3 Ways You Can Beat Warren Buffett in the Stock Market | The Motley Fool

Warren Buffett, who has been at the helm of Berkshire Hathaway ( BRK.A 0.23% ) ( BRK.B 0.28% ) for more than 50 years, has grown rightly famous for his investing skills. From 1965 through 2020, shares of Berkshire Hathaway grew at an average annual rate of about 20%, roughly double the 10% annual rate of the S&P 500 during the same period.

Thus, many investors would love to see their own portfolios performing similarly. Few of us are likely to ever surpass Buffett’s record, but you might still want to try. Here are three ways you might beat him at his own game.

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1. You can invest in small stocks

One advantage we all have over Warren Buffett is that we can invest in small stocks, which are often tied to young, relatively fast-growing companies. Once a company grows to, say, the size of Walmart ( WMT 1.39% ) — which recently sported a market value near $400 billion — it’s hard to grow quickly.

Even Buffett’s own company illustrates this, as it grew much more rapidly in its earlier years, when it was smaller. From 1965 to 1995, the company grew its pre-tax earnings per share by an average of 14.7% annually. But over the past 20 years, its shares grew in value by only 9.3% annually, on average, beating the S&P 500’s 9%. (Over the past decade, Berkshire has lagged the S&P 500, averaging 13.6% versus 15.9%.)

Small-cap stocks have outperformed their large-cap counterparts over long periods. Between 2000 and 2020, for example, small-caps (as measured by the Russell 2000 index) grew by 511%, versus 337% for the S&P 500 index of large companies.

Why can’t Buffett invest in small-caps? Well, he could, but they’re problematic. He has many billions of dollars to invest, and small-cap companies tend to be worth between $300 million and $2 billion. If he bought 10% of the shares of a $1 billion company, that would cost him $100 million, which is just a tiny part of his cash hoard (recently near $150 billion). If that $100 million investment quadrupled in value, his overall portfolio would not grow very noticeably.

We smaller investors can find much more success with small-cap companies. (Though, ideally, we will balance them with large-cap and mid-cap companies, for diversification’s sake.)

2. You have more time

Next, you likely have a lot more time to generate great returns — from this point out. Buffett has been at it for many decades, and that long time period is a great part of why he has been so successful: He has reaped the generous rewards of long-term compounding.

But right now, he’s 91 years old. He has relatives who have lived very long lives, but even if he makes it to 110, that’s 19 years. You are probably considerably younger than 91, so you may have 30 or 40 or even 50 years ahead of you. From this point on, you likely have a time advantage over Buffett. Check out how regular investments can grow over time, and you’ll see that they grow much more powerfully in later years:

Calculations by author.

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3. You can hold less cash

Remember that “near $150 billion” that Berkshire recently held in cash and cash equivalents? Well, considering that Berkshire’s total assets recently were about $921 billion, this cash pile represents about 16% of total assets. That’s a lot.

It can be smart to keep some cash on hand yourself, for when the market heads south and great bargains materialize. But keeping 16% of your assets in cash or low-growth investments is not going to help you grow your worth very quickly. Berkshire needs to keep a lot of cash on hand, as it’s a major insurance business (among other things) and needs to be able to cover any claims. And Buffett also likes to be ready and able to pounce on any big acquisition opportunities that arise.

You and I are different, though. We might keep, say, 5% of our portfolio in cash, while putting the remaining 95% to work growing for us in stocks.

Here’s how you can match Buffett’s returns or come close

If all the strategies above sound like more work than you’d like to take on, fear not. You have some solid wealth-building strategies you can still consider. For example, simply parking your money in one or more low-cost index funds for a very long time can deliver great growth.

Alternatively, or in addition to that, you might simply invest in Buffett’s company, Berkshire Hathaway. That way, you can match his returns. That’s pretty good, too.