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4 Simple Steps to Beating the Market in 2021 (and Beyond)

By Ryan Downie - Feb 25, 2021 at 8:36AM

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Consider these four strategies if you want to set up a stock portfolio that can beat the market.

There's nothing wrong with your stock portfolio matching market performance over the long term, but some people just need to set their sights a bit higher. Perhaps you're behind on savings and won't be able to meet retirement goals by mimicking the stock market indexes. Maybe you're just confident in your research and too competitive to settle for market returns. 

Regardless of the reason, there are a handful of important steps that give you a chance to beat index investors. These four tips are important to keep in mind as you set up your stock portfolio.

1. Make investing part of your overall plan

Investments shouldn't live in a silo separate from all your other financial decisions. You reap the most benefits from investing strategies that act harmoniously with the rest of your financial plan.

For example, don't overextend yourself by chasing growth if you don't have enough cash on hand to deal with liquidity. Unexpected household expenses or a loss of income can have disastrous consequences for your investment performance if you don't have safe assets elsewhere to weather a storm.

Fve white paper airplanes with one yellow paper airplane flying in a different path

Image source: Getty Images

A lot of people were heavily invested before the global financial crisis and the COVID-19 pandemic. Many were laid off during those events and then were forced to sell at the bottom of the market crashes to cover expenses.

Those unfortunate people missed out on the rapid market recoveries that followed and certainly didn't have assets elsewhere to invest further into the bull market. This decimated their investment returns. If you aren't able to thrive in volatility, you should build up a secure nest egg that covers three to six months of expenses.

2. Allocate for growth

If your goal is to beat the market, you have to allocate the right way. First, you'll probably have to remove bonds almost entirely from the portfolio. Bonds are generally utilized to generate modest returns with low volatility, and most retail investors will fall short of long-term market returns with bond holdings. 

You'll also have to largely abandon the passive indexing strategies that have become so prominent over the past decade. Broad index funds, such as those that track the S&P 500, are designed to deliver market-like performance. To beat the market, you obviously cannot invest in the market averages. Long-term outperformance requires substantial allocation to individual growth stocks and niche exchange traded funds (ETFs) with fundamental upside.

In my opinion, the best bet is to make educated predictions about long-term global economic fundamentals and create a diversified allocation within that framework. Success in this strategy relies on broad trends rather than individual companies.

Right now, you might consider emerging markets ETFs, which provide exposure to economies around the world that have a swelling middle class and are primed for growth. This strategy could also include holdings related to disruptive technology trends such as data centers, cybersecurity, artificial intelligence, robotics, and automation. 

3. Don't time markets

Timing markets precisely is extremely difficult and rarely successful. Market timers not only need to identify the ends of bull markets to exit positions, but they also must recognize the onset of the following bull market to capitalize on the new growth phase.

This comes with an important caveat -- it's entirely valid to monitor market conditions and make slight adjustments to your allocation. For example, looking at valuations relative to broader economic conditions can provide clues on long-term upside potential and downside risk. However, abnormal or extreme conditions can persist for multiple years, so investors shouldn't be straying too far from their long-term target allocations. Just do some educated housekeeping to give you a slight edge over the market.

4. Minimize expenses

Expenses eat away at returns, so minimizing these will boost your returns when you're comparing your performance to the stock market. ETFs and mutual funds charge fees, which are typically measured by the expense ratio. It's OK to pay fees when value is being delivered, but any expense you incur should be justified by added performance.

Further, you need to consider the impacts of trading activity. Many brokerages charge commissions or fees per trade. Even if you use a no-commission brokerage, you still bear a cost from the bid-ask spread, which sets you immediately behind market prices upon purchase, and slices away some returns when you sell. Closing positions with gains can also be taxable events, so make sure you limit tax liability when possible.

Investing in 2021

Many of the steps to beating the market still apply in the strange market conditions of 2021 -- they just need to be adapted to today's unique circumstances. Equity valuations are at historically high levels. Accommodative monetary policy, low fixed income yields, government stimulus, optimism about economic recovery, and fears of inflation have all combined to keep stocks flying high.

Some people fear that a bubble is about to burst, while others are confident that the above conditions are enough to prevent a bear market from taking over. Keep these factors in mind, think about how they might impact different types of stocks, and set up your investments to outpace the market in any scenario.

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