Why Aren't You Earning 50% Annual Returns?http://www.fool.com/investing/small-cap/2010/03/02/why-arent-you-earning-50-annual-returns.aspx Joe Magyer and Tim Hanson
March 2, 2010
Look at the title of this article. Is there any more preposterous question a client or boss could ask an investing professional?
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?"
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 could be done. How convenient.
Nuts to that, Tom
Ready to learn more?
Lesson 1: Sell your index fund
Given that scenario, what would possess a returns-hungry investor to go that route? Owning an index fund makes sense in many cases, but if you're serious about market-beating returns, selling your index fund is step one.
Lesson 2: Don't lose money
Losing principal soaks your long-run returns. 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
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 do. Second, because Wall Street players are typically constrained to looking only at large- and mid-cap companies, you can take advantage of pricing inefficiencies.
Just take a look. If you're sticking with only S&P 500-type stocks, you're swimming with sharks: