“Beat the market” is a phrase used by experts, newspapers and TV channels in the investing community. It is often used in regards to famous investors who outperform the market consistently. Peter Lynch, one of the most successful investor who managed the Magellan fund for 13 years was able to beat the market very consistently, thereby making a huge profit in the stock market. Many investors know that beating the market is good, but what is exactly meant by “beat the market”?
What is meant by “beat the market”?
When a portfolio performs better than the stock market index, it is called as beating the market. For the Indian stock market, the benchmark of the market performance is set by the two leading indexes – Nifty 50 & Sensex. So, in order for a portfolio to beat the market, it needs to provide a higher return than the Nifty 50 or the Sensex index.
Let’s consider an example. Ram is an experienced investor with multiple years of experience in the stock market. He is good at selecting stocks which perform well in the future, thereby providing Ram a high return on his investment. To learn more about how to pick stocks for investment, visit this article! In the year 2021, Ram made an annual return of 18% on his portfolio. On the other hand, Shyam is a new investor who wants to start his investment journey. Since he is not experienced in the stock market, he invests in the Nifty 50 Index fund. To learn more about why new investors should invest their money passively using Index funds, visit this article! In the year 2021, Shyam made an annual return of 12% on his portfolio of index funds.
From this example, we can conclude that Ram was able to “beat the market” by 6% in the year 2021. His portfolio provided a return of 18% whereas the index fund (which closely tracks the Nifty 50 Index) was able to provide a return of only 12%. Many readers might be thinking that beating the market by 6% doesn’t seem like a huge accomplishment. After all, Ram only made 6% more money than Shyam on his investments. But in the long run, beating the stock market even by a small margin can make a huge difference!
Can beating the market by a small percentage make a big difference?
Beating the market by a small margin might not seem like a huge accomplishment but it can cause a huge difference in the long run. This happens because of the effect of compounding! Let’s consider the same example of two investors – Ram & Shyam. Ram’s portfolio consistently beats the stock market by 6% per annum whereas Shyam’s portfolio consistently provides the Nifty 50 returns (12% per annum). Let’s see what happens in the long run assuming both Ram & Shyam start with the investment amount of Rs. 1 Lakh.
| Years of investment | Ram’s Portfolio | Shyam’s Portfolio |
| 0 | 1,00,000 | 1,00,000 |
| 1 | 1,18,000 | 1,12,000 |
| 2 | 1,39,240 | 1,25,440 |
| 3 | 1,64,303.2 | 1,40,492.8 |
| 4 | 1,93,877.776 | 1,57,351.936 |
| 5 | 2,28,775.7757 | 1,76,234.1683 |
| 6 | 2,69,955.4153 | 1,97,382.2685 |
| 7 | 3,18,547.3901 | 2,21,068.1407 |
| 8 | 3,75,885.9203 | 2,47,596.3176 |
| 9 | 4,43,545.3859 | 2,77,307.8757 |
| 10 | 5,23,383.5554 | 3,10,584.8208 |
| 11 | 6,17,592.5953 | 3,47,854.9993 |
| 12 | 7,28,759.2625 | 3,89,597.5993 |
| 13 | 8,59,935.9298 | 4,36,349.3112 |
| 14 | 10,14,724.397 | 4,88,711.2285 |
| 15 | 11,97,374.789 | 5,47,356.5759 |
A small difference of 6% per annum caused Ram’s portfolio to become Rs. 11.9 Lakhs which is more than 2 times the portfolio of Shyam of Rs. 5.4 Lakhs. This difference will keep on compounding even further as the years of investment increase.
| Years of investment | Ram’s Portfolio | Shyam’s Portfolio |
| 15 | 11,97,374.789 | 5,47,356.5759 |
| 16 | 14,12,902.251 | 6,13,039.365 |
| 17 | 16,67,224.656 | 6,86,604.0888 |
| 18 | 19,67,325.094 | 7,68,996.5795 |
| 19 | 23,21,443.611 | 8,61,276.169 |
| 20 | 27,39,303.46 | 9,64,629.3093 |
| 21 | 32,32,378.083 | 10,80,384.826 |
| 22 | 38,14,206.138 | 12,10,031.006 |
| 23 | 45,00,763.243 | 13,55,234.726 |
| 24 | 53,10,900.627 | 15,17,862.893 |
| 25 | 62,66,862.74 | 17,00,006.441 |
| 26 | 73,94,898.033 | 19,04,007.214 |
| 27 | 87,25,979.679 | 21,32,488.079 |
| 28 | 1,02,96,656.02 | 23,88,386.649 |
| 29 | 1,21,50,054.1 | 26,74,993.047 |
| 30 | 1,43,37,063.84 | 29,95,992.212 |
The act of beating the market by a mere 6% per annum led to a difference in the portfolio of around 5 times in 30 years! Ram’s portfolio increased to Rs. 1.43 Crore at the end of 30 years compared to Shyam’s Portfolio of Rs. 29.9 Lakhs. This effect will only get compounded even further if an experienced investor is able to beat the market by an even bigger margin.
Conclusion
Beating the market is the difference by which an individual’s portfolio performs better as compared to the index. Even a small percentage of outperformance compared to the average market returns can lead to a massive increase in wealth creation over the long run. Experienced investors who can have good experience in the market should invest by themselves in the hopes of beating the market. On the other hand, novice investors should invest in index funds until they gain enough experience to invest by themselves. However, the final investment decision depends entirely upon the reader!
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DISCLAIMER : I am not a financial advisor. I am not for or against any company which I have mentioned in this article. All the information provided here is for education purposes. Please consult a financial advisor before investing.
Contact me at investmentabshuru@gmail.com
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Power of compounding👌