Some investors may feel they need to take huge risks to generate high returns from the stock market. For example, they may purchase struggling businesses in the hope of a turnaround or they may buy extremely small companies due to their higher perceived return potential versus larger stocks.
Meanwhile, other investors may determine they need to devise an exceptional investment strategy to deliver attractive capital gains. For instance, they may seek to create a complex formula that apparently provides them with a probability edge over their peers.
However, it is unnecessary to pursue either of these strategies to be a successful stock market investor. Instead, a simple strategy that is executed in a disciplined manner over the long run could be far more effective.
Index tracking
Indeed, Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) Chairman Warren Buffett (Trades, Portfolio) has previously commented on this subject. He once said, “It is not necessary to do extraordinary things to get extraordinary results.”
In fact, even investing in an index fund that tracks the S&P 500 could generate surprisingly high returns over the long run. The index has produced an annualized total return in excess of 10% over the past 50 years. Assuming the same rate of growth in future would cause a $100,000 portfolio today to be worth in excess of $1 million within 25 years.
Moreover, the index’s return could be significantly higher than the gains made by actively managed portfolios. Indeed, the S&P 500’s returns were greater than those of 85% of U.S. large-cap fund managers between 2009 and 2019.
Value investing
Of course, many investors wish to outperform the stock market instead of merely matching its returns. In this regard, I also believe a simple strategy could be more effective than a complex plan or a high-risk strategy.
Indeed, a buy-and-hold strategy that focuses on purchasing fundamentally sound businesses when they trade at fair prices has been a successful route to stock market outperformance for many investors, including Buffett.
Such a strategy allows investors to avoid relatively high-risk stocks through undertaking an assessment of their financial strength. It also means they avoid overpaying for stocks by requiring a discount to their intrinsic value before purchase. And, through buying and holding stocks over a multiyear period, they can benefit from the positive influence of compounding over the long run.
A disciplined approach
Maintaining the discipline to avoid veering away from a simple strategy over the long run is likely to be challenging. That may especially be the case while other investors benefit from taking high risks during the current bull market and espouse the benefits of their complex strategies.
However, investing is a simple task. It essentially requires investors to buy stocks at low prices and sell them at higher prices further down the line. Therefore, it does not require complications or high risk-taking. Berkshire Hathaway’s 20% annualized return since 1965, achieved using Buffett’s simple strategy, is arguably ample evidence to prove this.
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