Active investors are continually looking for innovative ways to beat the market. They want to believe that some perfect combination of fundamental or technical indicators will lead to the holy grail of outperformance (otherwise known as alpha).
In the broadest sense, there are two ways to beat the market: on the upside or on the downside. You either take more risk or less than the benchmark.
This is where you must begin your journey and set your expectations if you are ever going to successfully compound your wealth over the long-term. We can sit here all day and debate security selection, asset allocation, risk management, or other strategic factors. They don’t mean anything if you don’t understand where you are starting from and where you are going.
Beating the market on the upside is what most aggressive investors strive for. It’s also the most rewarding when some combination of luck and skill coalesces in your favor. You see your account growing in leaps and bounds, which leads to greater confidence in your own abilities and further risk-seeking behavior.
Maybe you bought all the big momentum stocks before they became truly popular or ran much further than anyone thought possible. Maybe you got in on Bitcoin when it was trading for a few bucks a token. Maybe you use double or triple leverage ETFs to magnify your gains. Maybe you are shorting volatility with every penny of your retirement savings.
Whatever the case may be. You are a rock star when stocks are relentlessly grinding higher. When volatility is low. When credit is abundant. You tell tales to your buddies on the golf course or over the water cooler about how much money you are making and how easy it is.
The downside of course is that you are far over-leveraged and emotionally unprepared for a contraction when the peak finally comes. Confidence in strategies that have worked for the last couple of years turn into doubt, then denial, then regret, then capitulation.
Those same dynamics come into play over every full cycle in the market and take a long time for you to shake off when the market does turn. It takes you months or years before you are finally able to muster the confidence to start the process all over again.
Think about it this way: when it’s good, it’s GOOD and when it’s bad, it’s BAD. That’s the life of a risk-seeker.