Yes, You Can Beat the Market

"75% of actively managed mutual funds fail to beat the S&P 500 over the long run."

I'm sure you've heard this statistic before. Index fund fanatics tout it all the time to show how investors are better off simply buying the market rather than entrusting their money to a fund manager who actively buys and sells stocks.

Index fund proponents have a point when it comes to mutual fund selection. Index funds are certainly excellent options for those who want to diversify on the cheap or simply don't have the time to research superior mutual funds.

But then the indexing champions always seem to take the lesson one step too far by saying something like, "See? If the highly paid Wall Street fund managers can't beat the market, there's no way that you can do it by picking your own stocks."

To that, I say baloney.

Analyzing the 75%
Have you ever wondered why the majority of active fund managers fall short of the market? After all, these professionals didn't get to be professionals by being bad investors.

A study done by finance professors Gordon J. Alexander, Gjergji Cici, and Scott Gibson sheds some light on the subject. The study shows that one reason active fund managers have trouble beating the market is their funds' liquidity policies.

When a fund has had some success, new money tends to pour in as investors chase performance. The fund's liquidity policy forces the fund manager to buy more shares of the companies already in the portfolio or even add new securities to the mix. The new shares, therefore, may not be as attractive (from a valuation standpoint) as the fund's original purchases and may, in fact, compel the manager to buy overvalued shares.

The study supports the stock-picking competency of fund managers under normal circumstances by concluding, "When managers made purely valuation-motivated purchases, they beat the market by a substantial margin. In contrast, when managers were compelled to invest extra cash from investor inflows in stocks, they were unable to beat the market."

Dowhat Wall Street can't
With this in mind, consider that you as an individual investor aren't constrained by the factors that sink many active fund managers. You can stick to your strategies in good times and bad and buy and sell stocks only when you think the time is right.

Growth-minded investors, therefore, can continue to wait for dips in the prices of high P/E fare such as Whole Foods Market (Nasdaq: WFMI  ) , Amazon.com (Nasdaq: AMZN  ) , and Apple Computer (Nasdaq: AAPL  ) , while value investors can pore over companies trading near their 52-week lows like St. Jude Medical (NYSE: STJ  ) , Kinder Morgan (NYSE: KMP  ) , and Apollo Group (Nasdaq: APOL  ) .

Foolish bottom line
As an individual investor, you have mobility and freedom on your side -- something mutual fund managers don't always have. So by no means should you take the aforementioned statistic to mean that you can't beat the market. You can, but it takes some extra time, research, and patience on your part.

If you need some help finding market-beating ideas, consider a free 30-day trial to Motley Fool Stock Advisor, where Fool co-founders David and Tom Gardner scour the investing universe for superior companies. One of these companies, Marvel Entertainment (NYSE: MVL  ) , famous for its library of comic characters, was picked in July 2002 on the back of increasing revenues and diminishing long-term debt. Marvel has since returned more than 700% for Stock Advisor subscribers. On average, their picks are currently outpacing the S&P 500 by 45 percentage points since 2002.

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Todd Wenningdoes not own shares of any company mentioned in this article. Whole Foods and Amazon are also Stock Advisor picks. The Fool's disclosure policy is able to leap tall buildings in a single bound.


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