to give you the opportunity to earn another 60 cents per hour. Would you like to do that?
You probably wouldn’t. Moreover, you would probably report me to the authorities for exploiting my employees!! But, millions of people are doing this when they are trying to beat the market.
Can you beat the market?
Many people say it is impossible to beat the market and the figures generally support their argument – the majority of funds underperform the general market despite their managers picking stocks for a living.
Research by Brad Barber of UC Davis and Terrance Odean of UC Berkeley found that only about 1% of active traders outperformed the market. The more frequently people trade, the worse they do.
In 2012, the mid-year S&P Indices Versus Active Funds Scorecard (SPIVA) shows that, with few exceptions, index funds have dominated their actively managed counterparts. In the 2012 year, the S&P Composite 1500 beat 90% of all actively managed domestic stock funds in the UK. Over the earlier three and five years, those numbers were 73% and 68% respectively.
If the professionals cannot be the market, it is unlikely that you can beat the market.
What is beating the market by 5% worth?
Let’s imagine you can outperform the market by 5%.
Instead of returning 15.79%, this would mean that your returns would be 16.58%. This means that you would obtain additional returns on our investment of 0.79%.
If you invest $10,000, that 0.79% is equivalent to $79 per year.
Now, I’m not knocking earning an extra $79 each year. We should all try to do it. However, what I am concerned about is the work that we had to put in to earn that $79.
To beat the market by 5%, you are going to have extensive knowledge and perform continual research. Before your first investment, picking that first stock for investment took hundreds of hours. You will need to read text books, investing books, autobiographies and newspaper articles on investing and money for years before you even started to think about picking individual stocks to beat the market. You may even need to pay for professional qualifications to fully understand companies’ financial statements and other information.
Then, you will need to research around 10-15 companies (at least), selected through a stock-screener (which will take you about an hour alone), and then spent at least another hour analyzing each company.
For arguments sake, we can ignore all the original investment education and reading as a sunk cost. Let’s imagine that it was “fun”!!
Let’s also imagine that you’ve become so efficient in my research that you can earn 5% above the market by only researching 10 stocks each time you buy a stock, and only research each company for 30 minutes.
You’ll then need to spend 30 minutes each week analyzing your overall portfolio and the markets.
For a “diversified” portfolio of 20 stocks, this would take:
- Research before each buy: 10 * 0.5 hrs * 20 stocks = 100 hours
- 30 minutes research each week = 52 * 0.5 hrs = 26 hours
I think we will probably all agree that this is an underestimate of the hours you really need to spend if you are going to beat the market.
Therefore, each year, you will earn $79 / 126 hours => $0.63 per hour.
Yes, that’s right, beating the market for the average investor could be worth as little as 60 cents per hour!
Are you sure that this is still your goal??
Editor’s Questions: Would you work for $.63 per hour for a few percentage points more in investment gains? How much time per month do you spend monitoring your investments? What is your favorite tool for screening stocks?
This post is written by Graham Clark from moneystepper.com who writes regular posts covering every aspect of money, investing and saving; helping you increase your net wealth in the short, medium and long term. Check out his recent post on the ONE tip to financial success.
Prior Post: Why I’m Quitting My Job to be a Stay at Home Dad