Many part-time market enthusiasts would love to quit their day job and consistently make profits from trading the market, but the biggest detriments are generally time and resources. Unless you have a career based on the financial markets, it’s very difficult to trade consistently and profitably without putting in the required time. This goes for any skill. Moreover, generating high returns in the financial markets is one of the most difficult things to do and professions to succeed at. It’s the nature of the fact that there are so many people out there doing it – and a lot of very intelligent people being how lucrative the business can be. And the game is inherently “unfair” as well-moneyed institutional investors have a lot of resources plowed into research in order to get the decision-making process as correct as possible. The odds can be very stacked against smaller traders and investors, as value added (“alpha”) is a zero-sum game. Of course this is not made to discourage but rather inform what everyone, including the largest institutions, has to go up against. Well capitalized investors largely understand this. However, the median investor tends to be much more reactive to how the market moves if you look at the nature of their transactions. For example, it’s very difficult to earn a high return on something over time if you buy it at high prices. Moreover, we tend to have a psychological bias toward believing that when something goes up in price, it means it’s a better investment. If you’re in the market for buying a new couch and your favorite one goes up by 50%, you’re likely to become materially less likely to buy it. If some stock or security in the market goes up by 50%, the thinking is much more biased toward believing it’s a great investment. It’s not viewed in the sense of, this is becoming a more expensive investment where the risk/reward starts becoming adversely skewed in a non-favorable direction. Likewise, when an investment falls in price, it’s not viewed as an asset that’s becoming cheaper – and therefore more attractive from a risk/reward perspective – but rather a bad investment that should be sold to mitigate further pain. So it largely leads to a lot of buying high and selling low. Generating Alpha Not Essential? So while alpha – return in excess of beta – is difficult to generate over statistically significant periods of time (especially controlling for risk), traders/investors can still reliably take more from the market than what they put in by generating return from beta. The underlying assumption when we invest is that financial assets outperform cash, otherwise capitalist economies simply wouldn’t work. Namely, we’re attempting to defer consumption now in order to consume more later. Sometimes this doesn’t work out (e.g., economic depressions) but central banks will face enormous pressure to get things moving again, with tools such as cutting interest rates, buying financial assets to lower yields further and generate market demand for riskier securities, or even – if they get desperate enough – potentially putting money in the hands of consumer directly. Therefore we have good evidence to believe that investing into stocks, bonds, and relevant securities from cash-producing entities will yield a higher return on our assets than simply keeping it in cash. Integrated into asset prices is a risk adjustment – typically called a “risk premium” – that compensates you for taking on the risk itself. It is higher for riskier, more volatile asset types (e.g., equities) and lower for others (investment-grade bonds). Provided enough time, you will come out ahead unless: a) You bought at very high prices that sometimes take 10+ years to recover from (similar to buying a house at the top of the market). b) Capital markets relevant to what you invested into are unstable and not well developed. (This is largely not a problem in developed market economies.) c) You simply made the wrong investments, which is more a microeconomic problem (poorly managed companies, companies with non-viable business models, sector-specific tribulations, etc.) than a macroeconomic issue. This is one argument in favor of indexing. d) You “invest” in markets that are purely speculative. Cryptocurrency markets, for example, have no risk premium associated with them unless it’s specifically tied to something with a viable business model. In the US stock market there is reason to believe that your investments will go up provided enough time because there is genuine wealth creation associated with productivity gains and growth in the labor market. If you have money you can’t afford to lose, don’t put it into purely speculative assets like the vast majority of cryptocurrencies. How Returns Are Determined Total returns over time, if we assume our alpha (value-added) is zero, is equal to our beta plus the risk-free rate. If we take returns with respect to cash, we can take the cash rate – usually a short-term bond of a duration of under one year – and calculate a beta by finding total expected future returns using discounted cash flow and backing it out that way. For those who hold assets over long periods – say ten years of more – the 10-year US Treasury may be a more appropriate risk-free rate. The beta would change accordingly; namely, it would shrink relative to the cash rate in most circumstances. The exception would be inverted yield curves, which generally occur for only small periods. So how do we take advantage of beta? The basic answer is to invest in quality assets. This can mean different things to different people. It can mean investing in name-brand companies that are likely to be around in some form several centuries in the future – e.g., Coca-Cola, McDonald’s, Wal-Mart, Boeing. Marketplace Portfolio Example On the WhoTrades Marketplace, there is one portfolio that places an emphasis on buying quality companies. This trader also does a lot of trading of individual names, including more speculative stocks, but terms his portfolio “Long-term holdings” and abides by the following philosophy: "Brand power determines my key holdings, $SBUX and $T. If $T's deal go through, the stock may skyrocket. Starbucks is just an industry leader despite a lot of coffee shops coming up lately. Prefer to stay long in the position and lock some profits in a couple of months, sometimes longer if the stock is still performing. Don't like holding through earnings, sometimes sell before the announcement, vol kills profits." In short, he likes companies a lot of brand power – an intangible asset – and prefers not to trade in volatile environments. Earnings-related volatility can be either good or bad. Tax laws also favor holding assets over longer periods. However, volatility from a macroeconomic standpoint is mostly bad for stocks. Fear is a stronger emotion than greed, so stocks mostly lose value quickly on the way down due to high volatility and gain value relatively slowly due to comparatively lower volatility. The portfolio is quite concentrated, with 39% in Bank of America (BAC), 34% in Lowe’s (LOW), and 27% in CBS (CBS). (Source: Marketplace Portfolio Page) It’s a little more concentrated than one might prefer, but combined with his trading activity (shown in the image below), this portfolio has done extremely well over the past year, netting 100% yield (doubling its size), with just a 23.5% drawdown. Conclusion In investing/trading, there’s a lot of traditional emphasis on “alpha generation.” This may be true for investment managers, otherwise there’s no reason to invest in an actively managed product that is expensive and (usually) illiquid. However, for those looking to generate quality returns over the long-run, there is nothing wrong with earning a risk premium (roughly in accordance with the perceived risk of the overall asset mix) plus the risk-free rate. Holding quality assets is essential to accomplish this task. “Quality” is a subjective term that doesn’t have a clear definition. It can mean owning stocks or bonds in companies with high amounts of brand equity – e.g., Apple, Amazon – investment-grade sovereign or corporate bonds, companies with high and/or stable cash flow, among other things. But the overall idea is that if you can buy quality assets and achieve balance in the portfolio – some stocks, some bonds, some commodities/alternative currencies such as gold – it’s a virtual guarantee, provided enough time and patience and avoidance of selling during painful periods – you will take more from the markets than what you’ll pay into them. This particular trader on the WhoTrades Marketplace provides one particular interpretation of investing in "quality." Overall, there are thousands of traders on the Marketplace where you can check out strategies of interest, track their progress over time, and generate trade ideas for your own portfolio.