How do I Beat The Market? With Lots of Rules!

I am often asked how I invest to beat the market.  Well, let’s make things clear: I don’t always beat the market, often I do, but not always. My goal has always been to be, on average, ahead of the market by 1-3 percent.  So for the years that I may lag a little, I more than makeup in others. I attribute my success to developing simple market strategies but more importantly, following lots of investing rules! For more than a decade, this approach has worked quite well, and I’m sharing it with you here.

Is it Hard to Beat the Market Consistently?

If you wing it, as most people do (i.e. buy stocks based on emotion and without regard to weight, risk, and diversification), you will most likely underperform. That is the sad story of most small investors who on average return 3-4%. Professional managers do much better, but surprisingly, they also generally underperform the market in the long run (but for other reasons). So the answer to the question is yes, it is quite difficult to beat the market consistently.

Should You Try to Beat the Market?

This is the dilemma: the only way to beat the market is to be different than the market. By being different, your returns will be different. However, returns can be “up” different or “down” different, and herein lies the problem. If you deviate significantly from the composition of the market, you are likely to be either a big winner or a big loser. A big winning year is great and motivating, but by contrast, a losing year can really lower your average returns. Without an underlying strategy, the small investor is working mostly on luck, which in investing is never consistent.

My Overall Strategy

My overall strategy is to keep my portfolio similar to the market, but deviate a little from time to time from when I identify opportunities. This might mean loading up on energy stocks when no one wants them, or not having a lot of tech when this sector is overbought. But I never deviate by an amount that would cause too much loss in case I am wrong. Unfortunately, this also means that overperformance is limited when I’m right. But that is ok, slow and steady wins the race.

Bring on the Rules Already!

I am generally not a big fan of rules, but I do recognize their merit in some instances – like for investing! I had to get over my penchant for avoiding and breaking rules, and so should you. The rules are the most important part of my investing approach because they keep me safe from myself. They prevent me from betting the farm on “a sure thing” (that doesn’t exist), selling when it’s the end of the financial world (it never is), or buying on the premise that it’s different this time (it usually isn’t).

My rules are not about stock picking, but rather about stock management. I don’t spend much time picking stocks, believe it or not. Instead, I spend my time managing portfolio weight, diversification, and strategies. I pick stocks through screeners, online articles, and podcasts, and I sometimes look at what good investors have in their portfolios. I clone, steal, and review the works of others and determine how their ideas fit into my portfolio. I let others do the hard work for me. I am armed with the knowledge that more than 75% of returns come from portfolio management, while only 25% comes from stock picks. So even if I am mediocre at picks, I can do pretty well.

Marc’s Rules for Investing

1. No position should be more than 5% of the total portfolio weight. Don’t get greedy. If a company disappears overnight, a 5% loss is not terminal. Just think of Crypto companies for a recent example.
2. Be diversified by sector and by country. It’s a big world out there; get your head out of your own country’s biases.
3. Be diversified by style i.e. growth versus value stocks. I tend to prefer boring value stocks, but having some fast growers is important to round out the portfolio.
4. Invest in all sectors. Be aware that any omission is a clear bet against it. Example: If you do not have any tech stocks, then you’re betting against tech. Only by exception should you bet against an entire sector and if you do, you better have a well-thought-out strategy and even then, it should be a measured bet in case you are wrong.
5. If you can’t find a good stock pick for a particular sector, then buy a representative stock – a big quality company that dominates the index. This keeps you in a market-like position until you find something better. You can also use a sector ETF to achieve the same thing.
6. Maintain a minimum of 20 positions, and a maximum of 45. Generally, 25 is a good number of positions, but I sometimes hold more or less depending on market risk.
7. Measure your performance against a benchmark, e.g. the S&P 500. You may have returned 15%, which seems good – yay! Until you discover that the market returned 25%… this is bad – boo!
8. Have the same sector weighting as your benchmark. For example, if the index has 10% financial stocks, your portfolio should have 10% financial stocks. This is how you stay market-like.
9. Establish a cap on speculative positions. I only allow myself to invest 3% in stupid things, not more.
10. Rebalance the portfolio no more than 2 times per year, unless something is going really wrong and requires intervention.
11. Buy and sell as little as possible. Any changes to the portfolio should be based on a strategy that benefits the portfolio. Changes should be a big deal.
12. Most positions should be under a price-earnings (PE) ratio of 35. I do hold some exceptions to this rule, as I try to include some high-quality growth stocks in the portfolio.
13. Avoid fads like Crypto, meme stocks (yes – social media memes), ARK funds, and obviously overpriced stocks (e.g.Tesla). However, as per rule #9, I allow 3% for stupid things, so I can choose a fad stock for that 3% if I wish.
14. Don’t hold gold positions. I simply do not like the boom-bust and long wait for mediocre returns. Gold is speculative in nature, and not good investment material for the long run. However, feel free to use this as your speculative position.
15. Be aware of cyclical stocks and only buy them when they are out of favour. These stocks are notorious for trapping small investors at their highs, followed by huge falls. Some examples are commodity companies, copper, and steel but also include cars, RVs, and any company that relies too heavily on the economic cycle.
16. Don’t hold fixed-income positions, bonds, or GICs. Bonds underperform in the long run. Exceptions can be made if you truly believe the market is providing that rare opportunity where they will overperform.
17. Avoid leveraging the portfolio except in the rare instance of big bear declines. A formal strategy is required and not more than 10% should be leveraged.
18. Never have a cash position – always be fully invested. Holding on to cash and trying to time the market is too difficult and will likely result in lower returns over the long run. Sorry, no one can actually time the market, including you.
19. Never invest in Initial Public Offerings (IPOs). They have little history and are based mostly on promotion by the big investment banks. Historically they underperform. You can often buy these companies a year or two later with better information and for less money.
20. Do not become arrogant when your portfolio is doing well. Recognize that luck plays a big role in your returns and remain cautious.
21. Learn from your mistakes and don’t hesitate to tell everyone what an idiot you were. Seriously. I do this (often in this blog) and it helps me learn.
22. Avoid making big mistakes. Always contemplate “what if I am wrong?”. You can make small mistakes, that’s ok, just not too many.

ETFs – An Alternative Investing Approach

Whoa, I know, that is a lot of rules and a lot to digest. You may now be thinking, investing doesn’t sound like much fun. So here I go again with my ETF (Exchange Traded Fund) spiel. If you are interested in an easier approach to investing, I highly recommend investing in a market index ETF. No, you won’t beat the market with this approach, but it will guarantee you market-like returns. If I didn’t love investing and if it weren’t a passion and hobby for me, I would never put this kind of effort into it. I would hop on easy street and get a couple of good ETFs.

A Final Word

So there you have it, there is no magic here. Beating the market is possible, but the most important goal is achieving market-like returns that compound year after year. By following my rules, you will likely achieve this. If you add some strategy and a bit of luck, then beating the market is within reach. Remember, if investing becomes exciting, you’re likely gambling… not investing.