Many investors seek to outperform the stock market over the long run. Indeed, the track records of well-known value investors such as Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) Chairman Warren Buffett (Trades, Portfolio) are likely to be encouragement to do so. The Oracle of Omaha's 20% annualized return from 1965 to 2020, versus 10.2% for the S&P 500, has lifted his net worth to in excess of $100 billion.
However, not all investors beat the market. In fact, a large proportion of investor portfolios lag the S&P 500 over the long run. In some cases, they may even lose money overall.
Clearly, there are likely to be a variety of reasons for this. However, a common theme is that many investors underestimate the time needed to develop the detailed knowledge required to identify the most attractive stocks in a particular industry.
Indeed, they may invest in companies without taking the time to undertake thorough due diligence on their prospects, or those of their peers. The result may be that they fail to purchase the most attractive companies in a specific sector, thereby increasing their chances of underperforming the stock market.
Buffett’s commitment
Before they seek to outperform the market, prudent investors should determine how much time they have available to analyze stocks. This practice may provide them with guidance as to their capacity to develop the detailed knowledge required, albeit in a limited number of sectors, to beat the S&P 500’s return. This viewpoint has previously been expressed by Buffett when discussing the prospect of trying to outperform the stock market. As he once said:
“If you like spending six to eight hours per week working on investments, do it. If you don't, then dollar-cost average into index funds.”
Of course, Buffett has dedicated his life to researching stocks. For many investors, this is not an option because they require an income in the short run. Meanwhile, other individuals may have commitments, such as family, that mean they are unable to commit what is essentially an extra day’s work per week to seek out the most appealing stocks.
For those individuals, an index tracker fund could be a surprisingly worthwhile option. The S&P 500 has generated an annualized total return of 10.9% over the past 50 years. While past performance is not necessarily indicative of future success, simply buying and holding a fund that tracks the stock market, for a low fee, could produce attractive returns.
Outperforming the professionals
Indeed, an S&P 500 tracker fund is likely to produce superior returns than the majority of professional fund managers. Around 78% of U.S. large-cap fund managers underperformed the benchmark index between 2015 and 2020. While time available to research companies is unlikely to have held back their returns, the fees they charge make it more difficult for them to outperform the stock market.
Active investors who purchase individual stocks may have a competitive advantage over professionals due to the lack of, or at least lower, fees and charges that are deducted from their returns. While this may attract many investors to the challenge of beating the market, ensuring they have ample time to unearth the most attractive stocks could be of even greater importance.
