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Investing: Can you really beat the market?

Prices are influenced by both an &ldquo;investment value&rdquo; and a &ldquo;speculative element.&rdquo;<em></em>

Given how erratically stocks have performed over the past couple of years, it’s “tempting” to think you could achieve more predictable returns by picking stocks yourself, said Jason Zweig in The Wall Street Journal. Consider the odd performance of Bank of America’s stock. Between October 2007 and March 2009, it fell 94 percent, then finished 2009 up 380 percent. So much for “efficient markets.” Truth is, the market very often does behave irrationally, but that doesn’t mean you can beat it, even if you know better. That’s because prices are influenced by both an “investment value” and a “speculative element.” But to really tell where a price is about to go, you would need to be able to predict “the changing emotions of tens of millions of people.”

“If sophisticated money managers using the most advanced techniques” can’t beat the market, odds are you can’t either, said Mark Hulbert in The New York Times. Sure, there are countless investment advisory newsletters that promise to help you get an edge by telling you when to trade in and out of stock funds. But over the long run these model portfolios “generally fail.” Only 11 out of 200 such portfolios made money during the recent bear market, and even then their average annual five-year return of 1 percent was “statistically indistinguishable” from the average actively managed U.S. stock fund. A word to the wise: “Performance during a bear market has little to do with long-term returns.”

All this seems to suggest that you’re better off parking your assets in index funds, said Pat Regnier in Money. Yet “twice in less than a decade,” investors who took that passive approach have been burned by “bursting asset bubbles,” and they ended up facing steep losses. Because index funds base their weightings on market capitalization, they often overexpose investors to the “bubbliest” stocks. One way around this “design flaw” is to hold fewer equities when prices seem high and to buy a “little extra” when they seem cheap. You might also take a look at the alternative indexes developed by money manager Rob Arnott; his weightings are based on company valuations, rather than on market cap. Had it “actually existed” back in 1999, Arnott’s FTSE RAFI 1000 Index would have outperformed the S&P 500 by five percentage points over the past 10 years.

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