If You Want to Beat Wall Street, Here’s the Best Way to Invest

Wall Street is full of smart people who are paid extremely well to analyze a handful of companies and the industries in which they operate. Professional investment firms have whole teams dedicated to making financial decisions in order to generate the best risk-adjusted returns possible for their clients.

If you think you can do better than Wall Street in any given year, you're probably mistaken. The stock market is an information game. You don't have the same time and resources as Wall Street pros to dedicate to uncovering and analyzing new information as it becomes available. The odds of outperforming in a single year aren't great.

But you, as an individual investor, have an advantage over Wall Street. You can play a different game.

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Change the rules

Wall Street is beholden to monthly, quarterly, and annual performance reviews. Portfolio managers don't want to show a big loss at the end of the month; they often get paid for performance. What's more, a bad year could send clients looking elsewhere. These things fundamentally change the way Wall Street pros manage portfolios.

You can invest with a multiyear time horizon. You don't need to care what your portfolio does over the course of a month, quarter, or year. If your aim is to maximize value in the long run — five, 10, or 20 years from now — who cares what happened this month?

Benjamin Graham wrote that the stock market is a voting machine, not a weighing machine. His acolyte Warren Buffett contends, however, that it's a voting machine in the short run, but a weighing machine in the long run.

In other words, the price of a security at any given time is affected by various factors, including investor sentiment, the news of the day, or just which side of the bed some big shareholder woke up on. In the long run, a security's price is more likely to reflect its intrinsic value — its weight.

It's much easier to invest based on the idea of a stock's intrinsic value. You can ignore all the noise of the voting machine and invest based solely on what a company is actually worth. Wall Street can't do that. It needs to invest based on whether it thinks the stock will beat the overall market right now.

The best predictor of investor success

Successful investors don't need to outsmart Wall Street. Indeed, the best predictor of investors' success is how much time they give an investment decision to work out. The longer you hold an investment, the more likely you are to generate returns in line with expectations.

The average annual return of the S&P 500 index from 1957 to 2021 has been about 10.5%. In some years, it's much higher; in others, it's lower or even negative.

The longer your time horizon is, though, the less variation there is in your returns. Using one measure of statistical variation, the standard deviation for one-year returns is 19.2%. But when you look at longer periods of 10 years each, it drops to 5.1%.

In other words, it's much easier to predict where the stock market index will be in 10 years than where it will be in one year. That's why having a long-term time horizon is important to achieve good investment results. You, as an individual investor, can do that. Wall Street cannot.

If you want to beat Wall Street, the best way to do so is to stay away from the games it plays. Analysts put out reports with exact prices they expect a stock to trade at one year from now. Rarely, if ever, do they call it right on the dot.

It's much more valuable for you to determine how much a company is worth right now based on expectations for the long term, and invest in its shares when the company is valued well below that number. Over time, if your analysis is good, you'll see share prices move toward their true weight.

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