How to Outperform Professional Investors Effortlessly

You can outperform most professional investors with zero effort.

Yes, it is guaranteed. We will first understand the why part of it and then the how part of it.

The WHY Part

Mathematics of the market: you and me

Let’s imagine a simplistic scenario. There is only one stock listed in the stock market. Only one stock of only one company. And there are only two investors in the market—you and me.

On a given day—any day, but let’s say 1st January 2022—the price of the stock is Rs. 100. You and I trade in that stock. When I sell, you buy; when I buy, you sell.

On another given day—any day, but let’s say 31st December 2022—the price of the stock is Rs. 115.

What’s the total amount of money you and I made? The answer is Rs. 15. If you earned Rs. 4, I earned Rs. 11. If you earned Rs. 20, I lost Rs. 5. If you earned nothing, I earned Rs. 15. Plain arithmetic.

But wait. We also paid the brokerages, taxes and advisory fees. Let’s assume these amounts totaled to Rs. 3. Now how much you and I earned in total? The answer is Rs. 12. If you earned Rs. 4, I earned Rs. 8. If you earned Rs. 15, I lost Rs. 3. If you earned nothing, I earned Rs. 12.

Two things are obvious. Firstly, you and I put-together must have earned less than the total gain in the market value of the stock. Secondly, you and I are in direct competition. If you are smarter or luckier or a cheat (that is, you have ‘insider information’), you earn more; and that would automatically mean that I would earn less. And vice-versa.

Mathematics of the market: you, me and everybody

Now let’s go to the real stock market. We have around 5000 listed companies, hundreds of billions of shares and tens of millions of investors. 

But the arithmetic is the same. The two obvious facts still persist. All investors are in direct competition and, in total, they must earn less than the amount by which the price of all the stocks have increased (or reduced) in any given duration of time.

If the total value of all the listed shares in India as on 1st January 2022 is 20,00,00,00,00,00,000 and as on 31st December 2022 is 23,00,00,00,00,00,000, then all the investors put-together earned 3,00,00,00,00,00,000 in the year 2022. Let me spare myself from writing so many zeros—call that 15%.

All investors put-together earned 15%. But they also paid brokerages, taxes and advisory fees, which totals to around 3%. So, net-net, they earned around 12% or Rs. 2,40,00,00……..

Just like in the case of you and me alone, all the investors competed against each other—although in the very large system they never realised that.

Just like in the case of you and me, the ones who were smarter, luckier or insiders, made more than 12%. Those who were not in that group made less than 12%.

Obviously, since the average is 12%, those who made more than 15% were quite few. They have to be extremely few. Anyone who achieved 15% must be better than ~85th percentile. I'm talking about professional investors here. You'd easily be in 98th percentile of retail investors.

But what if the data shows that most of them made more than 15%? In that case, the data is wrong, because the arithmetic cannot be wrong.

But why doesn’t everyone know that they are underperforming the market?

Have you ever computed your rate of return and compared it with gains of Nifty or Sensex? Nobody seeks; so nobody finds.

Does that apply to mutual funds as well?

Of course. What applies to you and me, also applies to mutual funds. Mathematics is impartial, you see. It is also very difficult for MFs to beat the market-returns—15% in our hypothetical case.

MFs have teams of smart people working full-time for them. That results in advantages and disadvantages if I choose to invest through MFs.

Advantage: the team is well equipped to find best businesses that have high chances of succeeding in the future.

Disadvantages: Firstly, I will have to bear the salaries of those smart people and their office rentals and their coffee machines because they are working for me—they call it ‘expense ratio’. Secondly, all mutual funds have such teams, and those teams are competing against each-other as we have seen in the simplistic example of you and me. Smart and resourceful people are canceling out each other’s efforts and I’m paying fees to them—I’m the one who loses.

Net net, I would consider myself lucky if the advantages are merely cancelled out by the disadvantages in my MF. In other words, the majority of mutual funds will not be able to beat the market-returns—15% in our hypothetical case. And that is because of arithmetic, so nobody can fix it, no matter how smart.

I will repeat this: But what if the data shows that most of the mutual funds outperformed the market? In that case, the data is wrong or selective, because the arithmetic cannot be wrong. Click here if you want to understand that in detail and with some data.

Of course, a few MFs would actually beat the market-returns in some years. But not every year. On the other hand, those who would do that over a period of more than 10-20 years would be extremely few, if any.

Even if a rare MF beats the market consistently over decades, how would I know today which one that will be 20 years down the line? They themselves declare that past performance is not an indicator of future performance (SEBI mandates them to declare this truth to the investors).

So, I can only know which MF outperformed the market in the past. I can never know which of the rare MFs will beat the market-returns in the long-term future.

That was the why part—why (almost) everyone underperforms the market-returns. Now we understand the how part—How you can take home (almost) all of the market-returns.

The HOW Part

The power of passive investing

Knowing that (almost) everyone underperforms the market-returns, if you had a chance to earn the market returns—15% in our hypothetical case—without any effort, shouldn’t you grab that chance with both hands?

The instrument that allows you to do that is called ‘index funds’—our unsung heroes.

Index funds are mutual funds that don’t buy selected stocks in their portfolio. Rather, they buy all the companies in the market (or in a given index such as Nifty 50, Nifty 100, BSE 30, Nifty 500, etc.). By buying Index Funds, we buy a piece of the whole market. Of course, you earn the market-returns.

When we invest in Index Funds, we  eliminate (almost all) brokerages, taxes and advisory fees. In our hypothetical scenario, where the market-return is 15% and everyone else is competing for 12%, we have an option to walk away with something like 14.8% while enjoying Sunday afternoon siesta.

By being exactly average, we can easily end-up somewhere around 85th percentile. Sounds weird, right? Thanks to arithmetic holding the others back. It’s a day-time robbery.

Do index funds have any disadvantages?

Yes, quite a few. You can’t brag about your stock-picking genius at the dinner parties impressing everyone. Your illusions of earning supernatural returns will be shattered. And you won’t get any thrill of stock-picking.

Index funds are only for solid long-term wealth creation. So boring.

Why doesn’t anyone tell you about the superiority of index funds?

Doctors earn money if you fall ill. Lawyers earn money if you get into conflicts. Fund managers, brokers and Zee Business earn money if you actively invest in the market.

It is in the money-management industry’s benefit to promise you supernatural returns. But, you are hoping against mathematics there. Sorry.

Which Index Funds to buy?

Choose anyone that satisfies the following (I'm taking about Indian market here):

1. Low fees: expense ratio should be low. Less than 0.1% is good.

2. Covers broader market: A fund with 100 largest companies is better than a fund covering 30 largest companies. 500 companies is great.

3. Has a sizable chunk of assets under management: above Rs. 2000 crore is fine in my opinion

4. Being managed by a reliable fund managing company (for example ICICI Prudential AMC, HDFC AMC, SBI, UTI, Axis, Aditya Birla, etc.).

5. Low tracking error: The fund should be tracking the market as closely as possible.

Write in the comments if you need more inputs.

Since the Index Funds are less popular in India presently, options with broader market funds (those covering top 500 companies for example) are limited. But they are coming up, and in the next few years we might have many options. Index investing has become quite common-place in the USA in the last few decades and that’s bound to happen in India as well.

For now, I like Axis Nifty 100 index fund covering 100 largest companies, and ICICI Pru’s Nifty Index Fund & UTI Nifty Index fund—both covering 50 largest companies. When a good option covering 500 companies become available, consider shifting to that.

Good day! Thanks for reading.

If you liked, do mention in the comments. It means a lot.

If you’d like to read more on indexing, here is a longer piece I wrote in 2019. The data is old but the concept is evergreen. If you need more convincing, I recommend The Little Book of Common Sense Investing by John C. Boggle—I’m sure you’ll never be able to unsee the truth.