Opinion: This investment strategy is an extremely effective way to beat the S&P 500
Note to readers: This is an article I’ve written and updated every year since 1995. It outlines what I think is the best way for long-term investors to build a stock portfolio.
This article has three parts. The first summarizes the key points. The second tells exactly how to create this wallet. The third discusses the risks of this strategy and what its future may hold.
“Ultimate” is not a term to be used lightly. But I think it fits here: it’s the best way for most investors to achieve long-term growth in stock markets.
I will admit up front that I did not create this strategy. It’s based on the best academic research I can find – and it’s the basis for most of my own stock investing.
Most investors rely almost exclusively on the S&P 500 SPX,
But based on everything I know, I’m confident that investors who diversify beyond the index will achieve greater long-term success.
The ultimate buy and hold strategy is based on this belief.
For more than half a century, investors who held equal shares of the S&P 500 and nine other equity asset classes were able to more than double their long-term returns — with surprisingly little additional risk.
Much of the extra return comes from adding value stocks.
This “ultimate” 100% equity portfolio automatically takes advantage of market opportunities wherever they are.
To help you follow, here is a table which shows the components.
The basic “ingredient” of this portfolio is the S&P 500 index, which is a good investment in itself. Over the past 52 calendar years, from 1970 to 2021, the S&P 500 has risen 11%. An initial investment of $100,000 in 1970 would have grown to $23.1 million by the end of 2021. Remember that number.
For the purposes of our discussion, think of the S&P 500 index as Wallet 1.
The next step is to move 10% of your portfolio from the S&P 500 to large-cap value stocks.
This is explained by Wallet 2, which is still 90% in the S&P 500. Assuming annual rebalancing (an assumption that applies throughout this discussion), the 52-year compound return is 11.2%. It may not seem like much, but this small step would have turned that $100,000 investment in 1970 into $25 million.
In dollars, this small step adds over 19 times your entire initial investment of $100,000, the result of changing just one-tenth of the portfolio. And that’s just the first step.
Wallet 3 shifts an additional 10% to mixed US small cap stocks, reducing the weight of the S&P 500 to 80%.
This pushes the 52-year compound return to 11.3%; an initial investment of $100,000 would grow to $26.7 million, still with 80% of the money in the S&P 500.
To create Wallet 4, we are shifting an additional 10% of the portfolio to US small-cap value stocks, which have historically been the most productive of all major US asset classes. That bumps the compounded return to 11.7%, enough to turn that initial $100,000 investment into $31.7 million — with more than two-thirds of the portfolio still in the S&P 500.
If you are satisfied and want to quit after these three steps, I forgive you. But it just keeps getting better.
To continue to diversify, we are creating Wallet 5 by transferring an additional 10% to US REIT funds. The result: a compound return of 11.8%, adding another $1 million.
That’s it for the US equity asset classes. However, I believe that any portfolio worthy of being described as “ultimate” must venture beyond US borders.
To create Wallet 6, we are moving an additional 40% of the portfolio into four larger asset classes: international large-cap blend stocks, international large-cap value stocks, international small-cap blend stocks and international small-cap value stocks.
This reduces the influence of the S&P 500 to 20%. The result is a compound return of 12.3% and a portfolio value of $40.8 million over 52 years.
The last step, Wallet 7comes from the addition of 10% emerging market stocks, representing countries with expanding economies and prospects for rapid growth.
That bumps the compounded return to 12.6% and a ending value of $47.7 million, more than double what the S&P 500 alone provided.
Over the past 52 calendar years, this 10-part portfolio has met every asset class forecast of academic researchers — and more than doubled the dollar return of the S&P 500.
You can build this portfolio using exchange traded funds. Our specific recommendations, which are updated annually as needed, are available here.
The Ultimate Buy and Hold strategy is an extremely effective way to “beat the market” if you think of the S&P 500 as “the market”.
Best of all, it doesn’t involve trying to pick individual stocks, predict the future, or time the inevitable stock market ups and downs.
Its only major downside is that it requires owning and periodically rebalancing 10 components. Relatively few investors have the time or inclination to do this.
Fortunately, my team and I have designed several best-in-class four-fund ETF alternative portfolios that, since 1970, would have produced virtually the same results. I will talk about it in a future article.
One of the first things many investors ask me is how much additional risk they need to take to adopt this strategy.
Over 52 years, this portfolio has had a standard deviation 18.3%, compared to 16.9% for the S&P 500 alone. Given the much higher result for the portfolio of 10 funds, I don’t think this should be a deciding factor.
Since 1970, the worst calendar year for the S&P 500 – and for the Ultimate Buy and Hold strategy as well – was 2008; the index lost 37% and the portfolio of 10 funds fell 41.2%. Again, if you can tolerate a 37% loss, I don’t think a 41.2% loss is much worse.
Another common question I get is: how likely is the future to look like the past?
Of course, there’s no way to know. However, I think investment returns over the next 40 years should be within the range of the past 40 years.
Since 1928, the worst 40-year period for the S&P 500 was a compound annual growth rate of 8.9%; the best was 12.5%.
I expect the long-term returns of the Ultimate Buy and Hold strategy to be higher, but there’s no way to know that in advance.
There is more you should know about this strategy, and I discuss some important points in my podcast, “The Ultimate Buy and Hold 2022 Update.”
Richard Buck contributed to this article.
Paul Merriman and Richard Buck are the authors of We’re talking millions! 12 easy ways to boost your retirement.