Why Wall Street Can Be Beaten

Billions of dollars change hands in the market every single day. A huge chunk of that money is managed by mutual fund managers -- people who handle other people's money. According to data from Bloomberg, retail investors (a.k.a., you and me) account for only 5% of daily trading volume.

While those highly educated professionals largely understand how the markets work, the people whose money they manage do not.

More money, more pressure
Because they deal with other people's money, the professional fund managers have to deal with more than just the daily fluctuations of stock prices. They also have to deal with daily inflows and outflows of cash. If the fund underperforms, people will start pulling their cash out and moving it to funds that have overperformed.

All that cash chasing past performance creates problems for the fund managers. The ones that underperformed are often forced to sell to meet redemptions.

On the flip side, the ones that outperformed can wind up with a glut of extra cash to deploy. And yes, in the mutual fund world, having too much cash can be a bad thing. It often forces fund managers to choose between a poorly thought-out investment or the long-term performance drag of holding cash.

As a result, that glut of cash tends to draw even otherwise great performing fund managers back to the middle of the pack -- before fees and taxes. Include fees and taxes in the mix and it becomes clear why so many actively managed funds lose to the market indexes every year.

Exploit their weakness
Unlike fund managers, you're only responsible for your own money. That gives you a tremendous leg up over the pros. Mutual funds have to keep up with the money flowing in and out, and that tends to move stock prices. The more they move, the more likely they'll be out of whack with what can be truly justified by the business behind the stock.

You can see the effect of all that forced buying and selling by looking at companies' actual market performance compared to their predicted performance.

If stocks were always appropriately priced, a Wall Street metric called beta would predict how well a stock would perform. Stocks with higher betas would outperform a rising market, and stocks with lower betas would trail a rising market. (The market itself, by definition, has a beta of 1.)

The stocks below, however, all sport betas below 1 -- and they all still easily outperformed the S&P 500 over the past year:

Pay attention to what counts
That real-world result would be utterly impossible in an efficient, unbeatable market. Yet how many investors who buy into the predictive power of beta had been scared away from Stericycle by its negative beta? That's a strong return turned in by a traditionally strong company that would have been ignored and even shunned by anyone who paid attention to what is a useless metric.

If you want a real shot at beating the market, you need to exploit the biggest advantage you have: control of your own money.

Take advantage of the inefficiencies created when Wall Street's customers force the market to make bad decisions. You can do that by focusing on the business behind the stock and buying when a strong business sees its stock decline.

That's exactly what we do at Motley Fool Inside Value. You can see all our picks and research by joining the service free for 30 days. Click here for more information.

At the time of publication, Fool contributor and Inside Value team member Chuck Saletta did not own shares of any company mentioned in this article. The Fool has a disclosure policy.