There is no better tool out there to build generational wealth than the stock market. Despite the negative impact of wars, pandemics, and recessions, the S&P 500 has increased at an average annual clip of roughly 10%. In fact, a $10,000 investment in the broad index 50 years ago would be worth more than $400,000 today.
But ambitious individual investors might want to achieve better returns than the overall market. And I'm here to tell you that it's definitely possible. Although they are remarkably simple, the necessary actions and mindset are very difficult to execute. That's because they require unwavering discipline.
Here are three effective strategies that can help place you in the rare group of investors who outperform the stock market.
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1. Don't try to time the market
It can be awfully tempting to try to time the stock market, buying and selling positions frequently in an effort to make a quick profit from price movements. That is the wrong approach. Competing against multi-billion-dollar funds with massive research and technology budgets is certainly a losing proposition for the individual investor.
Had you possessed the foresight at the start of 2020 to predict that a pandemic would bring the global economy to a standstill, you would've certainly sold all your stock holdings. However, this would've been a huge mistake because the S&P 500 gained 16% in 2020.
You need to not only know what event (and its timing) is going to happen in the future but also be able to predict how the rest of the market will react to it. This is virtually impossible to do in a repeatable manner, and it's best avoided for long-term investors.
Instead, regularly adding savings to your portfolio is a more prudent approach, allowing you to dollar-cost average into the stock market over time. And focus on staying fully invested through the inevitable ups and downs. Time in the market beats timing the market.
Keep this in mind the next time you have an itch to make a change to your portfolio, and your investment returns will dramatically improve.
2. Seek to own high-quality businesses
To achieve market-beating returns, restricting your portfolio to holding only high-quality companies is a smart move. These are businesses growing revenue year in and year out, boast steady and improving margins, generate profit and free cash flow, and have some sort of edge over industry peers because they sell a superior product or service or have a better management team. They are rare but not necessarily difficult to find if you pay attention.
Over the long term (five years or more), these competitively advantaged companies should do much better than businesses with no edge over rivals. They have staying power and can defend themselves from the constant threat of newer industry entrants and existing competitors.
Three such businesses that immediately come to mind are the online marketplace Etsy, home-improvement chain Home Depot, and athletic-apparel maker Lululemon. All three have been winning investments over recent years because they continue stealing market share in their respective industries by operating exceptional business models and finding ways to serve customers in better ways than the competition.
Limiting your portfolio to the best companies out there reduces the risk of losing money, an obvious requirement to actually making money in the stock market. Knowing that you own stocks that possess strong underlying fundamentals will also help you sleep better at night.
3. Ignore the financial news
Lastly, I think all long-term investors would benefit tremendously by paying less attention to the financial news. There are tons of media outlets out there providing a never-ending, 24/7 news cycle that we can access at our fingertips. This unfavorable situation encourages us to trade more frequently, which studies show actually leads to poorer investment returns.
I'm not saying to ignore any developments with your portfolio companies. That would be reckless. You always want to know any important information related to the stocks you own. But instead of relying solely on third-party sources for your news, it's worthwhile to pay attention to news that comes directly from your companies' investor relations websites.
Spend more time reading company investor presentations and annual reports and less time looking at the news. You'll gain a deeper understanding of the businesses you own from primary sources of information, and you'll be less influenced by the constant news cycle.
I'm certain that if investors immediately adopted these three strategies, their long-term stock returns would vastly improve.
