Investment is like sports. Performance can be measured, and compared with others. It’s important. One percentage point of excess return over 20 years can add 25% or more to a portfolio.
The market’s return is just an average of every investor, weighted by size. For someone to beat the market, someone else has to get less than the market. It’s like a running race: each competitor has his or her individual time, but each contributes to the course average. How you do relative to the course average is your relative performance.
In investing, there are really only three sources of excess relative performance: market timing, security selection, and execution efficiency. Market timing is easy to understand but hard to do: be in stocks when the market is going up, and in cash when it is falling. The problem comes in picking which days. It’s possible, but it requires a lot of focus.
Execution efficiency has to do with trading. It’s what trading firms with microsecond algorithmic computers are trying to do. It’s interesting, but most people don’t have access to the necessary data.
The most common source of excess return is security selection: finding the right stocks or bonds or funds, and holding on. There are a lot of ways to do this: value investing, growth investing, global investing, and others.
It makes sense to pursue every way to get an edge. Because when the returns are in, that market may weigh the dollars, but what determines your results will be your sense.