Individual investors should not spend a lot of effort in
- Picking individual securities and funds in an effort to outperform the market
- Timing the market in an effort to outperform the average market performance
Financial markets are very competitive. There are many smart, well-resourced players looking to find undervalued securities to buy and overvalued securities to sell. When people find an undervalued security, they buy it and that takes the price higher and when they find an overvalued security, they sell it taking the price lower. A lot of the players are very large institutions with a lot of resources and there are many of them. With lots of people competing furiously to find the mispriced securities, the result is that securities tend to be reasonably efficiently priced. As a result, it is very hard to beat the market. The historical evidence in the largest market with the most research on historical outcomes, which is the US market, shows that even most professional investors fail to beat the market after costs and fees. If large well resourced institutions with teams trying to outperform the market have a hard time being successful, it is reasonable to expect that individuals who have much less time, training and resources are likely to fall short.
The evidence shows this to be the case. Actively picking securities and funds is a very complex problem and competitive market dynamics have made the rewards to this activity low even for the most sophisticated institutions. Identifying who is going to beat the market is also a very complex exercise. Individuals should stay away from active security selection and finding managers who can do that to the large institutions, and use index funds instead. This simplifies the investment problem by an enormous factor and frees up time and cognitive resources to focus on the factors that can really improve the plan and outcomes.
There is evidence that retail investors underperform the market.
Independent investment research firm Dalbar Inc. publishes an annual Quantitative Analysisof Investor Behavior report, or QAIB.
It consistently shows that people are “more often than not their own worst enemies when it comes to investing, often succumbing to short-term strategies such as market timing or performance chasing.”
The bottomline: A simple strategy of investing in the S&P 500 Index would have yielded better results.
A SEBI initiated analysis of Profit and Loss of Individual Traders dealing in Equity F&O Segment done by the Department of Economic and Policy Analysis to analyze the trading by individual investors between FY 2019 and FY 2022 threw up sobering data as well. The study found that “89% of the individual traders (i.e. 9 out of 10 individual traders) in equity F&O segment incurred losses with an average loss of Rs. 1.1 lakh during FY22, whereas, 90% of the active traders incurred average losses of Rs. 1.25 lakh during the same period.”
The BSE Sensex is the benchmark index of the Bombay Stock Exchange and the oldest stock index in India. It is made up of 30 of the most actively traded and financially sound stocks and serves as a reflection of the economy. The composition is reviewed every 6 months
It has delivered 11.91% returns annually over the last 10 years while progressing from 19,427 in March 2013 to 57,702 in March 2023.
This is better than one would have earned on most forms of financial investments such as bank deposits, corporate deposits and bonds in the same period.
How does it help?
It can be done without thinking. All you need to do is either match the composition of the index in your stock picks or buy a fund that does the same.
Another way of looking at it is that a team of experts, who have access to more information than we as individuals will ever have, are taking decisions on the composition of the index. Why don’t we put their combined knowledge and skill to work for our own investments? Especially if our ability to bear risk is limited.
Between the Bombay Stock Exchange and the National Stock Exchange, a variety of indices are tracked, with different areas of focus. A variation of the strategy could be to choose one of the other indices and not the primary BSE Sensex.
Of course, it does not mean that the future performance is guaranteed.
