Beating the S&P 500, part 1

You may have heard the phrase “beat the market. ” In this case, the market usually refers to the S&P 500 index. There are other U.S. indices such as, DJIA, NASDAQ 100, NASDAQ Composite, Russell 2000, Wilshire 5000, and many other domestic and international ones. However, the S&P 500 is by far the most used benchmark for investment performance. It is a good benchmark because it represents a well diversified portfolio of large and medium, as well as value and growth, stocks in many industries.

Why do I compare my investment performance against the S&P 500?

An investment that returned 15% sounds spectacular. However, if this happened in 2003 when the S&P 500 returned 28%, then it’s terrible. By comparing against the S&P 500, we get a more accurate measure of the investment true performance.

When I first started, I made several mistakes; including comparing my investment performance against a fixed number like 10%. After a few years, I learned that it’s better to compare against the index — and have been doing it since.

Why is beating the S&P 500 a big deal?

You may also have heard people talk about how hard it is to beat the market. Let us look at the Vanguard 500 Index (VFINX):

• It is classified as a Large Blend fund according to Morningstar
• There are currently 2,170 mutual funds in this Large Blend category
• This year VFINX ranks 38.99%. In other words, it performs better than 1,324 funds that are actively managed by professional investors!
• Its expense ratio is only 0.18% compared to category average of 1.13%

The last two bullets are the main reasons why so many people choose to invest their money in index funds. As such, beating the S&P 500 is actually quite an accomplishment for any stock investor.

Show me the numbers!

You can see from the table below (column H) that my 401k managed to beat the S&P 500 from the end of 2000 through the end of 2006. I do expect to beat, or at least come close to, the S&P 500 by the end of 2007.

Note: Prior to 2000, my 401k underperformed because I was over-allocated in my company stock

Chart updated October 1, 2007

A few notes:

• Column E — S&P 500 performance reflected index growth plus dividend yield; using last trading day of the year data from Yahoo!Finance Historical Prices.
  
• Column G — My 401k performance discounted my company matching contribution; otherwise the return would be about 1-2% higher
• Column I — My IRA did not perform as well, due to late contributions and lack of certain advantages that I will share later. As for contributions, I ended up contributing in April of the following year instead of right at the beginning of the contribution year. This is something I am planning to correct.

Wow, this is becoming a long post. I will stop right here and part 2 will be ready for tomorrow morning.

Next: Beating the S&P 500, part 2