Want to Beat the Market? This Is the Only Way to Come Out on Top

It's a solid strategy worth employing.

The stock market has delivered an average annual return of 10% over the past 50 years, assuming we're measuring the broad market's performance by the S&P 500 index. That's not a bad benchmark to follow, though.

The S&P 500 consists of the 500 largest publicly traded companies. So often, when you hear things like "the stock market fell today" or "the stock market rose," what it really means is that the value of the S&P 500 index declined or inched upward.

For many people, investing in the S&P 500 itself is a great way to grow wealth over time. So you may be inclined to load up your portfolio with S&P 500 ETFs. But if your goal is to beat the market, then you'll need to take a different approach.

What it takes to beat the market

When we talk about beating the market, we basically mean having a portfolio whose gains outpace that of the stock market on a whole, as measured by an index like the S&P 500. So remember how we said the S&P 500 has delivered an average annual 10% return over the past five decades? If you were to build a portfolio that generates an average yearly return of 12%, you'd be beating the market. 

How do you do that? It’s not easy by any stretch of the imagination, but there are two important things you'll need to do.

First, you won't be able to just fall back on shares of a broad market ETF. Instead, you'll need to hand-pick individual stocks for your brokerage account. Specifically, you'll need to do a lot of research to make sure you're focusing on quality businesses with the potential to grow and see their share price increase significantly over time. 

The second part of the equation involves adopting a strategy called buy and hold. And it's a simple one. You buy shares of quality businesses and then hold them for years -- many, many years, if you can. Over time, the value of your shares is likely to increase if it's truly a quality business, thereby allowing you to outpace the market and feel really good about the wealth you've managed to accrue.

Make sure your portfolio is diversified

Hand-picking stocks and holding them for many years could make it possible to grow more wealth than the average investor who puts money into the S&P 500 alone. But it's also important to make sure you're loading up on a nice mix of stocks across a range of market sectors.

The nice thing about broad market ETFs is that they do that work for you. When you're buying individual stocks, you need to be careful about branching out into different segments of the market. But if you make a point to maintain a balanced portfolio, you'll be able to buy yourself some protection from losses, all the while potentially setting yourself up for a lot of upside.

Best of all, many brokerages today allow you to buy stocks on a fractional basis. That makes it even easier to diversify your portfolio, since you don't have to commit to full shares for stocks with high price tags.