How I consistently beat the market, and how you can too.
Most investors are looking for ways to beat the market, right? Putting money in the S&P500 and letting it ride is just SO boring it makes most of us want to shoot ourselves in the head!
Some people recommend growth stocks, others value stocks, some selling options or using leverage.
My portfolio, which I will share today, has averaged a 30% compounded annual growth rate (CAGR) for almost a decade. The S&P 500, with dividends reinvested, returned a 12% CAGR over the same time.
This has allowed me to build more wealth faster than passive index investing, and indeed faster than most people trying to beat the market (and let’s admit it, most people trying to beat the market actually do worse than the market).
Want to know my secret?
My secret is that I beat the stock market by investing outside the stock market.
Ok, so you might be frustrated or disappointed at this point since I don’t have a secret to beating the stock market by investing in the stock market.
Sorry, not sure anyone does except Buffett and Munger. But don’t worry, it’s not clickbait!
What I said above about the returns is true, and I will walk you through how I have built a small portfolio of single-family rental homes that have returned, on average, a 30% CAGR over the past 7 years.
So if you are still with me, let’s take a trip to think outside the box and learn a new way to build significant wealth.
Why Is Everyone So Focused on Stocks?
There is nothing wrong with investing in low-cost index funds, and hands down it is the best way for novices to invest their money.
I have a considerable amount of money in the S&P 500, all in tax-advantaged accounts like my 401k and 529 plans for the kids.
I also use the S&P 500 for my kid’s own accounts where they can do work around the house and get rewarded with an investment contribution.
However, for those who want to do better, trying to beat the market in the market is notoriously difficult, and most people fail. Even highly experienced professionals generally fail to beat the market when they invest in the market.
As per this article from Business Insider, “nearly 90% of actively managed investment funds failed to beat the market over a 15-year period.”
Those are not good odds, and those are professionals!
But who said you have to limit yourself to the stock market?
People like the stock market because it feels easy. You can just look at a few stocks, then buy them with the click of a mouse. Likewise, if you don’t like how they perform, you can sell them anytime with another few clicks.
Easy peasy, right?
The problem is that this leads to all kinds of bad behavior.
People get excited about something and buy based on emotion rather than logic.
Then, if it drops, they sell based on emotion.
They do a few minutes of research and think they are experts, so they just blindly follow the advice of someone they think is smart.
In the end, most people, even professionals, end up buying high and selling low.
The results speak for themselves.
But it doesn’t have to be this way. I may not know how to beat the stock market consistently when investing in the stock market, but I do know how to beat it consistently by investing in real estate.
Single-Family Rental Economics
In the US, single-family homes are everywhere. A quick Google search shows that there were some 140 million homes in the US in 2020.
That’s a lot!
We are familiar with houses. Most of us grew up in them and have bought and/or sold them for personal use.
While owning a home for personal use is not investing, buying a house to rent out is, and it can be quite profitable.
Even before the recent run-up in house prices, I was consistently making over 20% CAGR on single-family rentals year after year.
The stock market doesn’t come close to those numbers on aggregate.
Now to the details of why single-family rentals can do so well. Here are the main factors impacting your return in real estate:
- cash flow
- leveraged appreciation
- debt paydown
- tax advantages (my return calculations are pre-tax)
The basic economics of a single-family rental is that you need to have positive cash flow so that your tenant is paying for all of your expenses and then some.
If your tenant is paying all of your expenses, then you won’t have to put any money into the unit.
If you use debt (prudently), which you should, then you will get the boost of leverage on the appreciation of the house.
You can use debt prudently in real estate because it is a stable investment. It does not jump up and down in price like the stock market.
Trying to use leverage in the stock market is highly dangerous and unwise, especially for average investors.
But in real estate, it is common and accepted. Banks will lend you money on real estate because they know it is not a high-risk move. They will not lend you money on stocks in the same way.
If you make a 25% down payment (investors need to put down more than homeowners), you can get a 30-year fixed-rate mortgage at a bit over the going rate for homeowners.
Then, as you rent out your house with positive cash flow, your tenant is paying off your mortgage for you. You have no expenses, and you get to keep the appreciation in the form of equity.
If your house appreciates by 5% in a year, your return will be over 20%.
For example:
- house price = $300,000
- down payment = $75,000
- original loan = $225,000
- loan remaining after one year = $221,680
- appreciation = 5% ($15,000)
With 5% appreciation, you will gain $15,000 in equity plus the $3,320 that your tenants paid down on your loan.
That is a total of $18,320 in equity gain in one year.
This is where the leverage kicks in. Since you only put down $75,000, your return is $18,320 / $75,000 = 24.4%!
And this happens year after year after year. Note that 5% is not high appreciation by historical standards, and greater than 20% returns are very common if you know what you are doing.
The recent appreciation of 10%+ per year has been incredible for my returns. However, this is not sustainable, and returns will likely return to the 20% to 30% range moving forward.
Note the above didn’t include cash flow. If you have positive cash flow, which you should (or you are not really investing), then your returns will be even higher.
My Portfolio
I bought my first house in 2007 as a place to live. When we moved, we decided to keep it and rent it out.
Since then, we have continued to buy and rent out single-family houses.
We now have 7 single-family rentals that each generate positive cash flow every month while I reap the rewards of leveraged appreciation.
For simplicity, I will give average numbers rather than house by house. But keep in mind that the houses were bought at different times, and the returns on each vary quite a bit on many individual circumstances.
For all 7 houses, the starting point was:
- Total down payment = $482,000
- Total loan amount = $1,551,000
- Total purchase price = $2,033,000
- Total house value = $2,140,000 (I learned how to buy houses under market price, which also boosts returns)
- Average hold time = 6.9 years (I haven’t sold one yet)
Current state:
- Current market price = $4,412,000
- Current debt = $1,438,000 (after refinancing for better rates)
- Current equity = $2,974,000
Returns:
- Equity gain = $2,491,750
- Return on investment (ROI) = 617% (current equity / down payment)
- Internal rate of return (IRR) = 30% (compounded annual rate of return, or CAGR)
As stated above, the S&P 500 returned 12% with dividends reinvested over the same period, which was unusually high for the stock market.
If I had made the same investment of $482,000 in the S&P 500 some 7 years ago, I would today have $1,057,000.
That’s not bad, but it is almost $2 million less than what I was able to generate with my small portfolio of single-family houses.
Summary
If you really want to beat the stock market, you may need to look at other avenues.
To build wealth, you need investments that are both powerful and stable:
- the stock market is neither since you can’t really use leverage, and it is too volatile
- bitcoin may be powerful (the jury is still out), but it is certainly not stable
- starting a business can be powerful, but not stable
- the simple single-family rental house is both; it is stable enough to use leverage prudently, and therefore extremely powerful
I see so much human time and energy spent trying to beat the S&P 500, but to beat it with real estate is fairly easy.
It doesn’t take a lot of effort or brainpower to beat the market when you invest in real estate.
You just need to learn a bit, do some homework, find a good location, negotiate well, and manage efficiently (which can be outsourced to a management company).
It takes time and energy to find a good property, but to manage them (with a management company) I only spend about 2 hours per month keeping the books, and I made over seven figures last year alone.
I don’t say this to brag, but to show you how powerful real estate investing can be.
So next time you find yourself trying to beat the stock market, maybe ask yourself why you don’t look at something stable and powerful like real estate. It’s right under your nose, and it is much easier to beat the market with single-family rentals than it is with stocks.
Best of luck and let me know how I can help!
After struggling to build wealth early in my career while following traditional financial advice, I set out on a path to learn about investing. Over a decade later, I’m financially secure and working towards full financial independence through real estate and the stock market. I have succeeded in building my financial ark to help me weather whatever storms may come.
I founded Building Arks to help busy professionals like you ignore mainstream advice and build real wealth.
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I have no affiliation with any sites listed, nor do I make money from any partners or recommendations in my articles (other than Medium). I am not a lawyer, accountant, or certified financial planner. All material is presented in good faith for informational purposes only based on my knowledge and experience. It is not intended to replace professional advice. You should always consult an expert before making any legal, tax, or financial decisions.
