As winter and a new calendar year arrive, investors are struggling tomake sense of the market and what to do. Many investors are content, ifonly barely, to stick with tried-and-true wisdom and long-termstrategies. But other investors think (or hope) that they can figureout what the market will do and how to take advantage of it.

However, that is a dangerous endeavor, as a couple of the biggest names in professional money management found out this year. They of course knew the risks they were taking, but in each case they were expected to beat the market. To do that, they had to do something different from the market.

And in a year when the market itself turned in a dismal performance, the managers of Fidelity’s once-mighty Magellan Fund and the legendary Legg Mason Value Trust exceeded the market when it was going down. That wasn’t the way it was supposed to work.

“Every decision to buy anything has been wrong,” lamented Bill Miller, Value Trust’s much-admired manager. Miller was widely worshiped in the financial media for beating the Standard & Poor's 500 Index every calendar year for 15 straight years. Over the years we followed his progress, and periodically we warned investors that this winning streak was unlikely to last.

But in 2008, the streak was ancient history. (It actually ended in 2006). Through December 12, Miller’s fund lost 56.8 percent this year. According to Morningstar, that performance ranked it in the bottom 1 percent of funds in the large-blend category. Many investors these days are wondering what it will take them to break even. After a 56.8 percent loss, Value Trust would have to gain about 131 percent just to regain its value at the end of 2007. A tall order indeed.

In fact, the mathematics of breaking even have little mercy. Think for a moment about Vanguard’s 500 Index Fund, which does not try to beat the market, but only to reflect it. Through Dec. 12, the Vanguard fund was down 38.8 percent this year. That’s plenty dismal, but now let’s go back to the required gain to break even. Vanguard 500 Index could do that with a 64-percent gain. Legg Mason Value Trust would require a gain of more than twice that much just to break even.

In other words, it can be extremely expensive to try to beat the market and fail. Just ask Harry Lange, who has run Fidelity’s Magellan since late in 2005. The past three years hasn’t been a great time for any manager to become a star, and much of the market meltdown was far beyond Lange’s control. But in a report to shareholders this month, Lange admitted he lost some of their money by making big bets on a couple of individual stocks.

Nokia Corp., for example, represented 5.8 percent of Magellan’s portfolio on October 31. The stock lost more than two-thirds of its value this year. Then there was American International Group (AIG), once the country’s largest insurer. As AIG’s stock went into a steep dive in June, Lange made a big bet that it would bounce back. Instead it went into the tank and has been hovering between $1.50 and $2 a share. That’s down from $59 at the start of the year. (Magellan itself, by the way, lost 52.2 percent in 2008 through Dec. 12.)

If you’re dealing with “play money” that you can easily afford to lose (and this kind of money is getting pretty scarce these days), making bets on individual stocks might be interesting entertainment that doesn’t require flying to Las Vegas. But how could managers like Henry Lange and Bill Miller “play” like that with important money that serious investors were counting on them to manage prudently?

I think there are at least a couple of important answers.

First, these managers did not and do not have fiduciary responsibility to their shareholders. They may (and should) personally own substantial amounts of the funds they manage. But they are not legally responsible to act exclusively in the best interests of shareholders.

Second, as noted above, Miller and Lange are hired to beat the market. Nobody can do that without doing something different than what the market is doing. And that means they have to outfox or outguess other investors. In other words, they have to rely on some combination of judgment and luck; this always involves taking more risk. And in years like 2008, taking more risk means exposing your assets to greater losses.

Bill Miller is a contrarian. He calls himself a value investor, buying stocks that other investors have beaten down in price. Over long periods of time, such stocks in the aggregate have outperformed the broad market averages. To own many value stocks as an asset class can be very beneficial. We advocate owning value stocks, both U.S. and international, both large and small, as part of a well diversified portfolio. But we don’t advocate buying individual value stocks or even owning a few dozen, as Miller does in his fund.

When managers like Miller and Lange choose stocks that do manage to outperform the market, many people regard those managers as geniuses. And when they choose stocks that go into the tank, those managers may look like dopes. I don’t think either description is accurate. No genius would load up heavily on a single company that was obviously heading toward fast failure. And nobody who’s a dope could possibly land the jobs held by Lange and Miller. These are very bright men who work hard.

The way I see it, when they pick stocks that win, these men are lucky. When their stock picks lose, they are unlucky. If there’s anybody who’s a dope in this picture, I wonder if it’s the investor who relies so heavily on a manager whose job description requires him to take above-average risks … especially when there are plenty of less expensive alternatives that entail less risk and more upside potential.

I am talking about owning a broadly diversified portfolio of index funds. Over the years, that portfolio has outperformed the gurus, hands down. Although it is based on numbers only through last June, the article on our web site called “Ten years of superior performance was no accident” carries a message that’s just as valid now as it was at mid-year.

The message is simple: Investors can beat the crowd without having to try to beat the market.   

Tom Cock is a financial educator for Merriman