How to Beat the S&P 500

The S&P 500 is a grouping of the 500 largest companies in America.  It is a very popular thing to invest in for many reasons.  First of all, it is made up of incredible companies that we all know and love like Google and Apple.   But, another reason is, the business and financial media puts a lot of emphasis on shoving the current price and up or down movement of the S&P 500 in our faces every single day. For people that don’t know as much about investing, why would they even think there is something else to invest in then the S&P 500.

We recently met with a young man that was investing in only a low cost S&P 500 index fund.  He could not understand how he could pay a higher fee for a diversified portfolio, and end up with a huge advantage long term.   Let me explain further.

There are over 13,000 total stocks in the world that are available to invest in.  So the 500 stocks in the S&P 500 make up less than 5% of the total stock market.  So you cannot really consider yourself diversified if you invest in only 500 stocks in one country that are all very large companies.   If you could, wouldn’t you want to be more spread out into different countries, different industries, and different sizes of companies.  That way when 1 industry or country has major issues, your portfolio isn’t killed.

I’m here to tell you it is possible to beat the S&P 500 in terms of annual return, be more diversified, and lower your risk (Standard Deviation) all at the same time.

The mountain chart below shows that 3 globally diversified Matson Money Portfolios, with risk levels below or similar to the S&P 500 have absolutely blown away the returns of the S&P 500 for the long term 15 year period of 2000-2014.  And the Matson Money Portfolios shown below are Net of Fees, meaning this is the return after all fees are taken out. 1.

S&P

As you can see, the S&P 500 (100% stocks) was well below the Balanced Growth Portfolio, (50% stocks, 50% fixed income) the Long Term Growth Portfolio (75% stocks, 25% Fixed Income), as well as the Aggressive Growth Portfolio (95% stocks, 5% Fixed Income).    If you invested $100,000 into the S&P 500, your gain would be $86,482 at the end of 2014, which is about half the $162,523 gain you would have received investing in the Aggressive Growth Portfolio with Matson Money over the same time period.

Although the S&P 500 is popular, and has been up lately, that doesn’t mean you can forget the long term projections and academic studies that have proved again and again that a efficient diversified portfolio beats the S&P 500 in the long term.

By Jimmy Hancock

References

  1.  Matson Money. IsSomethingWrongWithOurPortfoliosPowerpoint. N.p.: Matson Money Inc., 6 Apr 2016. PPT.

Can you Lower Risk While Increasing Return?

Many people are scared of investing in stocks because they have heard that they are very risky.  Then on the other hand you have people who take investing risks that they don’t need to take in order to try to get a higher return.  Well today I hope to answer some questions for people on both sides.  

Modern Portfolio Theory

You may have heard the phrase Modern Portfolio Theory but what is it and how can it help your portfolio?

Modern Portfolio Theory-  An idea originated by Harry Markowitz in 1952 explaining the benefits of diversification, and the correlation of risk and return in an investment portfolio.

Harry Markowitz eventually won the Nobel Prize in Economics for his research on this topic.  He stated that as you add to the number of holdings in your investment portfolio, your risk should in turn go down.

Two kinds of risk

“Modern portfolio theory states that the risk for individual stock returns has two components:

Systematic Risk These are market risks that cannot be diversified away. Interest rates, recessions and wars are examples of systematic risks.

Unsystematic Risk– Also known as “specific risk”, this risk is specific to individual stocks and can be diversified away as you increase the number of stocks in your portfolio.” 1.

Modern Portfolio theory states that diversification helps to take away the unsystematic risk that comes along with any stock or even category of stocks.

The Efficient Frontier

Below is a chart created by Matson Money using the principles that Harry Markowitz found and taught.  The chart explains that for whatever amount of risk you are willing to take, there is an optimal return that you can get for that risk level.  The level of risk or volatility is measured by standard deviation.

MPT EMT

2.

There are 5 points on the chart that I would like to explain.  The first 4 are Matson Money portfolios.   The conservative portfolio is made up of 25% stocks and 75% fixed.  Moderate is 50/50, Growth is 75% stocks and 25% fixed, with Aggressive being 95% stocks and 5% Fixed.   Those 4 portfolio types fall on the efficient frontier.  This means that they are diversified to the point of efficiency and reach the highest expected return for the specific risk that you are taking.   Any point that is above that line is impractical in the long term, and anything below the line is inefficient.  

Should I Just Invest in the S&P 500?

Notice the S&P 500 is well below the efficiency line.  This means that for the amount of risk that is inherent in that group of stocks, the return is not optimal.   This is due to a few reasons; it only includes 500US stocks out of the almost 13,000 total stocks possible to own in the world, it does not include small or value companies with higher expected returns, nor does it include any fixed income to keep the standard deviation down.  If you wanted you could invest in a diversified growth fund and increase the expected return while decreasing the risk.  Keep in mind this chart and data is based on past performance, and past performance is no guarantee of future results.

The coolest thing about this is that the average investor can invest in a diversified portfolio that fits their risk tolerance by the way it is designed and know exactly what the risk and expected return is up front. 

We have software that can take your specific investments and show you exactly where you fall on the efficient frontier.   If you are interested contact us today. 

By Jimmy Hancock

References

1.”Modern Portfolio Theory: Why It’s Still Hip.” Investopedia. Investopedia US, n.d. Web. 13 Oct. 2014. <http://www.investopedia.com/articles/06/mpt.asp>.

2.Matson Money. TheEfficientFrontierPowerpoint. N.p.: Matson Money Inc., 6 May 2014. PPT.