3 Ways to Beat the Market

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Intelligent investors don't come in one shape or size, and neither do market-beating strategies. I have my favorite approach (see No. 3 below), but choosy types like choices. Here are three of 'em:

1. Be a bear.
If you're the pessimistic type, you can stuff your nest egg under a mattress (or into fixed-income investments) and hope that stock prices will fall. Pessimists of the daredevil persuasion, meanwhile, can "short" the market, which is tantamount to making an active bet that equities will hit the skids.

The trouble with this strategy, of course, is that over time, stock prices have risen, giving long-term types a big bang for their investment bucks. The upshot? As formulas for beating the market, staying on the sidelines or betting on a downturn are short-term solutions. They might work over a particular market cycle -- see 2000 to 2002 for the gory details -- but if history is any guide, investing in (rather than against) the market is the better tack, which leads us to ...

2. Be a bull.
Folks with the time and inclination to research and invest in individual stocks can make out like the proverbial bandits. Just ask shareholders in the likes of Apple (Nasdaq: AAPL), Potash (NYSE: POT), Amazon.com (Nasdaq: AMZN), and Qualcomm (Nasdaq: QCOM). For the 10 years that ended with 2007, each of those companies delivered an annualized gain of more than 25%, easily surpassing the S&P 500's return of roughly 5.6% over the period.

And while the margin of victory hasn't been quite that wide, Sasol (NYSE: SSL), Hansen Natural (Nasdaq: HANS), and Guess? (NYSE: GES) -- three stocks whose price-to-earnings ratios currently fall below the S&P's -- have gotten the long-term job done, too.

Thing is, while cherry-picking individual winners packs plenty of rearview-mirror appeal, it's harder said than done. Indeed, of all the aforementioned, only three -- Potash Corp., Qualcomm, and Sasol -- have made money for shareholders this year. The rest are down year to date, and while that may be good news for prospective investors, current shareholders may be licking their wounds.

That point underscores the riskiness of hitching your nest egg to a portfolio of individual picks, but not to worry: If you hate losing money but still want to beat the market, consider option No. 3:

3. Be a realist.
World-class mutual funds are the best vehicle for the lion's share of your long-term investment dollars. The diversification that funds provide takes the edge off the market's occasionally sharp turns. They make it relatively easy to assemble a razor-sharp portfolio, too: From emerging markets to municipal bonds, mutual funds have got all the asset classes covered.

The question, of course, is how to identify worthy prospects, the kind of picks that are worth building your portfolio around.

The Foolish bottom line
The answer -- or at least a part of it -- is to look for funds with below-average price tags and managers whose long-term track records indicate that they know how to navigate both downturns and upswings.

In fact, those are the core criteria I'm using to develop the Fool's latest and greatest investment service, Ready-Made Millionaire, where we've assembled a "best-of-breed" portfolio of funds, stocks, and ETFs that are built for the long haul. For more information on joining us as we build wealth by delivering market-surpassing performance, simply enter your email address in the box below.