Here at the Motley Fool we bang the drum for investing in the stock market. The reason is simple. Despite its ups and downs, the stock market has knocked spots off the returns of other assets over long periods.
Many investors like to build a portfolio of individual stocks, but today I want to tell you about a simple FTSE 100 index tracker strategy I think could beat almost all stock pickers.
Time is money
Because time in the stock market is the great wealth builder, we recommend starting to invest as early in life as is practical. This might be a monthly investment of say £100. If you opt for a FTSE 100 tracker, you simply set up your regular payment and forget it.
If you decide to go down the route of picking individual stocks, you’ll likely spend a few hours a week reading company news and commentary, maintaining a watch list of stocks you’re interested in, deciding which particular stock you want to buy when each monthly investment date comes around, and so on.
However, if you’re a tracker investor, you could instead spend those few hours a week earning extra money, and bump up your monthly subscription to your tracker.
You might have a job where extra hours are available or you might go for a bit of paid work doing something else. Either way, those few hours a week could easily add up to double your £100 monthly tracker investment.
Let me show you the effect on your returns of using this strategy, and what you’d have to achieve as a stock picker to better them.
Following this strategy, your total investment after paying £200 a month into a tracker for a year would be £2,400. If you were spending a few hours a week on stock picking instead of earning extra cash, you’d have £1,200 invested in your portfolio.
The FTSE 100 has delivered an average total return (including dividends) of 7.9% a year over the last 10 years. This is above the average of 7% over the very long term (100 years), so let’s go with the more conservative 7%.
The £2,400 tracker investment, growing at an annualised 7%, would be worth £4,720 after 10 years, £13,025 after 25 years, and £35,900 after 40 years.
If the £1,200 stock picker’s portfolio only matched the tracker’s 7% growth, it would be worth £17,950 after 40 years. Put another way, that initial £1,200 difference would have widened to nearly £18,000.
What returns would the stock portfolio need to produce just to match the value of the tracker? Over 10 years, it would have to deliver more than double the tracker’s 7% average annual growth. Over 25 years it would have to produce 10% average annual growth, and over 40 years, a tad less than 9%.
Given most investors – both professional and private – underperform the market over the long term, an average 9%-a-year return for 40 years is quite a tall order.
Having said that, it’s not impossible, as my Foolish colleague Edward Sheldon has explained in his article, ‘Why I pick stocks for my portfolio instead of investing in a FTSE 100 tracker fund.’