Lesson 13 of 43: Can You Really Beat the Market by Buying Your Own Stocks?

  • Some investors (for example, Warren Buffett and Renaissance Technologies) have shown they can consistently beat the market by a healthy margin over time. 
  • There are several investing strategies (such as buying value stocks, momentum stocks, and high yield stocks) and portfolio design strategies (such as how much of each stock you buy) that have beat the market by a wide margin over time.

  • We believe it’s worth working hard for every extra inch of returns because they can compound and substantially grow your wealth over time. 

There’s a wisdom among experienced investors that goes something like this:

“Your average investor is better off simply buying a low-cost index fund like the S&P 500 than trading his own stocks.”

This sentiment stems from the feeling that it’s difficult for the average investor to beat the performance of the S&P 500 over time.

As a quick review, to “beat the market” means your investing gain over time (in percent) is greater than the gain of a common stock market index such as the S&P 500 or the Dow Jones Industrial Average.

As we learned in an earlier lesson, the S&P 500 is expected to return an average of 7% – 10% per year over long periods of time.

Can you really beat a long-term average of 7% – 10% per year by trading your own stocks?

To be honest, many investors can’t. And we agree they’d be better off simply buying an S&P 500 index fun.

But if you’ve come this far in our course, you’re clearly intelligent and motivated enough to try and beat the market. We applaud you.

We believe that beating the market over time is challenging, but not impossible.

We disagree with cynical investors who scoff at the concept of outperforming the S&P 500 as if it has never been done before.

With the right strategy, tools, and mindset, we believe you can do it and the rewards are well worth it.

First, let’s walk through a few examples of how investors have consistently beaten the market.

Two Investors Who Consistently Beat the Market

To find an example of an investor who has consistently beaten the market over time, we need look no further than the Oracle of Omaha himself: Warren Buffett.

Warren Buffett is the CEO of Berkshire Hathaway and a legendary value investor.

Looking at this chart from Atlas, we can see how Warren Buffett’s investments have performed relative to the S&P 500 going back over 40 years.

The blue bars show where Buffett has outperformed the S&P 500 (and by how much), and the purple bars show where he has underperformed the S&P 500 (and by how much).

We can observe a few things from this chart:

  • Buffett has beaten the S&P roughly twice as much as he has lost to it (by my count, 35 beats vs 17 losses).
  • On average, the size of his outperforming years was much larger than the size of his underperforming years.

So, this means Warren Buffett beat the market twice as often as he lost to it and won by much larger margins than he lost.

Over time, Warren Buffet has consistently outperformed the market by a substantial margin.

You’ll notice that Buffett has had fewer wins in recent years and they’ve been smaller in size. This could be due to the Law of Large Numbers, which in his case basically means he has amassed so much money that his investment choices have become very limited.

Back in the 1970s, Warren Buffett may have been able to buy all kinds of stocks, including mid cap stocks, small cap stocks, and micro cap stocks. Now, he has such a large amount to invest he has to focus only on large cap companies such as Apple (AAPL).

We don’t have that problem (which is actually a big advantage).

Warren Buffett is a legendary old-school investor who beats the market by practicing value and quality investing.

Now, let’s look at a very different type of investor.

The Medallion Fund is a black-box hedge fund run by Renaissance Technologies. It’s a quantitative fund that uses complex mathematical models to place trades.

The Medallion Fund’s returns have been beyond astounding.

Since inception, the Medallion Fund has earned 71.8% per year (or around 38% after fees) over the last 29 years compared to just 10% for the S&P 500.

One dollar invested in the Medallion Fund in 1988 would’ve grown to $14,000 today (including fees) vs. just $17 if it had been invested in the S&P 500.

Here’s a look at the returns for the Medallion Fund, provided by Harvard Business School:

Keep in mind, the Medallion Fund performance above (blue line) is AFTER a 5% management fee and a sky-high 44% performance fee. So the fund itself actually performed MUCH better than we see above.

Since 1990, it has never had a year where it lost money. And that includes the crash of 2008 – 2009 when the Medallion Fund had one of its best years ever, returning nearly 100% for the year while the S&P 500 went into a 50% nosedive.

Want to invest your money with the Medallion Fund?

Sorry, it’s only open to employees of Renaissance Technologies.

So, both Warren Buffett and Renaissance Technologies have a long and consistent history of beating the market by a healthy margin.

And they couldn’t be more opposite.

Warren Buffett is worth $86 billion and doesn’t have a computer in his office and has only sent one email in his entire life.

Renaissance Technologies has 290 employees with PhD’s in physics, mathematics, and statistics. They refuse to hire MBAs or anyone with Wall Street experience.

And yet, both are able to beat the market using very different approaches.

Now, these are just two examples. There are many others.

Of course, we’re not expecting you to invest like Warren Buffet or Renaissance Technologies – both are legendary in their own right.

The point is it’s possible to beat the market. And not just “barely possible, sometimes.” But highly possible with some regularity, assuming you use the right approach.

If Buffett and Renaissance can do it so consistently and by such a wide margin, surely you can apply some of their strategies and also earn strong profits.

So, let’s look at a few strategies they (and other successful investors) employ to try and beat the market.

Strategies That Consistently Beat the Market Over Time

One way to show that it’s possible to beat the market is to point to stock-pickers such as Warren Buffet and Renaissance Technologies who have consistently done it.

We’ve shown that above.

Another approach is to show stock-picking strategies that have consistently worked over time to deliver above-market returns.

Value Stock Investing

Let’s look first at how a simple value investing strategy has performed over time.

Book-to-market is a method of comparing the value of the assets of a company (their book value) to the value the market has assigned to the company (their market value).

Sometimes when companies become undervalued, their market value falls (as the stock sells off) yet their book value remains the same. This creates a situation where the ratio of the book value is relatively high compared to the market value. This company would be considered undervalued.

On the other hand, a company with a low book-to-market value would have a relatively low book value (total value of all assets) compared to its relatively high market value (elevated stock price). This company would be considered overvalued.

Book-to-market is just one simple way to measure if a stock is undervalued or overvalued. Don’t worry too much about understanding it now, except to keep in mind high book-to-market means undervalued and low book-to-market means overvalued.

Looking at this chart from the Journal of Portfolio Management, we can see how each type of stock has performed relative to the market from 1926 – 2016:

The yellow line shows that the U.S. market has returned an average 9.8% per year since 1926 – right in line with our 7% – 10% long-term estimate.

Buying the most overvalued book-to-market stocks has returned just 9.3% per year – trailing the overall market.

However, buying the most undervalued book-to-market stocks has returned an incredible 12.9% per year, beating the market’s average returns by 3.1% each year.

How much is that extra 3.1% worth over time? One dollar invested in the overall market turned into $4,274 whereas $1 invested in the most undervalued stocks turned $56,247.

That’s more than 13x the return of the market since 1926!

Our point isn’t to say you should buy undervalued book-to-market stocks. We think there are other value stock strategies that are better (we’ll cover them in a future lesson, Lesson 22 of 43: A Step-by-Step Guide to Picking the Best Value Stocks).

Our point is to show that a single simple valuation metric has beaten the market by an enormous margin over the last 90+ years.

Clearly, beating the market can’t be impossible.

Momentum Stock Investing

Let’s look at another example of an investing strategy that has worked well over the long term.

Momentum investing involves buying stocks that have gained the most over the last 3-12 months and avoiding stocks that have lost the most.

The idea is that the winners will keep winning and the losers will keep losing.

According to the Journal of Portfolio Management, here’s how a moment strategy would’ve performed from 1926 – 2016:

The momentum “winners” returned an average of 17.5% per year while the momentum losers returned just 9.5% per year.

That means the momentum winners returned 587 times as much as the losers.

This shows that buying positive momentum stocks has beaten the market over the long term.

Dividend Stock Investing

Another example of a strategy with long-term success is buying high dividend stocks.

In this scenario, we see the difference between stocks with no dividend, a low dividend yield, a medium dividend yield, and a high dividend yield.

The Journal of Portfolio Management shows us the breakdown of how each group performs:

Again, we clearly see that stocks with higher dividend yields have performed better over time than stocks with lower dividend yields.

In fact, a $1 investment in the zero yield group would’ve grown to $1,451 from 1926 – 2016, whereas that same $1 investment in the high yield group would’ve grown to $13,991.

That’s nearly 10x the return.

This shows yet another strategy that has beaten the market over the long term.

Portfolio Weighting

Finally, let’s looks at a fascinating concept from Andreas Clenow at Following the Trend.

Whereas the value, momentum, and dividend yield strategies above show you can beat the market by picking certain types of stocks, this example shows you can beat the market simply by how much of each stock you buy.

Clenow shows us how a random stock picker can consistently beat the S&P 500. 

Here’s how his strategy works:

“First day of every month, sell all portfolio holdings at market. Same day, buy 50 random stocks from the S&P 500 constituents. Weight positions by inverse volatility, i.e. simple vola parity sizing. Always be fully invested.”

What he’s saying is every month the portfolio buys 50 random stocks from the S&P 500 at the market price, holds them until next month, and then replaces them with 50 new stocks that are randomly picked from the S&P 500.

The magic comes in how much of each stock he buys.

Rather than buying them in even amounts or weighting by their market cap (for example, big stocks get more money than small stocks), he’s buying them based on inverse volatility.

Put simply, this means he’s buying more of low-volatility stocks and less of high-volatility stocks so that the amount of volatility each stock contributes to the overall portfolio is about the same.

He then runs this scenario 500 times to get an extensive sample of what could possibly happen.

The result is astounding.

We see that every single possible scenario of randomly picking S&P 500 stocks beats the S&P 500 index by a wide margin.

The black line is the total return of the S&P 500 index and the colorful lines are all sample tests of his random stock picker strategy. 

Clenow calls this his “Random Ass Kicking of Wall Street.”

How is this possible?

It’s because the S&P 500 is weighted by market cap, meaning it’s disproportionately impacted by the largest stocks in the index.

Take a look at the market cap of each of the members of the S&P 500.

We see that the S&P 500 is dominated by just a handful of huge names, while hundreds of stocks carry practically no weight.

The 12 largest stocks contribute over 25% of the S&P 500’s total weight, whereas the smallest 357 stocks also contribute 25% of the weight.

In other words, when you buy an S&P 500 index fund, the 12 biggest stocks count just as much as the 357 smallest stocks.

And those small stocks aren’t exactly nobodies.

They include companies such as Hewlett-Packard (HPQ), Baxter (BAX), Ford (F), Halliburton (HAL), Electronic Arts (EA), Twitter (TWTR), Paychex (PAYX), CBS Corporation (CBS), and Expedia (EXPE).

What Clenow has shown is that by simply weighting how much you purchase of each stock actively (based on volatility) instead of passively (based on market cap), you can consistently beat the S&P 500 by buying random stocks.

While value stocks, momentum stocks, dividend stocks, and position-weighting strategies can all be powerful approaches, we’re not pushing them as the best way to buy stocks.

Instead, we’re showing that there are relatively simple strategies that can consistently beat the market over the long term.

We’ll dig into which are best and how to successfully implement them in a future lesson.

Is It Really Worth Trying to Beat the Market?

OK, so now that we know it’s possible to beat the market by following some successful strategies, it raises another important question.

Is it worth trying to beat the market? How much extra money would you really earn? 

Our answer is a strong, “Yes, it’s very much worth trying to beat the market.”

Let’s look at how big a difference a few extra percentage points of annual returns can make over time.

Let’s assume you invest just $10,000 into the stock market every year for 10 years (total investment of $100,000) and then earn various different rates of annual returns.

How much money will you have at the end of 10 years?

Here we see that if you earn 0% annually on your return, you’ll have just $100,000 – exactly what you put into the market. That makes sense. 

If you earned in the 7% – 10% average annual return range (which is what the S&P 500 has returned over the long term) your investment grows to between $147,836 – $175,312.

Not bad.

But, if you could earn 25% returns per year (a highly impressive feat, without question), your investment would grow to $415,661. That’s more than double the 10% annual returns.

However, when it comes to stock market investing, 10 years is a fairly short time horizon that doesn’t show the full story.

So, let’s look at the same scenario (contributing $10,000 to the market every year) but for 20 years instead of 10.

Here we start to the see the impact of higher annual returns really add up.

If you earn the typical 7% – 10% that the S&P tends to deliver over the long term, you’d be sitting on $438,652 – $630,025.

But if you could earn 20% per year, you’d have $2,240,256 – that’s more than 5x more than you’d earn with 7% annual returns.

And finally, to really see the true compounding power of market-beating returns, you have to look at a 30-year time horizon.

Here we see that earning an extra 5%, 10%, or 15% per year above the S&P 500 turns into tremendous wealth when compounded over time. 

In fact, if you could earn an average of 25% per year, your $10,000 annual contribution to the market (a total of $300,000) would grow into $40,339,678 over 30 years! 

Now, consistently earning annual returns of 25% per year is extremely difficult to do. It’s definitely possible, but we wouldn’t suggest setting that as a goal.

Instead, focus on the difference between the 7%, 10%, and 15% return scenarios over 30 years:

  • 7% average annual returns becomes $1,010,730
  • 10% average annual returns becomes $1,809,434
  • 15% average annual returns becomes $4,999,569

So, returning on the higher end of the historical S&P 500 range at 10% per year would earn you an extra nearly $800,000 over 30 years.

And beating the market altogether at 15% per year would earn you an extra $3.2 million over 30 years.

Here’s a look at the full table:

And remember, this is assuming an annual investment of just $10,000.

If you put more in the market or are starting with a good size chunk of money, these numbers would be even larger.

Our goal isn’t to have you aim for a certain annual return number and expect to earn that over the long term.

Remember, we believe consistently beating the market is difficult (but not impossible).

The goal is to get you to appreciate the incredible value of every extra percentage point of average annual returns.

We believe it’s worth researching, analyzing, fighting, and clawing for every extra decimal point of annual returns, because they can add up to huge amounts of wealth over time. 

Beating the Market: Lesson Summary

This isn’t meant to be a guide on how to beat the market (we’ll cover that later), but rather a few simple examples to show it’s possible and VERY much worth it.

Here are the main takeaways from this lesson:

  1. Some investors (for example, Warren Buffett and Renaissance Technologies) have shown they can consistently beat the market by a healthy margin over time. 
  2. There are several investing strategies (such as buying value stocks, momentum stocks, and high yield stocks) that have beat the market by a wide margin over time.
  3. There are portfolio design strategies (such as how much of each stock you buy) that can consistently beat the market. 
  4. The S&P 500 is a market cap-weighted index, which means the bigger stocks contribute much more to the movement of the index that the smaller stocks.
  5. We believe it’s worth working hard for every extra inch of returns because they can compound and substantially grow your wealth over time. 

Next up, find out what’s the best investment strategy for you: Lesson 14: What’s the Best Investment Strategy for You?



Todd Lincoln


Passionate stock market investor with deep experience trading small cap, dividend, and growth stocks.

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