Simpler is better, less is more, and things that sound too good to be true usually aren’t.
Got a few hundred bucks you know you won’t be needing anytime soon and want to do something productive with it? If you’re reading this, then you probably already realize the stock market is your best long-term bet; it’s the only way to meaningfully outpace the impact of inflation. But how exactly? There are countless ways to put your money to work in the market.
As it turns out, your best option is probably just buying into the market as a whole and participating in its broad, long-term growth despite its occasional stumble. And one of the best ways to do that is with a stake in the S&P 500 ETF Trust (SPY -1.58%).
If you’re familiar with this ETF, it may seem a bit boring. Keep reading though. You’re about to get an eye-opener. And if you’re not familiar with it, it’s pretty simple actually.
The S&P 500 ETF Trust is a way of investing in the S&P 500 index, which acts as a barometer for almost the entire stock market. You obviously can’t “buy” the S&P 500, and holding 500 individual stocks isn’t feasible for the average person either. What you can purchase, however, is a pre-made basket of the same stocks that make up the S&P 500. You simply buy and sell these baskets as a single holding called an exchange-traded fund, or ETF.
(OK, veteran investors, you can get back on board now.)
But why would you want to merely mirror the broad market’s performance when you can choose individual stocks capable of beating the market? Because you’re probably not going to actually beat the market.
There are times when your portfolio will outperform the S&P 500. In some cases, you may even dramatically beat it — for a short while. Just know that not even most professional stock pickers can do it, and the ones who can don’t do so for very long.
Standard & Poor’s keeps close tabs on all major mutual funds, regularly reporting how many of them outperform their benchmark indexes. Most of the time the majority of them don’t. Last year, for instance, only a little over 40% of large-cap funds available to U.S. investors beat the S&P 500. Slightly less than 60% of them trailed the market barometer.
And the numbers get worse the longer the time frame. Over the course of the past five years, only 21% of large-cap mutual funds beat the S&P 500. For the past 10 years, less than 13% of them achieved that feat. For the past 15 years, only 12% of large-cap funds offered in the United States outperformed the S&P 500.
Things don’t look much different when you’re looking at small-cap or international funds either. Oh, and most of the market-beating funds in one time frame aren’t one of the market-beating funds in another time frame. If these well-equipped, full-time money managers can’t do it, what’s going on?
Generally speaking, these managers face the exact same challenges small, individual investors like yourself face. These are primarily the market’s unpredictable factors (like a pandemic), unpredictable developments (such as the advent of artificial intelligence or international trade wars), or unpredictable investor responses (like sell-offs meant to sidestep a recession that never actually take shape). If you’re in the market long enough, one or more of these stumbling blocks will trip you up at least once and likely more than once. There’s nothing you can realistically do about it.
Still want to try? OK. It is possible to beat the market even if the odds are stacked against you. You just have to make sure you fully capitalize on all of your advantages. One of your biggest is your relatively small size. You may be able to invest thousands of dollars in a stock without impacting that stock’s price. That’s not true for fund managers. They’re often placing trades worth millions (if not billions) of dollars. These can push prices to disadvantageous levels.
Just don’t fall into the trap of trading more often simply because you can. More frequent trading usually results in subpar results, because these trades are often emotionally charged rather than reasoned.
Another advantage: You may be able to specialize in a particular sector or kind of trade. Beating the market also requires a great deal of research. But not quite the research you may think. You might want to focus a little less on individual companies and a little more on technological, sociocultural, and economic trends. These are the ultimate drivers of a particular company’s success, which eventually is the ultimate driver of an individual stock’s price.
That being said, don’t ignore a company’s particulars either. How is it capitalizing on its opportunities? Can it continue to do so? Will it? This takes some digging, and it can get complicated. Take Nvidia as an example. We now know that it’s the king of artificial intelligence hardware. But investors really needed to know it was going to become the AI hardware market leader even before artificial intelligence became a megatrend.
You’ll also need to prepare for the temptation of buying or selling stocks simply because you feel unproductive if you don’t. Most of the time the best decision you can make is doing nothing. This might help: Warren Buffett’s Berkshire Hathaway is sitting on $168 billion in cash because right now the Oracle of Omaha doesn’t see anything out there worth investing in. Yet, it’s beating the market.
If this all sounds like a lot of work, that’s because it is a lot of work. In fact, it’s probably a full-time job. It’s also a job that never ends. Things are forever changing, requiring ongoing updates of your own research. And if you’re thinking you’ll just buy this sort of research, forget it. By the time you get the results of someone else’s digging, it’s old news. You’re also trusting they know what they’re doing. They may not.
Or you could just do the easier, completely passive, higher-odds thing with your $500: Park it in the S&P 500 ETF Trust and then leave it alone — a strategy Warren Buffett wholly supports, by the way. This particular position wouldn’t require any maintenance or monitoring. You’re simply betting on the market’s long-term track record of returning an average of about 10% per year, which isn’t a bad bet at all. Never even mind the fact that owning this index-based ETF means you can spend your time doing something besides staring at a computer screen scouring the internet for the next market-beating winner.
