How to Beat the Market:An Investment Philosophy from First Principles

This paper proposes a theoretical hypothesis: an interdisciplinary investment philosophy framework, aiming to provide ordinary investors with a logically rigorous and long-term executable strategic system. Its core contributions are: integrating Taoist philosophy, Sun Tzu's The Art of War, and principles from the sociology of science and technology into a complete deductive chain; proposing "Market Relativity" as a core concept to complement global financial paradigms; and demonstrating that the deductive path itself constitutes the ultimate source of investment conviction. The derived strategy—using a market benchmark as the core position, a technology broad index as the source of excess returns, and annual rebalancing as the execution discipline—does not rely on stock selection, market timing, or informational advantages. Logically, it possesses the necessity to outperform the market benchmark over the long term.The central insight of this paper is that markets are relative. The nature of investment returns—whether they are zero-sum and competitive or structurally necessary—is not absolute. Instead, it depends on the reference system chosen by the investor. Within a stock-picking reference system, excess returns are highly competitive; within an industry-wide reference system, excess returns can possess a degree of logical necessity (industrial-structural excess returns). This concept of "Market Relativity" forms the complementary foundation of this paper to global financial paradigms. Keywords: Market Relativity; Industrial-Structural Excess Returns; Investment Philosophy; Interdisciplinary Research; Philosophy of Science and Technology 0. Introduction: The Dilemma of the Ordinary Investor Investors in every era face the same dilemma: after accepting that the market cannot be consistently beaten, where does one go? Holding the market benchmark solves the problem of underperforming the market, but it leaves a deeper confusion: must one simply abandon the possibility of excess returns? Historical data suggests that the very act of trying to beat the market carries a significantly negative expected return for most individuals (Barber & Odean, 2000; Fama & French, 2010). The lives of many investors are spent oscillating between these two poles. The core task of this paper is to identify a third source of excess returns—beyond risk compensation and behavioral biases—which we term industrial-structural excess returns. Based on this, it constructs a complete investment philosophy and strategic framework. 1. The Value and Boundaries of Existing Theories 1.1 Risk Compensation Theory: Value and Boundary Risk compensation theory, exemplified by the Fama-French three-factor model (Fama & French, 1993), is one of the core theories explaining excess returns in finance. Its key insight is that an asset‘s expected return is proportional to its systematic risk (β), with higher returns compensating for higher risk. This theory has strong explanatory power for cross-sectional differences in individual stock returns and forms the cornerstone of modern asset pricing theory. However, this theory has an implicit boundary. When the unit of analysis shifts from “individual stock” to “industry-wide,” certain anomalies emerge. Using a technology broad index (e.g., NASDAQ 100) as an example, its long-term return is significantly higher than the market benchmark, yet its risk-adjusted return is not proportionally lower. In other words, a technology broad index provides “additional” returns that cannot be fully explained by its systematic risk. This is a theoretical gap this paper attempts to address. 1.2 Behavioral Bias Theory: Value and Boundary Behavioral finance, as represented by Shiller (1981, 2000), points to systematic irrational behaviors in markets (overreaction, herding, disposition effect, etc.). It suggests that rational investors can profit from these biases. This theory has enriched our understanding of market pricing mechanisms and explained numerous anomalies. However, its explanatory power is also challenged when focusing on the long-term performance of entire industries. The phenomenon of technology broad index consistently outperforming the broader market has persisted over decades. If this were solely driven by behavioral biases, it should have been gradually arbitraged away. The fact that it persists suggests that the excess returns of technology broad index may not originate (or not only originate) from market participants‘ irrationality, but from deeper structural roots. The existence of these two theoretical boundaries is the starting point of this paper. 2. Starting Point: Market Unbeatability and the Response of Taoist Philosophy 2.1 The Dilemma of Market Unbeatability Theoretically, the Efficient Market Hypothesis suggests that all known information is reflected in current prices, making the long-term pursuit of excess returns extremely unlikely (Fama, 1970). In practice, for most ordinary people with work and life responsibilities, spending significant time researching individual stocks in an attempt to beat the market often results in underperformance. 2.2 The Taoist Response: Winning by Not Contending This paper starts from the Taoist philosophy of “winning by not contending” to address the realistic dilemma of an unbeatable market. The core of Taoism’s wu wei (non-action) is not passive retreat, but “not acting recklessly”—knowing what cannot be done and refraining from doing it; knowing the natural direction and following it. Lao Tzu said: “The highest good is like water. Water benefits all things without competing with them.” Water does not compete with mountains for height, but it eventually flows to the sea and becomes part of it. Since the market cannot be beaten, one should own the entire market. Instead of fighting the index, investors should become part of the index. This posture can be called “winning by not contending.” Derivation 1: From “the market cannot be beaten” to “buy the market benchmark.” 3.Optimization: Sun Tzu‘s The Art of War and the Discovery of Benchmark Weaknesses If reasoning stopped here, merely holding a market benchmark like the S&P 500 and telling oneself “this is it, I’ll do nothing”——that would be a misunderstanding of wu wei. Wu wei is not passive resignation but precise action based on following natural laws. Sun Tzu said: “Know yourself and know your enemy, and you will never be defeated.” Knowing the enemy requires not only understanding their strengths but also discerning their weaknesses. Market benchmarks have significant weaknesses: their sector weightings are determined by market capitalization, not by long-term intrinsic value. Using a broad market index (e.g., the S&P 500) as an example, its technology sector weighting often lags behind the actual technological progress of the economy. Holding only this index essentially assumes that the past industrial structure will continue into the future. It is precisely this knowledge of the benchmark‘s weakness that leads to the necessity for improvement. Derivation 2: From “knowing the benchmark’s weaknesses” to “needing another tool to optimize the structure.” 4. Theoretical Definition of the Core Concept: Market Relativity 4.1 The Reference System Dependence of Excess Returns What are “excess returns”? This concept itself implies a default reference system. Most investors, when discussing “beating the market,” subconsciously think within a “stock-picking reference system”: the stocks I choose perform better than others’ stocks, and my returns come from defeating other investors. However, the choice of reference system is not unique. Changing the reference system fundamentally alters the nature of excess returns. Definition 1 (Excess returns within a stock-picking reference system): Within a stock-picking reference system, excess returns manifest as a zero-sum game among investors. When an individual earns excess returns by buying and selling individual stocks, those returns formally originate from the trading behavior of other market participants. This is a highly competitive environment where an investor‘s returns depend heavily on predicting the behavior of others. Definition 2 (Excess returns within an industry-wide reference system): Within an industry-wide reference system, the situation fundamentally changes. The overall return on capital for certain industries, particularly technology-driven ones, can be systematically and persistently higher than the market average. This is not profit stolen from other companies, but higher profits “created” by the industry from the real economy. When one buys a broad-based index representing an entire technology-driven industry, the idiosyncratic risk of individual stocks is diversified away. What remains is the profit margin that is necessarily higher than the social average, driven by the industry’s structural characteristics (e.g., low marginal costs). 4.2 A Formal Definition of Market Relativity Definition 3 (Market Relativity): Market Relativity posits that the nature of investment returns—whether competitive and zero-sum or structurally necessary—is not an inherent attribute of the investment itself, but depends on the reference system chosen by the investor. Switching reference systems changes the interpretation of, and strategy for, excess returns. The core value of this concept is that it reveals an unarticulated implicit assumption in the discussion of “excess returns”—namely, the default use of the “individual stock” as the reference system. By consciously switching to a “broad-index reference system” (specifically, an industry-wide broad index), investors can redefine the meaning of “excess returns”—not as a victory in a zero-sum game, but as an alignment with fundamental industrial-structural laws. This opens up new and more necessary sources of return. 4.3 Demonstrating the Necessity of Industrial-Structural Excess Ret