Human beings are naturally competitive animals. We compete for resources, status, mates and just about everything else. In most of these competitions, superior skill or natural abilities carry the day. The smartest and most talented typically win the race.

We all like to think that this applies to every field of endeavour. If we work a little harder or smarter we come out ahead of the next competitor – and reap our just rewards.

So when it comes to investing, investors tend to assume that there is a natural correlation between how much you know, and how much you earn. Surely we, as individual investors, have little chance against the Harvard Finance MBA who has a long resume of positions from inside the world of investing. It makes sense to ride on their coat tails rather than compete. Buy into the mutual fund they manage rather than go it alone.

This assumption that it takes extraordinary skill to navigate financial markets has led to an explosion in professionally managed products. It has also led to an explosion in the number of professional managers who can now afford to buy wineries in Tuscany, thanks client enthusiasm to pay management fees.

There are, however, a couple of cracks in this view. The most notable pointed out by John Bogle. Mr. Bogle founded the Vanguard group which introduced the first retail index fund. Mr. Bogle points out that, as a group, professionally managed funds under-perform passive benchmarks such as the S+P 500 by about 2% per year. The 2% figure bearing a striking resemblance to the management fees being paid.

The fact is 90% of institutional managers do not beat the market. If you think that putting your money with the 10% who beat the market last year, (or the last five years) is the answer; you might well consider that the managers who beat the benchmark change, so picking a winner is no small task.

So why do skilled, savvy market participants have such a problem beating the market? Why is there such a foggy link between knowledge and performance?

A Yale professor named Jurgen Huber took on these questions in his paper published in the winter 2007 Yale review. (If you would like a copy of the Yale Review article, send me an e-mail, I will send you a copy).

The explanation for the skilled players’ under-performance is rooted in game theory. It seems that the active players are all playing against one another. They win sometimes, lose other times, and generally incur costs along the way. The passive market participant who sits on the sidelines with a diverse, randomly selected portfolio avoids the wins, losses and costs along the way – and generally comes out ahead.

This has great relevance if you are selecting an advisor. Your selection criteria should probably contain something other than finding someone can beat the market. It’s likely the advisor, (through no fault of their own), will not beat the market over time. Your ability to accept market gyrations is much more critical to your investment success than a promise to beat the market. Most investors that do poorly buy at market peaks and sell at market bottoms, believing they or their manager “have to do something”.

If you are investing in stocks, remember that market returns are good returns, beating the market is nice but unlikely, and most of all – beating the market is not a necessary ingredient to your success.

Alan MacDonald is an investment advisor who helps high tech entrepreneurs make smart decisions about money. Contact Alan at Alan.Macdonald@RichardsonGMP.com