There are a handful of time-tested investment strategies that tend to outperform over time.
Just as importantly, being able to assess market conditions and valuations, and choose the right investment strategy at the right time, lets you maximize your wealth’s growth potential.
This article will outline six major types of outperforming investments, what the strengths and weaknesses are that can be capitalized on at certain points in a business cycle, and how to put them together into a wealth-building strategy.
Start here from the beginning, or jump to the strategy you want:
- Equity Index Funds and ETFs
- Dividend Growth Investing
- Selling Options for Growth and Income
- Real Estate Investing
- Alternative Investments
Putting it all together: How to choose the right investment strategy
1) Equity Index Funds and ETFs
Index funds are investment vehicles that track major market indices, like the S&P 500.
Rather than trying to outperform, they merely match the market, but they do so at such low costs that they end up outperforming most actively-managed investment funds that charge high fees for lackluster performance.
Usually, you’ll want to hold some stock index funds, some bond index funds, some foreign index funds, and maybe some alternative holdings like REITs. The key is, you need to re-balance your index investments at least once per year, or use a service that automatically re-balances it for you.
Historically over long periods of time, equity index funds vastly outperform bonds, so it’s important to have a large exposure to them during most stages of your life.
Index Fund Advantages:
- Super easy to start with.
- Extremely low cost.
- Commonly available for 401(k) plans, IRAs, and other retirement accounts.
- Fairly liquid and accessible if necessary, especially when not in retirement accounts.
Index Fund Disadvantages:
- Index rates of return are likely going to be lower over the next 10-20 years than they have been historically.
- Index funds don’t necessarily produce reliable growing investment income to cover your expenses.
How to start:
- If you want to invest directly in index funds, Vanguard is the largest and lowest cost provider.
- If you already have a brokerage account, see what index funds your broker offers, or buy indexed ETFs from within your account.
2) Dividend Growth Investing
Passive investing via index funds is becoming more and more popular, and outperforms active management in most cases.
However, there are still some areas where index funds do not perform well, or do not meet the needs of all investors. One of the biggest examples is in the specialization of dividend growth investing.
There are many companies in the United States that have not only paid dividends reliably, but have grown their dividends each and every year without fail for decades. Companies like Dover Corporation, Emerson Electric, Johnson and Johnson, Realty Income, and dozens of others, have incredibly long stretches of consecutive annual dividend growth.
In other words, even during recessions or when the stock market goes down, they keep increasing their dividends to shareholders. This is particularly important if you’re trying to live off of your investment income.
When you invest in index funds, the common rule is to withdraw up to 4% per year, so that you’ll never run out of money. The problem is, the stock market can go up and down severely, so if you’re restricted to a certain percentage to withdraw, it means your investment income will fluctuate with the stock market. This year you might have $20k in investment income while next year you might only have $15k. If you withdraw more than 3-4%, you risk reducing your principle.
Even dividend-focused index funds haven’t been able to solve that. They’re great investments for overall growth, but they’re still not ideal for producing reliable growing investment income. Just about any dividend index fund or ETF you look at, whether it’s the Vanguard High Yield, Vanguard Dividend Appreciation, or anything else, you’ll find that in some years the dividends go up, and in some years they go down a bit. They’re unreliable because they don’t have robust dividend stock selection criteria.
An investment strategy of using actively-managed do-it-yourself dividend growth investing can fix that, as long as you select a balance portfolio of the right companies.
3 Critical Rules of Successful Dividend Growth Investing:
- Only buy wide-moat companies with at least a decade of consecutive annual dividend growth.
- Diversify among several different sectors and with at least a dozen companies.
- Select companies that have a solid dividend yield (2-8% in most cases), solid dividend growth rate (4-15% per year or more), and low dividend payout ratio (under 80%).
It can be a lot to take up yourself, so it’s one of the areas where getting a low-cost reputable newsletter actually helps. A lot of investment newsletters on the market are garbage, but dividend growth investing is an area where there truly are some newsletter gems. You can save a ton of time and risk by letting experts curate a diversified portfolio of carefully-selected dividend growth stocks for you.
The goal isn’t necessarily to beat the market; it’s to produce reliable dividend income that grows every single year, even through recessions.
The #1 Concept to Master: Economic Moats
A company that is said to have an “ economic moat” has a durable competitive advantage that protects it from competitors for a long time, much like a moat protects a castle from invaders.
Companies without moats can fold and collapse quickly when put under pressure by competitors or market forces outside of their control. For example, a trendy fashion retailer can go out of business as soon as consumer preferences change, or a neat new software company can suddenly get trounced by another new technology.
But companies with moats can last generations, building and building upon their successes for decades. Even in the cases where wide-moat companies eventually become obsolete, such as due to the invention of the Internet or other highly disruptive technology, they usually fall gradually with plenty of time for investors to adjust.
Building and sustaining wide moats is the only way that companies can produce such reliable track records that they can pay growing annual dividends to investors consecutively without fail for decades.
The main types of moats are:
Consumers trust the brand, don’t bother to shop around for alternatives, and are willing to pay at least a small price premium for it. If someone wants cola, they buy either Pepsi or Coke. They don’t buy some knock-off brand to save ten cents per can.
Merchants around the world accept Visa because so many consumers have Visa cards in their wallets. And so many consumers have Visa cards in their wallets because so many merchants around the world accept Visa. Visa was an early-mover in this industry, and spent decades grinding out this powerful network, which now just keeps getting bigger and bigger. They have a couple competitors that also have wide moats.
But could you imagine how hard it would be for even the largest financial institutions to decide to just start a new credit card brand today? How would they even go about getting people to use it or accept it?
Cost or Size Advantages
When a company becomes big enough, they may be able to do their work more cost-effectively than competitors. They can centralize their overhead costs, they can use their scale to get better deals when buying things, and they can build bigger and better logistics infrastructure. Competitors have trouble growing as large because their prices are constantly undercut by this larger, earlier-moving company.
High Switching Costs
Some products inherently produce customer loyalty. A good example is that software developed by companies like Cadence and Autodesk allow engineers to design electrical and mechanical systems. These are extremely complex pieces of software, used exclusively by professionals, and they require years to obtain mastery of. These companies have been around for ages and have incrementally improved their software over years and years of user feedback.
Even if some new competitor could somehow create a better product, would it be worth it for engineers to spend years re-mastering this new software? Probably not.
Tech companies and pharmaceutical companies usually have a patent shield around their products, which creates a temporary monopoly for themselves. If a company has a large enough portfolio of products, each protected by patents, and they have enough momentum to replace expiring patents with new patents, then they can have a durable economic advantage in their technological or medical niche.
Real estate is inherently limited. There is limited space in Times Square, and there is limited space for waterfront property, as two examples. Real Estate Investment Trusts often have very desirable property portfolios that have enduring value.
Similarly, railroads and utilities and master limited partnerships build up large infrastructure that is either protected from competition due to having a regulated monopoly, or it simply would be self-destructive for a competitor to try to copy, like building a new set of railroad tracks right alongside a competitor that can’t get enough traffic to justify its costs since there’s already an established route there.
Strong Balance Sheets
Virtually the only way for an otherwise wide-moat company to fall quickly, is if they over-leveraged themselves. Debt can get out of control quickly if interest rates start going up or if the business takes an unexpected hit while they’re already highly leveraged.
Companies with solid balance sheets, that have better credit ratings and less debt-to-equity than peers, can weather economic downturns, make opportunistic acquisitions, waste less of their profit on debt interest, and easily absorb unexpected problems and keep moving forward.
Dividend Growth Advantages:
- Very low fees for buy-and-hold dividend growers
- Reliable passive income that grows faster than inflation and grows through recessions
- Dividend stocks historically have a great risk/reward ratio
Dividend Growth Disadvantages:
- Requires a degree of DIY investing, made easier with top-notch newsletters
How to start:
- Google dividend growth investing and learn from the top blogs and resources
- Consider a low-cost high-value dividend newsletter for curated investments and save time
3) Selling Options for Growth and Income
Selling covered calls and cash-secured puts is a great way to boost your income and reduce your volatility.
It’s my #1 preferred investment strategy by far in most market conditions.
Unfortunately, investing with options is an investment strategy that many people assume is risky or time-intensive. While that’s true in some cases, the reality is that options give you more flexibility than just about any other investment.
You can use them to increase the potential for risk and returns, but you can also use them to decrease risk and produce cash flow, which is what I do. I make thousands of dollars of investment income per year by selling covered calls and cash-secured put options, while reducing my exposure to market corrections at the same time.
When you sell a put option, you take on the obligation to potentially buy a stock at a certain price before a certain date. And when you sell a call option, you take on the obligation to potentially sell a stock at a certain price before a certain date. In exchange for taking on these obligations, you get paid an option premium up front by the option buyer.
In other words, if you’re interested in buying stock of a great company but would prefer to wait for a lower price, you can sell a cash-secured put option to get paid to wait until the stock dips to the price you want, and then automatically buy it.
- Historically outperforms equities on a risk-adjusted basis
- Produces reliable high investment income and growth
- Greatly reduces portfolio volatility
- Requires patience and a long-term focus
- Little excitement or big upward swings
- Is fairly advanced compared to other strategies on this list, but really not that hard
How to start:
- Read my tutorial on selling cash-secured put options
- Read my tutorial on selling covered calls
- Make sure you’re signed up for my free investment newsletter
4) Real Estate Investing
One of the oldest and most reliable smart investment strategies is to build a portfolio of high quality real estate.
Real Estate Advantages:
- Intuitive and long-lasting
- Can produce strong cash flow
- Provides opportunities for tax write-offs
Real Estate Disadvantages:
- May require significant capital if you buy a property yourself
- Lower liquidity than most investments, unless you use REITs
- May require hands-on fixing unless you hire a property manager
- Usually requires leverage for decent returns
How to start:
- Check out crowdfunding real estate platforms
- Research rental property in your area
- Invest in REITs
5) Alternate Investments
There are some investments that exist outside of the scope of other, more common investment strategies.
An obvious example through the ages is to invest in precious metals, either physically or with an ETF.
Master Limited Partnerships (MLPs) may be considered a form of alternative investment. With them, you get to invest in pipeline companies and other natural resource businesses.
A more recent opportunity is to invest in peer-to-peer lending to produce reliable cash flow from a diversified portfolio of personal loans.
And an example of an alternative strategy I’m using, is that I generate income from selling put and call options on gold and silver ETFs. In the current environment of very low interest rates, I prefer this investment strategy compared to holding bonds.
There really is no limit to the types of investments you can do. Some people can make a ton of money from coin collecting, or even buying and selling luxury watches in their spare time. You could buy a website and hold onto it for cash flow or to sell it at a higher price later.
Some of these can be really skill-based, and give you a competitive advantage for high returns.
- May be uncorrelated with equities and other investments in your portfolio
- Gives you more options for where to put capital
- Might be less efficient than other markets, leading to outsized gains
- Requires additional and separate research
- Takes additional time
How to start:
- Check outpeer-to-peer lending platforms
- Research precious metals
- Research MLPs and various types of trusts
- Identify skills you might have that you can leverage for investments
The other five investment strategies on this list require upfront capital, and are great for turning money into more money.
But if you want to accelerate your wealth accumulation, you can also trade time to build a business, which you can then hold onto for cash flow or sell for a big capital gain. And depending on the business, you can also put a lot of capital in to get an amazing rate of return over a fairly short period of time.
In my senior year of college, I started a small online business, which eventually brought in a meaningful amount of passive income, and which I eventually sold to another company when I was 26 or 27.
It wasn’t a ton of money, but it gave me a boost to pay off my student loans and increase my savings on top of my engineer’s salary. More importantly, I was able to serve over a thousand customers, and learn valuable skills that I’ll have for the rest of my life.
I’m a big proponent of small businesses and side gigs. In this increasingly globalized world, it pays to be diversified and to have streams of income that you control, and it’s such a valuable project to take on in terms of personal development.
Only world-class investors like Warren Buffett can achieve 15%+ rates of return on stocks, but you have a much better chance of earning high returns like that through small-scale entrepreneurship.
- Can produce astoundingly high rates of return if successful
- Provides opportunities for tax write-offs
- Doesn’t necessarily require a lot of capital to start
- Requires a ton of time and work upfront
- Significant chance of failure
- Has a high learning curve
How to start:
- Read everything you can about successful business
- If you’re starting online, buy a domain name and low-cost hosting to start
Putting it All Together
The advantage of employing multiple different investment strategies rather than relying on just one, is that you can shift more capital to the best strategies at the right times.
For example, when stocks are cheap, it makes sense to invest heavily in them. When real estate falls, it creates an opportunity to acquire a new property.
Many investments are highly correlated, meaning that when the economy is strong, they all do well, and when the economy slows down, they all suffer in price and value together. Fortunately though, there are investment classes that are not well correlated with each other, and that are even inversely correlated.
For example, gold historically tends to rise in price during recessions, when people get scared, which makes it largely inversely correlated with equities. The time to buy it is when it’s historically cheap, usually during the height of bull markets. Silver tends to fall in recessions but rise back quickly, and is only moderately correlated with equities and can fluctuate significantly in price compared to gold.
Real estate prices tend to decline during recessions, but typically not as much as equities, and recover more slowly. Investment-grade bonds and peer-to-peer lending can produce positive returns straight through recessions.
A smart investment strategy is to hold a diverse collection of different assets that are not well-correlated with each other, and invest into them when they become undervalued.
For more information on how to do that, read this article on contrarian investing.
Personally, I use discounted cash flow analysis, and monitor the CAPE and Cap/GDP ratio of the stock market, to determine how much to invest in equities compared to other investments.
When stocks are cheap, I invest heavily into them. When they get expensive, I still keep money in equities, but also seek out alternative investments to protect my capital and grow wealth outside of the stock market.