Why I Don't Care About Beating The Market

Let’s talk about the holy grail for most professional investors, and likely many of the amateur ones as well.

Yes, I’m talking about beating the market.

The logic goes a little something like this. Why even bother with active investing if your goal isn’t to beat the market? After all, you can match the market’s returns (minus a small management fee, of course) by simply putting your cash into an index fund and calling it a day. Why go to all the work of researching, reading, etc. when you get beat by some dumbass dollar cost averaging into a Vanguard ETF?

It’s a legitimate question, but the answers are much more complicated than you’d think. Basically, I think investors who want to beat the market are looking at the wrong metric. They’re missing the forest for the trees.

So without further adieu, let me explain why the elusive goal to “beat the market” isn’t nearly as important as many think.

Which market?

Whenever I compare my portfolio’s performance to “the market,” I always struggle with figuring out an index to compare it to.

I have a portfolio stuffed full of Canadian stocks with a small sprinkling of U.S. equities in there. Among those stocks are a few truly international names, things like the Mexican airports (PAC and OMAB), Philip Morris (PM), European apartments (ERE.un), renewable power in the developing world (PIF.to and BEP.un), banking in Latin America (BNS.to), and probably a few I’m missing.

This brings up a fairly complex question. What index should my portfolio beat in order to “beat the index”?

The TSX Composite is usually my default, but it’s a flawed index for a few reasons. It’s much more heavily weighted towards financials (30%+ of the index versus about 20% of my portfolio), energy (18% of the index compared to about 12% of my portfolio) and mining (a 12% index weighting versus about 1% of my portfolio).

Essentially, if oil or materials do well during the course of a year, I’m pretty much guaranteed to lag the TSX Composite. On the plus side, if commodities lag, then beating that index is much easier. Is trying to beat such an obviously flawed market a good test of my investing capabilities?

Lately, I’ve been more inclined to compare my performance compared to ZDV, the BMO Canadian Dividend ETF. This is a closer match to my portfolio, although it doesn’t touch many of the small cap dividend payers that I own, and it also doesn’t hold any REITs.

Purists will also argue it isn’t a great comparison because it charges a 0.39% management fee. I should be comparing my performance to the underlying index, not the ETF. But nuts to that. I’m a retail investor and I’m comparing my results to the after fees result of an ETF. That’s the investment product I’d buy if I wasn’t actively managing my portfolio, not the index. If that makes me a sellout or a phony or whatever, so be it.

One of the problems with index investing is just about every index will have periods of underperformance as the main sectors underperform. The TSX is largely commodity driven and will be weak when commodities are weak. The S&P 500 will suffer when tech stumbles. And so on. Even a world index will struggle at times, especially if investors are translating results back to local currency when the Canadian Dollar is strong. That doesn’t make indexing a bad strategy — especially for investors who are uninterested in reading balance sheets or cash flow statements — but it is a weakness people should be aware of.

What are my goals?

Now that I’m retired from the corporate world, my financial goals are significantly different than just a few years ago.

I’m the first to admit from 2001 to about 2016, I was 1,000% chasing total returns. I was trying to build my net worth as quickly as possible. The quicker I increased my net worth the quicker I could achieve my ultimate goal — freedom.

But I then started to realize that a big nut of retirement savings wasn’t as useful as cash flow. As Jim so eloquently put it last week, selling shares to pay for retirement isn’t as easy as the academics make it out to be. I’ve been investing for longer than 20 years now, and I’m the first to admit I’m still not great at selling. The last thing I wanted was a retirement strategy that depended on selling assets.

It was around that same time I started thinking about things a little differently. I asked myself what my goals were and then worked backwards from there. The goal was always early retirement, so I started with that. Working backwards, I started asking myself what was the best way to accomplish that goal, and it was pretty obvious. A basket of blue chip Canadian dividend stocks that consistently spit out enough cash to cover my expenses was the best way to accomplish this — at least for me.

Now don’t get me wrong. I didn’t abandon total returns at that point. I looked at the history of these stocks, analyzed their future, and realized these names could still deliver solid total returns. After all, names like Canada’s banks, telecoms, and top utilities — among others — have great moats, solid management teams, and nice pricing power. But, at this point, I view total returns as secondary. I’m mostly concerned with those dividends rolling in and, perhaps as importantly, I want those dividends to go up over time.

When I realized my goals didn’t revolve around beating an index, suddenly beating an index didn’t seem very important.

Even pretty good results will make you rich

Perhaps the most important reason why I don’t sweat beating the market is I can still get ridiculously wealthy even if I underperform a little bit. Most people reading this can, too.

Let’s say an investment in the S&P 500 returns 10% per year over time, for easy figuring. That’s right around the average for the last 50 years or so. I’m confident my collection of blue-chip Canadian stocks will deliver long-term returns of approximately that much, but let’s say they come up a little short and only return 9% per year.

If I was a professional fund manager, such a result would be a disaster. Trailing the market by 1% per year before fees is enough to get someone fired.

But for a amateur investor who has a good savings rate and a decent nest egg already put aside, underperforming a little bit is no big deal.

For instance, say I’m 30 with $250,000 already put away and the ability to add $10,000 per year to my portfolio. I’ve done the heavy lifting when I was young, and now want to take my foot off the accelerator a bit. Here’s what my portfolio would look like in 35 years after getting a 9% return:

Compared to a 10% total return:

Yes, you’re “leaving” $2.5M on the table by not stretching and getting a 10% return. But both scenarios still end up with this person becoming quite wealthy, and it’s more than likely both of these fictional investors will end up with more money than they’ll ever spend.

Only a bunch of hardcore investors would look at a prosperous retirement and declare it a failure because an investor failed to at least match an index. Is the purpose of investing to get wealthy, or is it to beat an index?

Personally, I take this a step farther. I worked incredibly hard to get ahead during my 20s and 30s. I usually worked Saturdays — mostly doing some sort of side hustle — and often spent chunks of my free time reading and learning. That sacrifice enabled me to get ahead at a relatively young age. Because of that heavy lifting, I’m now in the position that all I need to do is not fuck things up.

Once I realized that, I definitely got more conservative.

I still think my conservative portfolio does well over time — take a look at the long-term performance of the stocks I talk about if you don’t believe me — but protecting the downside matters too.

The index, meanwhile, does not give two you-know-whats about your downside.

Essentially, I’ve traded big outperformance during bull markets for smaller drawdowns in bear markets, which nicely meshes with my risk tolerance. I’m happy to lag a bit during good times if I’m more protected during bad times.

It keeps me busy

An index and chill strategy is a great one for many investors, especially those who don’t care enough about the stock market to learn the ins and outs of that particular world.

I’m pretty much the opposite of that. I’m fascinated by this stuff. I’m in the position where I can do pretty much whatever I want, and when faced with that overabundance of choice I default to reading annual reports, thinking about business quality, and analyzing dividend payout ratios.

I decided to monetize this newsletter because I wanted to get paid for my hobby.

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Keeping informed on what’s happening with my stocks is something I’d do no matter what I did for a living. I read annual reports on the weekends when I worked for a living. Now I do it on a Wednesday morning. It is my pleasure and my curse. I just can’t help myself.

I retired from the corporate world before I turned 40 because, to pump my tires a little, I’m pretty good at this stuff. My portfolio has steadily grown over the years, and my results have absolutely thumped the average retail investor. If I come a little short of being an index over the next 20 years, does that make my journey and all my hard work a failure? Hardly. I’ll still be wealthy, and that wealth will be spent on things like good food, golf, and travel.

The bottom line

People who say active investing is about beating the index are either completely missing the point or someone who is compensated in part by their ability to beat an index.

The important part is to end up wealthy. To do so, most people must make consistent sacrifice, save somewhat aggressively, and only then, must invest relatively well.

As long as returns are high enough to get someone where they want to be financially, then beating an index is a secondary goal.

Again, I’m not suggesting investors ignore total return. Far from it. One of the reasons why I invest the way I do is I’m convinced top Canadian dividend stocks can lead to good returns. They might not be market-beating returns, but the important part is I’ve chosen a portfolio that I can stick with over the long-term and one that helps me reach my goals.