Don’t Try to Beat the Stock Market (and Why You Won’t Need To)

studying the stock market

It’s really easy to look at the stock market and think you might get lost in the matrix. To the untrained eye, it can look like a sea of numbers and values and ever-changing data that only the most learned experts can understand. So, naturally, those experts know something that most people don’t know, right? Naturally, they must know a way to beat the market and earn returns that spell financial independence. Right?

Wrong.

When people try to beat the market, what they’re really trying to do is exploit a mistake that they know about that the rest of the market doesn’t. And based on the way the stock market works, it’s not possible to continuously exploit the same error and continue to keep it a secret from the rest of the market. Most people think that the mistake they’ve discovered is mispricing. Luck provides confirmation to half of those people. But as people press their luck, the stakes get higher and the number of those who remain lucky and continue to win fail.

Think about it this way, if you’re playing the card game “BS” with a group of people, you’ll be able to deduce what cards people are likely holding by considering what’s left in the deck as more and more cards are being put down. Once you do that, you might feel like you have a competitive edge. But guess what, everyone else in the game can do the exact same thing. Everyone has access to the same information and therefore everyone has the same competitive edge, therefore there is no competitive edge.

The same goes with the stock market. We can all see the same information and we can all make predictions based on the information we see. Of course, that doesn’t mean all of us acquire that same information or put the same amount of work into making those predictions, but the information is still available to all of us. The only people who have more information are the insiders for the individual companies – and they’re not allowed to make trades based on that information. So there you have it.

Every investor has access to the same information because that information is public knowledge. That knowledge has already been accounted for in the market and determines the price of the stock. Thus, it wouldn’t be accurate to assume that you know something more than the knowledge that has already determined the pricing of the stock.

In order to profit from new information, you would need to act on it before it becomes available to the public, so that when it does become public you can profit from it. That information, once discovered, is no longer a secret and therefore can’t be exploited. Therein lies the paradox.

So why invest your money if you can’t use it as a way to get rich?

Because every dollar you hold in a bank account loses value as time goes on, thanks to inflation. But when you put those same dollars in investments, their value will grow along with the market. You don’t have to earn 12% return for your money to grow, you just have to beat inflation. And the best way to do that? Dollar cost averaging.

Here’s how it works: instead of trying to time the market perfectly, the investor who focuses on dollar cost averaging puts the same amount of money into investments at a constant interval (for example, monthly).

In other words, set up a regular dollar amount and a regular interval to invest. Then diversify your investments by buying both stocks and bonds and you’ll be able to make investments that are safe and that grow your money.

In the end, it’s all quite simple. Great news for everyone!

Image Credit: Markus Spiske

Author: Shannon

Shannon McNay is personal finance writer who loves to talk about the emotional side of personal finance. Her work has been published in Business Insider, DailyWorth, Huffington Post, Lifehacker, ReadyForZero, Yahoo! Finance, and more. You can follow her on Twitter @shannonmcnay.