QUESTION: Can you beat the S&P 500 and other top index funds?
ANSWER: It depends on the time frame. While it’s possible to outperform the S&P, research shows that the outperformance will be lumpy with some significant periods of underperformance. To understand why, here is a brief history lesson.
Decades ago Wall Street spread the idea that good investors were the ones that could beat the S&P 500 on regular basis. At the time, this was largely true because the S&P was easy to beat. Then the index fund was invented. Attracted by the reasonable returns at low cost, investors started buying them. As their popularity grew, more
investors bought, driving the price higher. The higher returns led more investors to buy in and sent the index even higher. Managers not wanting to drift too far off the index performance started mimicking the index. All of this behavior led to higher prices and better performance.
Low fees and better performance! So what’s the catch?
Notice nowhere in anyone’s decision was the actual value of the investment considered. As a result, the indexes
can go through long cycles of outperformance, but when the earnings slow, or there is a recession, the positive feedback loop described above reverses and investors start
selling, or at least buy less. During these periods, managers who have focused on the fundamentals of valuation can outperform.
So yes, given enough time, investor discipline and patience, you can outperform the benchmark during some periods.