Why Aren't You Earning 50% Annual Returns?

Look at the title of this article. Is there any more preposterous question a client or boss could ask an investing professional?

Flip it around. Is there a scarier question for an investing professional to hear from a client or boss?

So you can imagine our surprise/heart-stopping fear when our boss, Fool co-founder Tom Gardner, put us in a room and asked point-blank: "Why aren't you earning 50% annual returns?"

50 what?
To put 50% annual returns in perspective, no money manager anywhere has been able to achieve that degree of success for any meaningful period of time. Perhaps the closest have been Jim Simons of Renaissance Technologies and Joel Greenblatt of Gotham Capital, whose funds reportedly have 40% annual returns.

So where did Tom get his outlandish number? From none other than Warren Buffett.

Of course, Buffett also said he had too much money to manage to prove it. How convenient.

Nuts to that, Tom
But after a few weeks that would have made Elisabeth Kubler-Ross proud, we finally answered the question. And while the answers may not help us earn 50% annual returns (still an outlandish number), they can help us all make more money in the stock market.

Ready to learn more?

Lesson 1: Sell your index fund
There is no surer way to not beat the index than by investing in the index itself. Not exactly a revelation, right? Investing in index funds leads to near-certain long-run underperformance due to transaction costs and management fees.

Given that, what would possess a returns-hungry investor to go that route? While owning an index fund makes sense in many cases, if you're serious about market-beating returns, selling your index fund is step one.

Lesson 2: Don't lose money
The aforementioned Warren Buffett has two rules. Rule No. 1: Don't lose money. Rule No. 2: Never forget Rule No. 1. While we ribbed Buffett above, we also respect him a great deal and believe he is spot-on about losing money.

Losing principal soaks your long-run returns. To illustrate, imagine you've lost 50% of your initial investment on your biggest holding. The next year, it bounces back with a 100% return. Guess what? You're still worse off than if you'd just left that money in a savings account.

Efficient market believers argue that risk and reward go hand in hand. That's generally true. But there is one obvious alternative path.

Lesson 3: Look where no one else is looking
Let us put this plainly -- you can't achieve anything even remotely close to 50% annual long-term returns by investing in large-cap stocks. Period. Sure, you can best the market in the long run with that approach (and doing so by just a couple of percentage points annually would be a notable triumph), but you won't get to 50% annually.

If you want to work toward that mythical 50% mark, you'll need to consistently crush the market by finding the next home run stock and holding for five years or more. Your best chance is by going small.

Why's that? First, small caps, because of their size, have more upside potential than large caps. Second, because Wall Street players are typically constrained to only looking at large- and mid-cap companies, you can take advantage of pricing inefficiencies.

Just take a look. If you're sticking with just S&P 500-type stocks, you're swimming with sharks:

Company

Market Cap

Number of Analysts Covering

ExxonMobil (NYSE:XOM)

$510 billion

24

Intel (NASDAQ:INTC)

$151 billion

42

Altria (NYSE:MO)

$143 billion

15

eBay (NASDAQ:EBAY)

$53 billion

32

Starbucks (NASDAQ:SBUX)

$20 billion

21

Valero Energy (NYSE:VLO)

$38 billion

22

Yahoo! (NASDAQ:YHOO)

$36 billion

40

Data from Thomson.

With small caps, you can get greater reward and you don't have to outwit a horde of Ivy League CFA-types to buy the best ideas.

Ready for 50%?
Let us be clear: You can do just fine financially by saving and investing regularly in an index fund. But if you want to shoot for 50% annual returns, those are three ready-made ways to get started.

Yes, there will be volatility. Yes, they may not get you all the way to 50%. But if you employ the strategy faithfully, you should be able to seriously accelerate your portfolio's growth.

At our Motley Fool Hidden Gems small-cap investing service, we specialize in identifying small, cheap stocks that Wall Street simply isn't willing to look at. Our picks are beating the market by more than 32 percentage points on average, and you can take a look at today's two brand-new recommendations by joining the service free for 30 days. Click here for more information.

Neither Joe nor Tim owns shares of any company mentioned. Intel is a Motley Fool Inside Value recommendation. eBay, Starbucks, and Yahoo! are Stock Advisor picks. CEO Tom Gardner also has high expectations for the Fool's disclosure policy.


Read/Post Comments (33) | Recommend This Article (131)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 27, 2007, at 12:21 PM, TMFTenacious wrote:

    Nice article, gentlemen. I'm going to set the over/under for readers who get the Elisabeth Kubler-Ross reference (sans google assistance) at 3.5

  • Report this Comment On September 27, 2007, at 5:03 PM, rmherbert wrote:

    don't know liz but i do know rio,fro,gfa and wynn. and i hate tech stox and mttg. did i mention i hate tech?

  • Report this Comment On September 27, 2007, at 5:08 PM, rmherbert wrote:

    oh by the way, dad bought a pile of xom in 92. how do ya like me now? and i still hate tech. wanna see apple tank? i'll buy 100 shares and jobs will do something stupid and it will drop 50 by weeks end.

  • Report this Comment On September 27, 2007, at 5:44 PM, vest0r2 wrote:

    I loved AAPL and it made me sad to sell. I cannot believe it's going any higher.

  • Report this Comment On September 27, 2007, at 10:53 PM, mikeinmadrid wrote:

    Gotham capital achieved 50% annualized gains from 1985 to 1994.

  • Report this Comment On September 28, 2007, at 10:58 AM, TMFMmbop wrote:

    Mike,

    Do you have a source for that? I've heard that, too, but couldn't verify it. The 40% number is the only one I could verify.

    Thanks in advance,

    Tim

  • Report this Comment On September 28, 2007, at 6:13 PM, TMFMmbop wrote:

    Mike,

    My coauthor, who has Greenblatt's book with that data, has alerted me that my response was opaque.

    What I meant was, do you know if they kept up that 50% for a 20 year period? That was the period which we judged Medallion, and I was searching for the same number for Gotham. The number I got was 40-something.

    Thanks again,

    Tim

  • Report this Comment On September 29, 2007, at 5:36 PM, matstao wrote:

    I'm with you on the idea of investing in small caps for large potential gains, but it's not really the way to follow Warren's first 2 rules. Invest in a few small caps, and you will lose some money on one of them. Just look at the Hidden Gems scorecard for supporting evidence.

  • Report this Comment On September 30, 2007, at 8:54 AM, Pilarchard wrote:

    Come on guys, 50% is no big deal. You can turn 50% by working small arbitage plays at home on your computer. It's the double up which is hard. If you know what you're doing though, and you're dealing with money you don't have to live on (HIGH RISK), making 140%/y in currencies is completely reasonable (I turned 80% since I started in March. Athough this return is above average, it is in every way mediocre compared with what is possible...). If you have an understanding of macroeconomic forces, technical analysis, and a little statistics, it's easy money. Also, since there's only 7-8 major currencies, rather than 10000 stocks, it's really easy to get your head around the marketplace, allowing you to pick your trades in minutes. And with commissions for major pairs falling steadily (EurUsd is at 0.065% at some brokers. That's 0.9 pips for those already in the forex), you'll never want to trade stocks again!

    If you're not comfy with currencies, options are your next best bet, since they supercharge your stock picks and give you greater flexibility than a simple long or short on a stock.

    NB:I am not (yet) a financial analyst or portfolio manager (just a McGill kid paying his tuition through his investments!!). You should talk with your investment professionals about the rewards and risks of forex before you chose to invest in currencies, as there is a tremendous amount of risk if you don't know what you're doing (Don't blow your retirement!!). If you and your advisors are comfortable with this risk, please swear you will test your strategies in a game account for no less than 3 months. I perfectly serious. 3 months is the Absolute Minimum sane testing time. Also, if you research various brokers, you'll find they try to woo you with leverage ranging from 100:1 to 400:1. Yes, it's true that 400:1 leverage magnifies your gains 400 times. However, it's also true that you can lose your life savings in 3 seconds at 400:1. Until you're extremely comfortable with the market, never trade more than 10:1. (Pros seldom trade more than 2:1. But they are often responsible for other people's money, and so they can't afford a large draw down.)

    Once you've done your homework and learned how the currency markets work, the double-up can be yours with less than an hour of trading each day.

  • Report this Comment On September 30, 2007, at 9:01 AM, Pilarchard wrote:

    Edit: Let me be perfectly clear about stocks. Although they are slow and much less exciting then other forms of investment, if you're reading this website, you're in good hands. I've monitored the returns of the various portfolios advertised on this site for quite some time, and I have to admit, I am very impressed. (There's no way I'd be able to beat the Gardners on stocks. That's for sure!) All I'm saying is that it's possible to do much better (although with much greater risk!) if alternative investments are considered (forex, derivatives, etc.)

    Cheers,

    C

  • Report this Comment On September 30, 2007, at 10:22 AM, babuthomas wrote:

    Hidden Gems recommendations are great and they do provide great appreciations. But most of the appreciation in the small cap stock happens in an hour from the time recommendation is posted except for a few I have noticed.(This month's hit about 20% up in a few minutes) If you follow the recommendation and buy it after that time practical for most non-day traders, the upside is much lower than claimed and the downside will be a lot higher.

  • Report this Comment On October 01, 2007, at 12:32 PM, dooooooom wrote:

    Agreed with the above. This also shows that the newsletter here is actually quite popular and powerful, enough to drive some of the less traded stock recommended in stock advisor up by a lot once it's recommended.

  • Report this Comment On October 01, 2007, at 12:34 PM, dooooooom wrote:

    Also, this article is mainly a "sales" piece for the hidden gem. It has nothing to do with value investing or Warren Buffet, and I don't quite like how the author of the article is using Warren Buffet's gains and strategies for something that's almost otherwise irrelevant (not to mention contrary to Buffet's value investing)

  • Report this Comment On October 01, 2007, at 4:56 PM, ikkyu2 wrote:

    I would prefer to outwit a hoard than a horde :)

  • Report this Comment On October 01, 2007, at 6:01 PM, chitownjester wrote:

    babuthomas and dooooooom- you must not be able to read the scorecard - Bill doubled your money in 9 months by recommending CMG-B, and it did not all happen in a few days, you could have jumped in weeks or months later and done fine. Fool HG has consistently beat the market for the past 5 years (more than doubled it in fact). The "pop" experienced when a stock recommendation is made, is sometimes result of the recommendation, more often it is not, just a general market move. Sometimes stocks even (gasp!) lose value after recommended. I've followed Fool for more than a year, there is plenty to be made following these guys. I bought NVT last year below $30 because it was a SA recommendation. Let me tell you, it went down before it went up. But it eventually went up nice. I also bought BWLD based on HG rec, and OYOG. Doing very well on both.

    And what about their recs:

    CTRP 01/06

    MIDD 10/05

    LOOP 4/07

    and on and on.

    Don't kid yourself that you can't make money. You need to research, buy and HOLD (the 3rd seems to be forgotten sometimes).

    And yes, the article is obviously a sales pitch, but it cost less than a couple hundred bucks for a year of investment advice. Trust me, its worth it. Andy why does it not have anything to do with Buffett? He said he could make 50% returns by analyzing and investing in small caps. This is what HG does, they look for exactly what Buffett looks for:

    1) growing business

    2) great management

    3) great balance sheet

    4) moat

    5) underappreciated/misunderstood by market

    Jesse

  • Report this Comment On October 05, 2007, at 2:57 PM, SinBySilence wrote:

    Personally I'm not earning 50% annually because I'm earning 60%, but good article anyway.

  • Report this Comment On October 05, 2007, at 3:34 PM, jspatei wrote:

    I agree with chitownjester. What about OMTR, just recently? Its been on a tear, was up ~38% the month of rec, and is now sitting at 140 odd % gain. I believe a buy and hold strategy on good small caps is very effective, even after you've missed the recommendation price surge.

  • Report this Comment On October 05, 2007, at 4:37 PM, PonderingItAll wrote:

    In almost every case, you can just wait a few days or weeks to buy a Hidden Gems pick at or below the recommended buy-in price. Then your results will track (or even beat) the HG Scoreboard. All it takes is a bit of patience and the ability to calmly accept it when you miss the boat on the rare pick that never goes down again.

  • Report this Comment On October 05, 2007, at 5:33 PM, playin4profit wrote:

    It is not hard to earn >50% annual returns using covered call options. I've easily and repeatedly locked in 5% or greater returns by buying stocks that have obvious short term upside potential, then selling covered calls on them. So far I've always been called out because the stocks went above the strike price. Just last month I gained 17% by buying TSL at 40 and selling the $45 dollar covered call one month out. The stock went above 55, but I don't care, because my goal was to lock in at least 5% a month and I exceeded my goal by another 12%.

  • Report this Comment On October 05, 2007, at 5:57 PM, cabostacos wrote:

    i think some of these guys might make a fortune sharing how they make 60% a year with stocks.

  • Report this Comment On October 05, 2007, at 6:10 PM, HunterMurphy wrote:

    I got the Kubler-Ross allusion, for what it's worth. For those of you who're interested, in the October 2007 issue of the magazine Better Investing, the very last article has as its subject Kubler-Ross's 5 stages of grief and investing. It's clever. Talk about cosmic synchronicity. By the way, the author of that article is Linda Goin. Cheers.

  • Report this Comment On October 05, 2007, at 6:55 PM, NotJesseL wrote:

    I just have two words to say to this: "Select Comfort"

  • Report this Comment On October 05, 2007, at 8:58 PM, pschaaf42 wrote:

    50% is not that hard to achieve if you use margin. I split my investments roughly half and half between (Hidden Gems/Pay Dirt) for the small and micro caps I've never heard of and my own picks for large caps and I'm up a little more than 50% this year so far.

    The downside is that margin increases your volatility so you're in for a roller coaster ride. I've started hedging against that lately with options.

    There's 2 big obstacles for most people:

    1. Forcing yourself to sell when the market is up

    2. Forcing yourself to buy when the market is down

    I made around $50,000 in 1 month on GS alone after backing up the truck in the $160-170 range.

    By the same token, I lost out on most of my paper gains on FTEK when I didn't sell after a ridiculous 1 day run up.

  • Report this Comment On October 05, 2007, at 9:00 PM, pschaaf42 wrote:

    50% is not that hard to achieve if you use margin. I split my investments roughly half and half between (Hidden Gems/Pay Dirt) for the small and micro caps I've never heard of and my own picks and I'm up a little more than 50% this year so far.

    The downside is that margin increases your volatility so you're in for a roller coaster ride. I've started hedging against that lately with options.

    There's 2 big obstacles for most people:

    1. Forcing yourself to sell when the market is up

    2. Forcing yourself to buy when the market is down

    I made around $50,000 in 1 month on GS alone after backing up the truck in the $160-170 range.

    By the same token, I lost out on most of my paper gains on FTEK when I didn't sell after a ridiculous 1 day run up.

  • Report this Comment On October 06, 2007, at 12:42 AM, NoIcons wrote:

    If all of the investment gurus i have been reading are correct about the horribly inflationary effects of recent Fed moves, then ALL investments are in for a bull market! But the best investments, in that case, will be to take my money out of stocks and put it into LEVERAGED rental real estate with a 30 year fixed loan, to be paid back with inflated rents as the value of the dollar falls! Or am i missing something? (AND i will get to depreciate not just the 20% down, but the entire investment!)

  • Report this Comment On October 06, 2007, at 11:56 AM, flierboy wrote:

    I agree with chitownjester - babuthomas and dooooooom are simply not Foolish. If they expect to be handed a choice and buy a ticket and watch a show they are in the wrong place. HG has been a great tool and my annualized return is 60% since I bought my first choice in July when the market broke 14,000 the first time. As of today, all 12 stock I own are up.

    One great way to use the HG info is go back in time and if something is down since being recommended and the underlying value has not changed then you have a strong choice. If the stock spikes an hour after HG recommends it, the Foolish method is to wait till it comes back down! If it does then buy some if you research it and agree with the logic. If it doesn't come back down then perhaps it is not a good choice. Be Foolish!

  • Report this Comment On October 06, 2007, at 12:07 PM, flierboy wrote:

    I agree with chitownjester - babuthomas and dooooooom are simply not Foolish. If they expect to be handed a choice and buy a ticket and watch a show they are in the wrong place. HG has been a great tool and my annualized return is 60% since I bought my first choice in July when the market broke 14,000 the first time. As of today, all 12 stock I own are up.

    One great way to use the HG info is go back in time and if something is down since being recommended and the underlying value has not changed then you have a strong choice. If the stock spike an hour after HG recommends it, the Foolish method is to wait till it comes back down! If it does then buy some if you research it and agree with the logic. If it doesn't come back down then perhaps it is not a good choice. Be Foolish!

  • Report this Comment On October 07, 2007, at 1:23 PM, pebergquist wrote:

    Hey Sinbysilence,

    I checked out your performance on your Fool profile here it is:

    Rank: 22300 out of 36906

    Score: -52.55 (-45.21)

    Accuracy: 61.90%

    Can you please share with us how you are making 60%

  • Report this Comment On October 08, 2007, at 11:12 AM, ruggles321 wrote:

    Warren Buffet's rule 1

  • Report this Comment On October 13, 2007, at 9:25 AM, seekmocha wrote:

    I just finished "Way of the Turtle" by C. Faith. In chapter 10 he lists 5 very simple mechanical trading strategies with annual returns ranging from 48.1% to 57.8%. Why does the Motley Fool think returns over 50% are so difficult to achieve?

  • Report this Comment On October 24, 2007, at 7:17 PM, webschooner wrote:

    My returns have been exceeding 50% a year, and with relatively low volatility compared with the high returns. Because of the declining dollar, and the slowed-down growth of a 'mature' economy such as the U.S., I invest strictly overseas, in stocks and mutual funds in explosive-growth emerging markets, mostly China right now.

  • Report this Comment On October 26, 2007, at 2:01 PM, xiaoma wrote:

    I remember the Motley Fool used to announce their picks *before* buying them. I quite enjoyed David's original Rule Breaker articles, and that openness really hammered in the point that he was in it for the long term.

    Why the move away from that practice? Readers can't be part of the bump.

  • Report this Comment On July 17, 2008, at 6:44 AM, jay1214u wrote:

    I wonder what %age of the fools invest in the stock recommedation of 50 % and the the frequency of the turnover of the stocks and the success rate of the stock picks.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 537562, ~/Articles/ArticleHandler.aspx, 10/24/2014 2:48:18 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement