The S&P 500 is one of the most widely used benchmarks for the US stock market. It tracks the performance of 500 large-cap companies across various sectors and industries. Many investors use it as a proxy for the overall market and try to match or exceed its returns.
But what if you want to beat the S&P 500
and achieve higher returns than the average market participant? Is it possible
to outperform this index consistently and reliably? And if so, what are some of
the strategies and tips that can help you do that?
In this article, we will answer these
questions and show you how to beat the S&P 500 with some simple and
effective strategies. We will also provide you with some examples and resources
that can help you implement these strategies and monitor your results.
Table of Contents
·
What is the S&P 500 and why is it hard to beat?
·
Strategy 1: Invest in individual stocks that have strong fundamentals
and growth potential
·
Strategy 2: Diversify your portfolio with other asset classes
and regions
·
Strategy 3: Use index funds and ETFs that track different
segments of the market
·
Strategy 4: Leverage the power of compounding and reinvest your
dividends
·
Strategy 5: Avoid fees, taxes, and emotional mistakes that can
erode your returns
·
Conclusion
What is the S&P
500 and why is it hard to beat?
The S&P 500 is an index that measures the
performance of 500 large-cap US companies. It is calculated by weighting each
company by its market capitalization, which is the total value of its
outstanding shares. The index is updated every 15 seconds during trading hours
and is widely used as a benchmark for the US stock market.
The S&P 500 has a
long history of delivering impressive returns to investors. Since its inception
in 1957, it has generated an average annual return of about 10%, including
dividends. This means that if you had invested $1,000 in the index in
1957, it would have grown to more than $1.6 million by the end of 20201.
However, beating the
S&P 500 is not an easy task. According to a report by S&P Dow Jones Indices, only 11%
of active US equity funds managed to outperform the index over the 10-year
period ending in June 20202. This means that 89% of the funds either
matched or underperformed the index, often with higher fees and risks.
There are several reasons why beating the
S&P 500 is challenging. Some of them are:
·
The S&P 500 is a diversified and efficient index that
captures the performance of the US economy and its leading companies. It is
hard to find individual stocks or sectors that can consistently outperform the
index over the long term.
·
The S&P 500 is a market-cap-weighted index, which means that
it gives more weight to the largest and most successful companies in the
market. These companies tend to have strong competitive advantages, loyal
customers, and high profitability. They also tend to be more resilient and
adaptable to changing market conditions and consumer preferences.
·
The S&P 500 is a passive index, which means that it does not
incur any fees, taxes, or trading costs. These expenses can significantly
reduce the net returns of active investors who try to beat the index by buying
and selling stocks frequently.
·
The S&P 500 is a rational and emotionless index, which means
that it does not suffer from any behavioral biases or psychological errors that
can affect the decisions of human investors. These errors can include
overconfidence, confirmation bias, loss aversion, and herd mentality, among
others.
Given these challenges, how can you beat the
S&P 500 and achieve higher returns than the average market participant?
Here are some of the strategies and tips that can help you do that.
Strategy 1: Invest in
individual stocks that have strong fundamentals and growth potential
One of the most common and popular ways to
beat the S&P 500 is to invest in individual stocks that have strong
fundamentals and growth potential. These are stocks that belong to companies
that have:
·
A clear and compelling vision and mission
·
A competitive advantage or a unique value proposition
·
A loyal and growing customer base
·
A high-quality product or service that solves a real problem or
meets a real need
·
A strong and sustainable financial performance
·
A positive and innovative corporate culture
·
A visionary and ethical leadership team
·
A favorable and attractive industry outlook
These are the kinds of stocks that can
generate above-average returns over the long term, as they can grow their
earnings and revenues faster than the market average. They can also benefit
from positive market sentiment, as investors recognize their value and
potential.
However, finding and investing in these stocks
is not easy. It requires a lot of research, analysis, and due diligence. It
also requires a lot of patience, discipline, and conviction, as these stocks
can be volatile and unpredictable in the short term.
Some of the tools and resources that can help
you find and invest in these stocks are:
·
Stock screeners: These are online tools that allow you to filter
and sort stocks based on various criteria, such as market cap, sector,
industry, growth rate, valuation, dividend yield, and more. Some of the popular
stock screeners are [Finviz], [Yahoo Finance], and [TradingView].
·
Stock analysis websites: These are websites that provide
detailed and comprehensive information and analysis on individual stocks, such
as financial statements, ratios, charts, news, earnings, ratings, and more.
Some of the popular stock analysis websites are [Morningstar], [Seeking Alpha],
and [Motley Fool].
·
Stock newsletters and podcasts: These are sources of curated and
insightful content on individual stocks, such as recommendations, opinions,
interviews, reviews, and more. Some of the popular stock newsletters and
podcasts are [Stock Advisor], [Rule Breakers], and [Market Foolery].
Some examples of individual stocks that have
strong fundamentals and growth potential and have beaten the S&P 500 over
the past 10 years are:
·
Amazon (AMZN): The e-commerce and technology giant that has
revolutionized online shopping, cloud computing, digital streaming, artificial
intelligence, and more. It has grown its revenue by 27% annually and its stock
price by 26% annually over the past 10 years.
·
Apple (AAPL): The consumer electronics and software giant that
has created iconic products such as the iPhone, iPad, Mac, iPod, Apple Watch,
AirPods, and more. It has grown its revenue by 16% annually and its stock price
by 25% annually over the past 10 years.
·
Netflix (NFLX): The streaming entertainment service that has
disrupted the traditional media industry with its original and exclusive
content, such as Stranger Things, The Crown, The Queen’s Gambit, and more. It
has grown its revenue by 29% annually and its stock price by 40% annually over
the past 10 years.
Strategy 2: Diversify
your portfolio with other asset classes and regions
Another way to beat the S&P 500 is to
diversify your portfolio with other asset classes and regions. These are
investments that have different characteristics, risks, and returns than the US
large-cap stocks that make up the index. They can help you reduce your
portfolio volatility, enhance your returns, and hedge against market downturns.
Some of the asset classes and regions that you
can diversify your portfolio with are:
·
Small-cap stocks: These are stocks that belong to companies that
have a market capitalization of less than $2 billion. They tend to have higher
growth potential, as they can benefit from niche markets, innovation, and
acquisitions. They also tend to have higher risk and volatility, as they are
more sensitive to economic cycles, competition, and regulation.
·
International stocks: These are stocks that belong to companies
that are based outside the US. They can offer exposure to different economies,
markets, cultures, and opportunities. They can also benefit from favorable
currency movements, lower valuations, and higher dividends. They also have
higher risk and volatility, as they are subject to political, social, and
environmental uncertainties, as well as higher fees and taxes.
·
Emerging market stocks: These are stocks that belong to
companies that are based in developing countries, such as China, India, Brazil,
Russia, and more. They can offer exposure to faster-growing and more dynamic
economies, markets, and consumers. They can also benefit from structural
reforms, demographic trends, and technological advancements. They have the
highest risk and volatility, as they are prone to instability, corruption, inflation,
and currency fluctuations.
·
Bonds: These are fixed-income securities that represent loans to
governments or corporations. They pay a fixed amount of interest and return the
principal at maturity. They can offer a steady and predictable source of income,
as well as a lower risk and volatility than stocks. They can also act as a
buffer against stock market declines, as they tend to have a negative or low
correlation with stocks.
·
Real estate: This is a physical or tangible asset that
represents ownership of land or property. It can offer a source of rental
income, as well as appreciation in value over time. It can also offer tax
advantages, such as depreciation and deductions. It can also act as a hedge
against inflation, as it tends to rise in value when prices increase.
·
Commodities: These are natural resources or raw materials that
are traded on exchanges, such as gold, oil, wheat, coffee, and more. They can
offer exposure to different supply and demand factors, as well as
diversification benefits. They can also act as a hedge against inflation, as
they tend to rise in value when prices increase. They have high risk and
volatility, as they are affected by weather, geopolitics, speculation, and
production costs.
Some of the tools and resources that can help
you diversify your portfolio with other asset classes and regions are:
·
Asset allocation calculators: These are online tools that help
you determine the optimal mix of assets for your portfolio, based on your risk
tolerance, time horizon, and investment goals. Some of the popular asset
allocation calculators are [Personal Capital], [Portfolio Visualizer], and
[Vanguard].
·
Mutual funds and ETFs: These are pooled investment vehicles that
allow you to invest in a basket of securities that track a specific asset
class, region, sector, or strategy. They offer diversification, convenience,
and low-cost access to various markets and opportunities. Some of the popular
mutual funds and ETFs that can help you diversify your portfolio are [Vanguard
Total Stock Market Index Fund (VTSMX)], [Vanguard Total International Stock
Index Fund (VGTSX)], [Vanguard Total Bond Market Index Fund (VBMFX)], [SPDR
Gold Shares (GLD)], and [iShares MSCI Emerging Markets ETF (EEM)].
·
Robo-advisors: These are online platforms that use algorithms
and artificial intelligence to create and manage your portfolio, based on your
risk profile, preferences, and goals. They offer automated, personalized, and
low-cost investment advice and services. Some of the popular robo-advisors are
[Betterment], [Wealthfront], and [Acorns].
Some examples of diversified portfolios that
have beaten the S&P 500 over the past 10 years are:
·
The All Weather Portfolio: This is a portfolio that was designed
by Ray Dalio, the founder of Bridgewater Associates, one of the largest and
most successful hedge funds in the world. It aims to perform well in any
economic environment, by balancing risk across different asset classes. It
consists of 30% stocks, 40% long-term bonds, 15% intermediate-term bonds, 7.5%
gold, and 7.5% commodities. It has generated an average annual return of 11.5%
over the past 10 years, with a standard deviation of 7.6%.
·
The Ivy Portfolio: This is a portfolio that was inspired by the
endowment funds of Harvard and Yale, two of the most prestigious and wealthy
universities in the world. It aims to achieve high returns with low volatility,
by diversifying across different asset classes and regions. It consists of 20%
US stocks, 20% international stocks, 20% emerging market stocks, 20% real
estate, and 20% commodities. It has generated an average annual return of 10.8%
over the past 10 years, with a standard deviation of 10.4%.
·
The Permanent Portfolio: This is a portfolio that was created by
Harry Browne, a libertarian economist and author. It aims to preserve and grow
wealth in any economic scenario, by allocating equally to four asset classes
that have different characteristics and reactions to market conditions. It
consists of 25% stocks, 25% long-term bonds, 25% cash, and 25% gold. It has
generated an average annual return of 8.2% over the past 10 years, with a
standard deviation of 6.8%.
Strategy 3: Use index
funds and ETFs that track different segments of the market
Another way to beat the S&P 500 is to use
index funds and ETFs that track different segments of the market. These are
funds that aim to replicate the performance of a specific index, such as the
S&P 500, the Nasdaq 100, the Russell 2000, and more. They offer a simple
and low-cost way to access various markets and opportunities, without having to
pick individual stocks or sectors.
However, not all index funds and ETFs are
created equal. Some of them can offer higher returns than the S&P 500, by
focusing on different segments of the market that have higher growth potential,
lower valuations, or higher dividends. Some of them can also offer lower risk
than the S&P 500, by focusing on different segments of the market that have
lower volatility, higher quality, or higher momentum.
Some of the index funds and ETFs that can help
you beat the S&P 500 are:
·
Growth funds and ETFs: These are funds that invest in stocks
that have high earnings and revenue growth rates, as well as high expectations
for future growth. They tend to outperform the market when the economy is
expanding and innovation is thriving. They also tend to have higher risk and
volatility, as they are more sensitive to market swings and valuation changes.
Some of the popular growth funds and ETFs are [Vanguard Growth Index Fund
(VIGAX)], [iShares Russell 1000 Growth ETF (IWF)], and [Invesco QQQ Trust
(QQQ)].
·
Value funds and ETFs: These are funds that invest in stocks that
have low prices relative to their earnings, book value, dividends, or other
metrics. They tend to outperform the market when the economy is contracting and
value is scarce. They also tend to have lower risk and volatility, as they are
more resilient and stable. Some of the popular value funds and ETFs are
[Vanguard Value Index Fund (VVIAX)], [iShares Russell 1000 Value ETF (IWD)],
and [SPDR S&P 500 Value ETF (SPYV)].
·
Dividend funds and ETFs: These are funds that invest in stocks
that pay high and consistent dividends, which are distributions of profits to
shareholders. They tend to outperform the market when the interest rates are
low and income is in demand. They also tend to have lower risk and volatility,
as they are more mature and reliable. Some of the popular dividend funds and
ETFs are [Vanguard Dividend Appreciation Index Fund (VDADX)], [iShares Core
Dividend Growth ETF (DGRO)], and [SPDR S&P Dividend ETF (SDY)].
Strategy 4: Leverage
the power of compounding and reinvest your dividends
Another way to beat the S&P 500 is to
leverage the power of compounding and reinvest your dividends. Compounding is
the process of earning interest on your interest, or returns on your returns.
It can help you grow your wealth exponentially over time, as your money works
for you and generates more money.
Dividends are payments that some companies
make to their shareholders, as a way of sharing their profits and rewarding
their loyalty. They can provide you with a steady and passive source of income,
as well as a cushion against market downturns. They can also help you boost
your returns, if you reinvest them back into the same or other stocks, instead
of spending them or keeping them in cash.
By combining the power of compounding and
reinvesting your dividends, you can significantly increase your chances of beating
the S&P 500 over the long term. This is because you can benefit from both
the capital appreciation and the income generation of your investments, as well
as the snowball effect of your reinvested dividends.
Some of the tools and resources that can help
you leverage the power of compounding and reinvest your dividends are:
·
Compound interest calculators: These are online tools that help
you estimate how much your money can grow over time, based on your initial
investment, interest rate, compounding frequency, and time period. Some of the
popular compound interest calculators are [Investor.gov], [Moneychimp], and
[The Calculator Site].
·
Dividend calculators: These are online tools that help you
estimate how much income you can generate from your dividend-paying stocks,
based on your investment amount, dividend yield, dividend growth rate, and time
period. They also help you estimate how much your income and portfolio can grow
if you reinvest your dividends, instead of taking them as cash. Some of the
popular dividend calculators are [Dividend Channel], [Dividend.com], and
[Dividend Investor].
·
DRIPs: These are dividend reinvestment plans that allow you to
automatically reinvest your dividends into more shares of the same stock,
without paying any fees or commissions. They can help you save time and money,
as well as increase your ownership and returns over time. Some of the popular
DRIPs are [Coca-Cola (KO)], [Johnson & Johnson (JNJ)], and [Procter &
Gamble (PG)].
Some examples of the power of compounding and
reinvesting your dividends are:
·
If you had invested $10,000 in the S&P 500 index fund in
1980, and reinvested all your dividends, your investment would have grown to
more than $1.2 million by the end of 2020, with an average annual return of
11.8%. If you had not reinvested your dividends, your investment would have
grown to only about $600,000, with an average annual return of 9.3%.
·
If you had invested $10,000 in Apple (AAPL) stock in 1980, and
reinvested all your dividends, your investment would have grown to more than
$50 million by the end of 2020, with an average annual return of 25.6%. If you
had not reinvested your dividends, your investment would have grown to only
about $40 million, with an average annual return of 24.8%
Strategy 5: Avoid
fees, taxes, and emotional mistakes that can erode your returns
Another way to beat the S&P 500 is to
avoid fees, taxes, and emotional mistakes that can erode your returns. These
are expenses and errors that can reduce your net returns and prevent you from
achieving your investment goals. They can also make it harder for you to
outperform the index, as you have to overcome a higher hurdle rate.
Some of the fees, taxes, and emotional
mistakes that you should avoid are:
·
Fees: These are charges that you pay to brokers, advisors, fund
managers, or other intermediaries for their services and products. They can
include commissions, spreads, loads, expense ratios, management fees, and more.
They can vary depending on the type, size, and frequency of your transactions,
as well as the quality and complexity of your investments. They can eat into
your returns and compound over time, especially if you trade frequently or
invest in actively managed funds. You should aim to minimize your fees by
choosing low-cost and passive investments, such as index funds and ETFs, and by
trading less and holding more.
·
Taxes: These are levies that you pay to the government on your
income, capital gains, dividends, or other sources of income. They can vary
depending on your tax bracket, filing status, location, and type of account.
They can reduce your returns and compound over time, especially if you trade
frequently or invest in taxable accounts. You should aim to minimize your taxes
by choosing tax-efficient and tax-advantaged investments, such as municipal
bonds, Roth IRAs, or 401(k)s, and by trading less and holding more.
·
Emotional mistakes: These are blunders that you make due to your
emotions, biases, or impulses, rather than your logic, reason, or plan. They
can include chasing performance, timing the market, selling low, buying high,
overreacting, underreacting, and more. They can impair your judgment and
performance, and cause you to deviate from your strategy and goals. You should
aim to avoid emotional mistakes by following a disciplined and consistent
approach, based on your risk tolerance, time horizon, and investment
objectives, and by reviewing and adjusting your portfolio periodically, rather
than constantly.
Some of the tools and resources that can help
you avoid fees, taxes, and emotional mistakes are:
·
Fee calculators: These are online tools that help you estimate
how much fees you are paying for your investments, and how they affect your
returns over time. Some of the popular fee calculators are [Personal Capital],
[NerdWallet], and [Investopedia].
·
Tax calculators: These are online tools that help you estimate
how much taxes you are paying for your investments, and how they affect your
returns over time. Some of the popular tax calculators are [TurboTax], [H&R
Block], and [TaxAct].
·
Behavioral finance books and podcasts: These are sources of
knowledge and insight on the psychological and emotional aspects of investing,
and how to overcome them. Some of the popular behavioral finance books and
podcasts are [Thinking, Fast and Slow] by Daniel Kahneman, [The Psychology of
Money] by Morgan Housel, and [Animal Spirits] by Michael Batnick and Ben
Carlson.
Conclusion
Beating the S&P 500 is not impossible, but
it is not easy either. It requires a lot of research, analysis, discipline, and
patience. It also requires a lot of luck, as the market can be unpredictable
and irrational.
However, by following some of the strategies
and tips that we have discussed in this article, you can increase your chances
of beating the S&P 500 and achieving higher returns than the average market
participant. These strategies and tips are:
·
Invest in individual stocks that have strong fundamentals and
growth potential
·
Diversify your portfolio with other asset classes and regions
·
Use index funds and ETFs that track different segments of the
market
·
Leverage the power of compounding and reinvest your dividends
·
Avoid fees, taxes, and emotional mistakes that can erode your
returns
We hope that this article has been helpful and
informative for you. If you have any questions, comments, or feedback, please
feel free to share them with us. We would love to hear from you and learn from
you.
Thank you for reading and happy investing! 😊