The Easy Way to Beat the Market
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
If you buy around $50,000 in an ETF like S&P Depository Receipts (NYSEMKT:SPY) and keep reinvesting the dividends for 50 years, you are likely to end with almost one and a half million dollars in real terms, meaning adjusted for inflation. Nobody says it’s fast, but it’s certainly easy to keep your money running in an ETF for the long term, and it can have some surprisingly interesting results.
Market returns are always hard to forecast, but predictability increases as you increase the time frame under analysis. The next five years are harder to forecast than the next 10, but once you start considering several decades, it becomes much more likely to achieve average historical returns. $50,000 invested in an ETF like SPY, which replicates the S&P 500 index, has a very decent probabilities of yielding around a 7% after inflation over the – very – long term, and that would make $1,472,851 to be precise.
If we increase the amount saved, or the return obtained from investments, the target can of course be achieved faster. Besides, the amounts chosen for the example are completely arbitrary; the important thing to consider is that the future value of our capital will depend on three key variables: how much we save, the return obtained from those investments, and the fantastic power of compounding returns over time.
There are different ways to work on improving the return side of the equation, one popular and effective long term strategy is to focus on picking the best individual stocks to beat the markets over time. It can be riskier than investing in ETFs, and it requires more work, but successful stock pickers have the possibility to outperform the markets by a wide margin in the long term.
If I had to choose one individual stock to buy and hold for decades, that would be Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B). The company includes a diversified collection of high quality businesses in sectors like insurance, energy, transport, utilities and consumer, among others, so Berkshire is in itself quite diversified. Even better, Buffett has selected each of Berkshire´s holdings with a long term perspective, planning to hold them “forever.”
Berkshire has outperformed the markets for a wide margin in the long term due to the quality of its holdings. The company has become much bigger now, and Buffett won´t be around forever, so we can reasonably expect a smaller outperformance in the future.
Still, the strategic principles which constitute Buffett´s approach to investing are eternal, and the company will be managed with the same philosophy after Buffett is gone. Decades of performing a few points better than the index are certainly a possibility for Berkshire in the future.
Even for those who prefer staying within the comfortable diversification provided by ETFs, there are many alternatives to consider for outperforming an index like the S&P 500. PowerShares QQQ Trust (NASDAQ: QQQ) is a popular ETF which tracks the NASDAQ 100 index, and it provides exposure to many innovative high growth names, companies like Apple, Google and Amazon, among many others, make the portfolio of this ETF.
Innovation is ultimately one of the most important drivers of investors’ returns in the long run, and these kind of companies are among the most recognized world leaders when it comes to adding value via innovative products and services. Besides, QQQ is trading at an average P/E ratio for its holdings of around 14.5, which is a very reasonable valuation for companies with superior growth prospects.
Focusing on emerging markets is another sound strategy for achieving higher returns in the long term. Higher economic growth, coupled with strong fiscal positions and economies focused on production and exports, instead of services and imports, are some of the factors which should provide superior returns for emerging market stocks in the long term.
WisdomTree Emerging Mkts Small Cap Div (NYSEMKT:DGS) invests in a portfolio of 530 emerging market stocks with small capitalizations and high dividend yields. The portfolio construction sounds like a very smart idea as smaller companies have the best opportunities for growth, and filtering by dividend yields avoids the riskier and more speculative names while at the same time providing income to investors.
Small companies from emerging markets that pay strong dividends bear three individual factors which combined should provide above average performance for this instrument over the following years. This ETF yields 3.3% in dividends and is trading at a very reasonable P/E ratio of 10.5 on average for its holdings.
Many investors would be surprised to make some calculations and see how much the stock market can produce in returns over the long term. Even better, obtaining higher returns than those produced by an index like the S&P 500 doesn´t need to be very risky or complicated. Patience and discipline, on the other hand, are two very important and scarce virtues that investors need to apply in order to stick with this strategy.
acardenal owns shares of DGS. The Motley Fool owns shares of Berkshire Hathaway. Motley Fool newsletter services recommend Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.