Mission Impossible: beating the market over long periods of time

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[Abridged from http://blog.empiricalfinancellc.com/]

We all hear about quantitative strategies that are supposed to earn us 20%, 25%, or even 30%+ returns over long periods by simply “maintaining discipline to the strategy.”

Here are some examples we have discussed on our blog and have seen in the media:

    Goodwill Gone Bad, 23%
        http://blog.empiricalfinancellc.com/2011/04/goodwill-gone-bad/

    Asset Growth, 26%
        http://blog.empiricalfinancellc. ... t-in-stock-returns/

    Magic Formula, 31% (or less depending on how you do the calculations)
        http://www.magicformulainvesting.com/welcome.html

This all sounds great, but it is intellectually dishonest to not highlight the logical conclusion of such high returns. And I definitely do not want this blog to convey the idea that earning 20%+ CAGR for many years is by any means easy, or possible. Perhaps this is possible on a very small capital base, but over time, the returns on pretty much ANY strategy will slowly revert to a fair rate of return (risk and return are in balance).

Summary Findings

Before I even begin, here are some findings (I use the CRSP return database which starts January 1, 1926 and runs through December 31, 2010):

    * Earning 20%+ returns over very long horizons is for all intent and purposes virtually IMPOSSIBLE (assuming the market experience of the past ~90 years is representative of the future).
    * 31.5%+ returns over the 1926 to 2010 period imply that an investor will end up owning over half of the ENTIRE stock market.
    * 33%+ returns imply that an investor will end up owning the ENTIRE STOCK MARKET!
    * A 40% return will have you owning the entire stock market in ~60 years–not a bad retirement plan!
    * A “doable” 21.5% a year implies an investor will own .62241% of the market at the end of 2010. With a $16.4 trillion total market value as of December 31, 2010, this would imply a personal stock portfolio worth $102 billion!!!

    Warren Buffett–and perhaps a very select handful of others–have been able to achieve 20%+ returns over very long time periods. These individuals represent some of the richest people on the planet because of this very phenomenon.
    An investor might have an epic run of 20% returns for 5, 10, maybe even 15, or 20 years, but as an investor’s capital base grows exponentially, the capital base slowly becomes ALL capital, and all capital cannot outperform itself!