Original Author:Nick MaggiulliFinancial blogger & author of "Just Keep Buying"
Translated by Felix, PANews
The investment community generally believes that generating excess returns (Alpha), or the ability to outperform the market, is a goal that investors should pursue. This is entirely logical. All else being equal, more Alpha is always better.
However, having alpha does not always mean better investment returns. This is because your alpha always depends on market performance. If the market performs poorly, alpha does not necessarily ensure profits for you.
For example, imagine there are two investors: Alex and Pat. Alex is very skilled at investing and consistently outperforms the market by 5% each year. Pat, on the other hand, is a poor investor and consistently underperforms the market by 5% annually. If Alex and Pat invest during the same time period, Alex's annual return will always be 10% higher than Pat's.
But what if Pat and Alex start investing at different times? Is there a scenario where, despite Alex being more skilled, Pat's return rate ends up surpassing Alex's?
The answer is yes. In fact, if Alex invested in U.S. stocks between 1960 and 1980, while Pat invested in U.S. stocks between 1980 and 2000, then 20 years later, Pat's investment returns would have exceeded Alex's. The following chart illustrates this:
Comparison of the 20-Year Annualized Total Real Returns of U.S. Stocks from 1960 to 1980 versus 1980 to 2000
In this case, Alex earned an annual return of 6.9% (1.9% + 5%) from 1960 to 1980, while Pat earned an annual return of 8% (13% – 5%) from 1980 to 2000. Although Pat's investment ability was not as strong as Alex's, Pat's performance was better in terms of total returns adjusted for inflation.
But what if Alex's competitor is a real investor? Currently, we assume that Alex's competitor is Pat, who underperforms the market by 5% annually. However, in reality, Alex's true competitor should be an index investor whose annual return matches the market.
In this scenario, even if Alex outperformed the market by 10% each year from 1960 to 1980, he would still lag behind the index investors from 1980 to 2000.
Although this is an extreme example (i.e., an outlier), you might be surprised to find that the frequency of having Alpha while underperforming historically is very high. As shown in the following chart:
Comparison of the size of alpha versus the probability of underperforming the index in all 20-year periods of the U.S. stock market from 1871 to 2005.
As you can see, when you have no alpha (0%), the probability of outperforming the market is essentially equivalent to flipping a coin (about 50%). However, as alpha returns increase, the compounding effect of these returns naturally reduces the frequency of underperforming the index, but the improvement is not as significant as one might imagine. For example, even with an annual alpha return of 3% over a 20-year period, there is still a 25% probability of underperforming an index fund in the historical context of the U.S. market.
Of course, some people may argue that relative returns are most important, but I personally do not agree with this view. Imagine: would you prefer to earn average market returns during normal times, or just "lose less" than others (i.e., achieve a positive alpha return) during the Great Depression? I would certainly choose the returns of the index.
After all, in most cases, index returns generate quite satisfactory gains. As shown in the chart below, the actual annualized returns of U.S. stocks have fluctuated over different ten-year periods, but have mostly been positive (note: data for the 2020s only shows returns up to 2025):
All of this suggests that although investment skills are important, the performance of the market is often more critical. In other words, pray for Beta, not Alpha.
From a technical perspective, beta measures the extent to which the return of an asset fluctuates relative to the market. If a stock has a beta of 2, it is expected to rise by 2% when the market rises by 1% (and vice versa). For simplicity, however, the market return is often referred to as beta (i.e., a beta coefficient of 1).
The good news is that if the market does not provide sufficient "beta" during one period, it may make up for the returns in the next cycle. You can see this in the following chart, which shows the 20-year rolling annualized real returns of U.S. stocks from 1871 to 2025:
This chart intuitively demonstrates how returns can strongly rebound after a period of underperformance. Taking the history of the U.S. stock market as an example, if you had invested in U.S. stocks in 1900, your annualized real return over the next 20 years would have been close to 0%. However, if you had invested in 1910, your annualized real return over the following 20 years would have been approximately 7%. Similarly, if you had invested at the end of 1929, your annualized return would have been about 1%; but if you had invested in the summer of 1932, your annualized return would have been as high as 10%.
This significant difference in returns once again highlights the importance of overall market performance (Beta) compared to investment skill (Alpha). You might ask, "I can't control where the market is going, so why does this matter?"
This is important because it's a form of liberation. It frees you from the pressure of "having to beat the market," allowing you to focus on what you can truly control. Instead of feeling anxious that the market is beyond your control, view it as one less thing to worry about. See it as a variable you don't need to optimize, because you simply cannot optimize it.
Then what should you optimize instead? Optimize your career, savings rate, health, family, and so on. Over the long dimension of life, the value created in these areas is far more meaningful than striving for a few extra percentage points of return in your investment portfolio.
Let's do a simple calculation: a 5% raise or a strategic career shift can increase your lifetime income by six figures or even more. Similarly, maintaining good physical health is an efficient form of risk management, significantly offsetting future medical expenses. And the time you spend with your family sets a positive example for their future. The benefits of these decisions far exceed the returns most investors hope to achieve by trying to outperform the market.
In 2026, focus your energy on the right things, pursuing Beta rather than Alpha.