Can You Beat the Market Index?

Logic says that, because most stock market investment is via professional management ("funds", for simplicity) charging a fee to investors, the average return to investors over all such funds must be essentially the overall market average, minus the average fee. It might be that a small proportion of fund managers can indeed "beat the average" in the long term by skill rather than luck. Even supposing that is true, can an investor benefit by being able to identify such funds in a reasonable time?

This page illustrates the issue via a game based on a simple model (more details of model here). There are 25 hypothetical funds, with different random returns each year. For 24 of the funds, the mean return for each year will be the index return, minus 1% fee. Only one fund will be "worthwhile", with mean return being the index return plus 2%. One could invest in the index without fee, but can you do better by trying to identify this "worthwhile" fund and investing in it?

In the game, you start by seeing the funds' gains for the previous 3 years. Then allocate your portfolio between funds (as percentages like 25, 64, 11 -- leave blank for 0s). Then press the "Simulate next year results" button. You will see

• In the first table, the gain of each fund in year 1 and the corresponding current fund value (from initial 100, three years before), together with the updated "recent 3 years" gain.
• In the bottom tables, your gain for the year compared to the index gain, and your current portfolio value compared to the index (both based on 100 when you start).

You then allocate your portfolio for the coming year, and again press the "Simulate next year results" button. To help you choose, the second table shows the best performing funds, both since inception and over the previous 3 years. And the bottom table updates so you can compare your portfolio value to the index. Are you performing better or worse?

Remember that in this model we have hidden one "worthwhile" fund that in the very long term will grow 2% faster than the index, whereas the others will grow 1% slower. Our game continues for only 12 years. Can you beat the index over 12 years, either by luck or by identifying the "worthwhile" fund? You can track progress in the bottom table. After 12 years, the "worthwhile" fund will be revealed. Often it will not be the best-performing fund over these 12 years -- a few other funds will "by luck" have done better.

Best fund growth rates:

Your gain for each year:

Your portfolio value compared to the index: