Beating the market is an obvious goal for active investors. After all, if you're not beating a zero-effort passive index, why go to all the time and trouble of being active?

This is true for both private and professional active investors:

  • Private investors often obsess over whether or not they beat the market last year, or over the last few years.
  • Professional investors often explicitly benchmark their funds against a market index such as the FTSE 100 or FTSE All-Share.

Conventional thinking says that if an investor has beaten the market, over whatever timeframe, they have done well. If they've underperformed the market, they've done badly.

But while I think beating the market is a necessary goal it is not a sufficient goal for achieving the real outcomes that most investors want.

You can beat the market and still perform badly

Here's the conundrum from my perspective:

Like most investors I want to know if my investment efforts are good or bad, so I need something to compare myself against.

My portfolio is split about 50/40/10 between FTSE 100/250/Small-Cap companies, so I use the FTSE All-Share as my benchmark. It's not perfect, but it's simple to track and reasonably close to the size and geographic characteristics of my portfolio.

Now that I've defined what “the market" is, what do I mean by “beating the market"?

There are lots of ways you could define it, but in my case I have the following performance goals, all of which are relative to the FTSE All-Share:

  1. Have a higher dividend yield at all times (at the portfolio level)
  2. Produce higher total returns over any 5-year period
  3. Have lower risk (using beta and maximum drawdown) over any 5-year period

So in simple terms I want it all: A higher yield, higher total returns and less risk than the market.

But there's a problem.

We have just seen the FTSE 100 break through to new highs after a wait of more than 15 years.

Just think about that. 15 years in which the market made zero capital gains and for much of the time was actually losing money. And that's before factoring in inflation.

With inflation factored in the FTSE 100 would need to be at something like 9,500 to have held its value in real terms.

So while beating the market may be a very sensible goal, I don't want to jump for joy just because my portfolio has beaten something which hasn't…

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