Investing in the stock market may seem complicated with all of the jargon, investing strategies, and arcane concepts that you get bombarded with from myriad sources. But in reality, you don't have to have a master's degree in finance to generate returns that beat those of the average investor. After all, the average investor, according to research by Dalbar, has underperformed the S&P 500 over the past 20 years through the end of 2019, with an average return of just over 4%.
While there is certainly a lot to learn, beginners and those who haven't been able to devote countless hours to studying the market can still top the average investor by just following a few simple concepts.
1. Keep it simple with ETFs
ETFs, or exchange-traded funds, are a great way for investors to get a diversified portfolio of stocks in one investment vehicle. ETFs are baskets of stocks that typically track an index, although there are many that track customized indexes and some that are even actively managed. But while they are diversified, like mutual funds, they trade on exchanges like stocks.
Rather than building a diversified portfolio of stocks complete with growth and value names and stocks that balance each other out to outperform through various market cycles, you can accomplish all this through a few ETFs. You can invest in the biggest technology names through an ETF like the Invesco QQQ, which tracks the Nasdaq 100 index, and maybe balance that out with a broad-market ETF like the Vanguard Total Stock Market ETF, which tracks all 3,700-plus stocks on the market, or a large-cap ETF, like the SPDR S&P 500 ETF.
Investing in a few different ETFs, as opposed to a bunch of individual stocks that perhaps you haven't fully researched, will give you a diversified portfolio with access to the top-performing stocks as well as returns that, at worst, match the benchmarks. At best, some well-chosen ETFs can even beat the major benchmarks.
2. Be patient and don't overreact to market volatility
One of the biggest mistakes that the average investor makes is overreacting to market volatility. Invariably, when the market goes down, or suffers a correction, meaning a drop of 10%, many average investors tend to sell to cut their losses. But what they are doing is locking in their losses -- those paper losses only become real losses when you sell. If you hold through the volatility, you'll likely regain those losses and then some.
Look at last year as a prime example. The market dropped about 33% in a span of about a month, finishing its drop on March 16. If you sold stocks on March 16 when the S&P 500 plunged to around 2,300, you locked in that 33% loss. But if you held on, well, the S&P 500 is now over 4,200 in a little over a year -- so you do the math.
Conversely, it is also just as important not to chase returns. Many investors see a stock surge and buy in to ride the wave, but what they are often doing is buying high. They likely missed out on the catalyst that caused the surge, and now have a stock that has plateaued or will drop. That then leads to the vicious circle of getting frustrated and dumping at the drop -- in effect buying high and selling low. Been there, done that.
3. Think long-term and have a goal
Another mistake the average investor makes is trying to time the market, meaning buying low and selling high. This strategy rarely works for the average investor. If you are investing in stocks for short-term profit, you are missing the big picture.
Whether you are investing in a portfolio of individual stocks or ETFs, you should go in with a mindset that you are in it for the long term to ride out the market volatility. If you set goals for your investments, the long-term focus is built in. If you are investing for college costs 15 years down the road, then stick to that plan. If you are investing for retirement in 25 years, then invest with that in mind.
Your best opportunity to build wealth is to invest in good companies over the long haul, taking advantage of not only solid annual returns, but compounding dividend reinvestment and ongoing contributions to make your money work for you. Remember, a stock or ETF that even just tracks the benchmark is going to beat the average investor over time.
Note that these simple ideas are just a start. As you grow in your investing journey, you can dive deeper into the concepts and strategies to become an even better investor. But these three concepts should help you generate better returns than the average investor.