How to Get the Maximum Returns Out of Your Portfolio

Jason is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

According to Mark Hulbert, investors collectively spend around $100 billion a year trying to beat the market. This includes fees charged by active mutual funds, hedge funds, and active ETF's. Unfortunately, for those investors, active funds have woefully underperformed the market. 

In 2012, 66% of all U.S. equity mutual funds underperformed when matched against the S&P. In 2011, 84% underperformed. The hedge fund industry isn't doing any better. The average hedge fund has underperformed the index over the past four years and the first half of this year as well.

The active part plays a big part in the underperformance  Active funds trade in and out of positions which generally generates slippage. Some of the trading may be short-term and subject to higher capital gains tax. Finally, fund managers may be subjected to the same emotions such as fear and greed that cause the average investor to sell during market panics and buy at market tops.

For most investors, a better bet would be to buy low cost passive index ETFs. Below are three good 'passive' choices.

The S&P 500 ETF

SPDR S&P 500 (NYSEMKT: SPY) is the ETF for the S&P 500, or the largest 500 domestic companies as determined by Standard & Poor's. Since it is a reflection of the S&P, the ETF is very diversified and broadly represents the U.S. economy as a whole. With the U.S. economy recovering, housing booming, and corporations starting to hire, the future for the S&P ETF looks bright. The past returns for SPDR S&P 500 ETF are not too shabby either. The ETF has had a three-year performance of 18.25%, five-year performance of 6.92%, and 10-year performance of 7.19%. It has a dividend yield of 2%, an annual fee of only 0.09%, and has generated returns of almost 20% year to date.

The Dividend Aristocrat ETF 

Another good choice for the passive investor is the SPDR S&P Dividend (NYSEMKT: SDY).

According to the investment manager SSgA Funds, the ETF is:

"SPDR S&P Dividend ETF seeks to closely match the returns and characteristics of the S&P High Yield Dividend Aristocrats Index (the Index). The Index is designed to measure the performance of the 60 highest dividend yielding S&P Composite 1500 Index constituents that have followed a managed-dividends policy of consistently increasing dividends every year for at least 25 consecutive years. "

Purchasing the Dividend Aristocrats index has historically been a good strategy. The companies in the Dividend Aristocrat index are generally great companies with large moats, pricing power, and sustainable durable advantages such as Johnson & Johnson or Proctor & Gamble. The index has beaten the S&P 500 over the past 25 years by an annualized 2.7%, and has experienced only 80% of the volatility.

Dividend Aristocrat stocks greatly outperform in market downturns and keep up when the economy is doing well. For example, in 2008, while the general market fell by 37%, the Dividend Aristocrat index fell only 22%. The ETF has a dividend yield of 2.5%, an annual fee of only 0.35%, and has generated returns of almost 30% year to date.

The Oracle of Omaha

Lastly, investing in Berkshire Hathaway (NYSE: BRK-B) would be a great choice. Warren Buffett has shown that he can beat the market. $10,000 invested in Berkshire in 1965 would be $60 million today. Berkshire is well diversified with divisions in everything from railroads to chemicals to insurance companies. Many of those companies and Berkshire portfolio investments are defensively positioned, have sustainable durable advantages, and wide, growing moats. They could be on autopilot in case Buffett decides to retire and still do well. 

The future for Berkshire looks bright, as well. Buffett's chosen investment successors, Todd Combs and Ted Weschler, have been outperforming the index and beating the Oracle of Omaha himself. If Buffett's investment mangers should fail to live up to the Oracle of Omaha's track record, Berkshire Hathaway might still do well. Many of the divisions such as Burlington Northern Railroad and Lubrizol are proxies for the U.S. economy, and would probably do well as the economy expands. Analysts, on average, expect Berkshire to grow earnings at a 5.4% rate going forward for the next five years. While it has no dividend, Berkshire stock has returned over 30% year to date.

Conclusion

Generally speaking, active investing is not a sure way to make money. Investors do not always get what they pay for. The safer bet is to invest in passive, low cost, and diversified ETF's such as SPDR S&P 500 ETF Trust or SPDR S&P Dividend. Another good bet is to invest with someone who has done it all before, Warren Buffett's Berkshire Hathaway. With the U.S. economy gaining strength, riding low cost passive ETF's and Berkshire Hathaway may be a good bet.

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Jason Bond has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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