Want to know how to beat the market? “Sure,” you may say, “it’s possible. If I spent my every waking hour researching undervalued companies.”
But, what if I told you I had a fool proof way for those with time to spare to win against the market, without searching rummage shops for discarded crystal balls, or trusting in your uncle’s stock advice? And on top of that, even the most novice investor can use this strategy and win?
Impossible? Read on.
The way to beat the market isn’t by finding the next hot mutual fund manager or dedicating yourself to becoming the next Warren Buffett, it’s simply how you manage your tilt.
Your “tilt” is how your portfolio is invested in the market. You hopefully are diversified over the universe of stocks, but your tilt tells your holdings of large or mega companies versus small or medium sized firms. It also tells if you tend to invest in companies trading at premiums or discounts to the overall market.
More often than not, most retirement investors I meet are “top heavy,” investing in a mix that doesn’t stray too far from the market represented to a higher degree by largest companies, or a mix that resembles the S&P 500 (most people refer to this as the market). This is often the case if you’re investing in a Target Retirement Date fund, or any other fund or funds, or have a managed account.
However, is this the best mix when you’re young and have time to take risks?
By shifting the weights of your portfolio towards areas of the market that tend to have higher degrees of return (and volatility), you may supercharge your retirement accounts when starting out, specifically by using a greater share than the market of smaller companies with more room to grow, and stocks that are trading at a discount to the market (value stocks).
How much better can you do than the S&P 500 by including more small and value in your mix?
The S&P 500 averaged 9.5% per year since 1928. One can not invest in an index, but if you could and had invested $1 in the S&P 500 way back then, you would have had $3,530 at the end of 2012.
Using a similar strategy of owning the stock market, but by shifting the tilt to include more small, and more value, a portfolio that tracks Dimensional Fund Advisors US Adjusted Market Value Index would have averaged 11.7% during the same period. An investment of $1 would have grown to $11,998.
A strategy of tilting more towards small and value stocks will be more volatile than the market, so don’t think this approach will only lead to gains; you still have to master the skill of not watching your accounts rise and fall in the short run. However, while you’re accumulating and have a long time horizon, volatility can be your friend.
The preceding blog was originally published by the Financial Planning Association®(FPA®). To view the original blog please visit the FPA Web site.