The S&P 500 is often seen as the benchmark for the overall performance of the US stock market. Many investors aim to simply match the returns of the S&P 500 by investing in ETFs that track the index. However, there are some investors who strive to beat the index and are able to outperform the market on a consistent basis. We'll explore how it's possible to outperform the S&P 500 and how one investing legend, Warren Buffett, has used options to do just that.
I used to believe it was a waste of time trying to outperform the market. The common advice was simple: buy an ETF like VOO, which tracks the S&P500 and minimises your fees, and let it go its course. This advice is given to most people because it is no easy feat to outperform the S&P 500 on a consistent basis.
I followed this advice at the start of my investing career, but over time I started to discover more and more evidence of market outperformance. Simple tweaks that can substantially increase those returns or at least decrease your drawdowns.
Most beginners often resort to day trading as an attempt to outperform the market. They fail to do so, because they don't understand that most gains happen overnight. And this exactly the period that day traders tend to avoid because they don't like the uncertainty of potential market gaps at the next day's opening.
One way to actually outperform the market is through active management, which involves selecting individual stocks that have the potential to beat the market. This approach requires extensive research and analysis to identify undervalued companies or those with strong growth prospects. The issue is that it could take many years until your thesis gets proven right and you might need a strong stomach as you might go through periods of severe drawdowns before seeing any profits.
Another way to outperform the S&P 500 is through the use of options. Warren Buffett, known as the Oracle of Omaha, is a prime example of an investor who has successfully used options to outperform the market. In his 2008 letter to shareholders, Buffett wrote that he had sold put options on the S&P 500, which allowed him to collect premiums upfront in exchange for agreeing to buy the index at a predetermined price if it fell below a certain level. This strategy allowed him to earn income while also providing a buffer against market downturns.
Buffett has also used options to acquire large stakes in companies, such as when he used put options to acquire a significant stake in Coca-Cola in the late 1980s. This strategy allowed him to acquire the shares at a lower price than if he had purchased them outright, while also limiting his downside risk.
On average, Warren Buffett has outperformed the S&P 500 by a significant margin. From 1965 to 2020, Berkshire Hathaway, the investment company led by Buffett, had an annualized return of around 20%, compared to the S&P 500's annualized return of around 10%. This may not seem like a significant difference in the short term, but when compounded over several decades, the difference becomes substantial. For example, a $10,000 investment in the S&P 500 in 1965 would have grown to around $1.2 million by 2020, while the same investment in Berkshire Hathaway would have grown to around $22.7 million over the same period.
In conclusion, while it's no easy feat to outperform the S&P 500, it is possible through active management or the use of options. Warren Buffett is a prime example of an investor who has successfully used options to outperform the market, and his long-term average annualized return of around 20% is a testament to the potential benefits of his approach.
It's important to remember that options are a more complex investment vehicle and without the appropriate understanding it can get you in a lot of trouble. But once you do understand options, it opens up many possibilities. This is why we have a master options coaching program, so you can understand both the possibilities, the dangers and mindset of using options.
