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How to Invest in the Stock and Bond Market

Written by Chris Nolt

The stock market has historically been an excellent place to invest your money. Since 1926, the U.S. stock market, as measured by the Standard and Poor’s (S&P) 500, has risen at an average rate of about 10 percent per year.  Deciding how to invest in the stock market, however, can be challenging, given the amount of information on investing and the number of investment products available.

The financial media, Wall Street and the investment brokerage industry disseminate information on investing that is often designed to entertain, to sell advertising and to move money so they can generate fees and commissions. Once you understand how destructive listening to some of their advice can be, you will learn to ignore much of what you hear from the media and Wall Street. 

Another source of investment information comes from academia. Academia refers to the people and institutions dedicated to the activities of teaching and learning, including research and discovery. This would include schools, colleges and universities. 

Over the past 60 years or so, academic research has discovered and established the most effective ways to invest.   You can benefit from their research and improve your odds of having a successful investment experience.

Active versus passive

While there are many strategies for investing in the stock and bond market, they all boil down to two basic investment philosophies – active management and passive management. 

Active management attempts to “beat the market” through a variety of techniques, such as stock picking, sector rotation and marketing timing.

In contrast, passive money managers avoid speculation and subjective forecasting. They take a longer-term view and attempt to deliver market returns using index or asset class funds.

Active management assumes the market is not completely efficient – that some securities are over- or underpriced and that it is possible to figure out which ones they are. 

On the other hand, passive investment managers avoid speculation and attempt to capture the market’s returns by investing in index funds without regard for future forecasts.

To a large extent, the investment media and brokerage industry would like you to believe that the key to successful investing is picking the right stocks, sectors or asset classes and getting in and out of those stocks, sectors or asset classes at the right times. Wall Street and the brokerage industry try to create the impression that their superior investment insight and ability to pick stocks, sectors and time the market will help you attain better performance. 

A 2008 study by Dartmouth Finance Professor Kenneth French estimated investors in the U.S. pay roughly $100 billion per year in fees and other expenses in an attempt to “beat the market” rather than investing in low-fee index funds that track the broader performance of the stock market.

Another study by French and the 2013 Nobel Prize in Economics winner Eugene Fama determined only one percent of active managers outperformed the market due to skill.

Can active manager outperform?

Many people are under the false notion that, to be a successful stock market investor, you need to hire someone who is continually monitoring the market and who will use their superior insight, knowledge, resources and abilities to get in and out of the right stocks and/or investment sectors at the right times. It assumes you need to be able to forecast what will happen in the economy and accurately predict the market’s direction in advance.

Active money managers try to sell you on their superior stock picking and market timing ability to justify the higher fees they charge.  The measure of successful active management lies in the ability of a manager to deliver above-average returns consistently over multiple years. Demonstrating the ability to outperform repeatedly is the only proven way to differentiate a manager’s luck from skill.

A comprehensive study was performed to determine the percentage of actively managed mutual funds that outperformed their passive index benchmark. From Jan. 1, 2000 through Dec. 31, 2015, of the mutual funds that survived this period of time, only 17 percent of stock funds beat their benchmark index and only seven percent of bond funds beat their benchmark index. The results of this study demonstrate how difficult it is to beat the market using active management and why more and more people are turning to passive index fund investment strategies.

The idea that you need to hire an investment guru to have a positive investment experience is simply not true. You can have a successful experience investing in the stock market without working with such an individual. In fact, by investing in the right mix of index or asset class funds and avoiding emotional reactions to the market, you will likely beat the vast majority of active money managers over time.

Chris Nolt is the owner of Solid Rock Wealth Management, Inc. and Solid Rock Realty Advisors, LLC, sister companies dedicated to working with families around the country who are selling a farm or ranch and transitioning into retirement. For more information, visit solidrockproperty.com and solidrockwealth.com.