Is there data and proof that a diversified portfolio can generate higher returns than the S&P 500 Index?
Is it POSSIBLE? Of course. I don't even need to do any research to prove that. Just some mathematical reasoning: Take the S&P 500. Find the performance of each stock in that list over whatever time period you want to use for your experiment. Now select some number of the best-performing stocks from the list -- any number less than 500. By definition, the X best must be better than or equal to the average. Assuming all the stocks on the S&P did not have EXACTLY the same performance, these 10 must be better than average. You now have a diversified portfolio that performed better than the S&P 500 index fund. Of course as they always say in a prospectus, past performance is not a guarantee of future performance.  It's certainly possible to do. The question is, if YOU selected the stocks making up a diversified portfolio, would your selections do better than an index fund? Stocks, Bonds, Bills, and Lottery Tickets notes the work of Fama and French who researched the idea of a small-cap premium along with a value premium that may be useful to note in terms of what has outperformed if one looks from 1926 to present. Slice and dice would also be another article about an approach that over weights the small-cap and value sides of things if you want another resource here. "While it's definitely possible (and likely?) that a diversified portfolio generates higher returns than the S&P 500, that's not the main reason why you diversify. Diversification reduces risk.  Modern portfolio theory suggests that you should maximize return while reducing risk, instead of blindly chasing the highest returns. Think about it this way--say the average return is 11% for large cap US stocks (the S&P 500), and it's 10% for a diversified portfolio (say, 6-8 asset classes). The large cap only portfolio has a 10% chance of losing 30% in a given year, while the diversified portfolio has a 1% chance of losing 30% in a year. For the vast majority of investors, it's worth the 1% annual gap in expected return to greatly reduce their risk exposure. Of course, I just made those numbers up. Read what finance professors have written for the ""data and proof"". But modern portfolio theory is believed by a lot of investors and other finance experts. There are a ton of studies (and therefore data) on MPT--including many that contradict it." "Yes, a diversified portfolio can generate greater returns than the S&P 500 by going OUTSIDE it. For instance, small stocks (on average) generate higher returns than the ""large caps"" found in the S&P 500. So if you own a diversified portfolio of stocks, some of which are smaller (in market cap) than the typical S&P 500 stock, you have a chance to outperform. You might also outperform by owning other asset classes than stocks such as gold, real estate, and timber (among others) at appropriate times. (You may also be able to get the relevant exposure by owning gold and timber stocks and REITS.) This was a lesson that David Swensen of the Yale endowment taught us."
Warren Buffet and Berkshire Hathaway took a 50% loss in each of the last two bear markets. His stock even lost 10% in 2015 when the S&P lost 8%. He doesn't have a track record to support the claim that his stock performs relatively better in a bear market, so perhaps it's best to take his letter with a grain of salt. Edit: As one commenter points out, Mr. Buffett is comparing the book performance of his fund to the market performance of an index. That is an apples to oranges comparison. It's deceptive at best. By definition, actively managed funds will underperform passive index funds as a whole. Or more specifically: The aggregate performance of all actively managed portfolio of publicly-tradable assets will have equal performance to those of passively managed portfolios. Which taken with premise two: Actively managed funds will charge higher fees than passively managed funds Results in: In general, lower-fee investment vehicles (e.g. passive index investments) with broad enough diversification to the desired risk exposure will outperform higher-fee options But don't take my wonkish approach, from a more practical perspective consider: "i know that hedge funds shouldn't be compared with index funds. they do different things. they serve different functions. but when the headline is they are reporting big gains, and then they report that ""Ken Griffin’s main Wellington and Kensington funds at Citadel rose almost 7 percent."" YTD, and ""Andreas Halvorsen’s Viking and an equity-focused quantitative fund at Renaissance are up more than 9 percent this year through July"" as reporting ""Big Gains"" it's a little silly when an index fund like SCHB is up 10.7% YTD with an ER of 0.03." "As an aside, why does it seem to be difficult to get a conclusive answer to this question? I'm going to start by trying to answer this question and I think the answer here will help answer the other questions.  Here is a incomplete list of the challenges involved: So my question is, is there any evidence that value investing actually beats the market? Yes there is a lot of evidence that it works and there is a lot of evidence that it does not.  timday's has a great link on this.  Some rules/methods work over some periods some work during others.  The most famous evidence for value investing probably comes from Fama and French who were very careful and clever in solving many of the above problems and had a large persistent data set, but their idea is very different from Damodaran's, for instance, and hard to implement though getting easier. Is the whole field a waste of time? Because of the above problems this is a hard question.  Some people like Warren Buffet have clearly made a lot of money doing this.  Though it is worth remembering a good amount of the money these famous investors make is off of fees for investing other peoples' money.  If you understand fundamental analysis well you can get a job making a lot of money doing it for a company investing other peoples' money.  The markets are very random that it is very hard for people to tell if you are good at it and since markets generally go up it is easy to claim you are making money for people, but clearly banks and hedge funds see significant value in good analysts so it is likely not entirely random. Especially if you are a good writer you can make a more money here than most other jobs. Is it worth it for the average investor saving for retirement?  Very, very hard to say.  Your time might be better spent on your day job if you have one. Remember because of the fees and added risk involved over say index investing more ""Trading is Hazardous to Your Wealth.""" This didn't answer his question. Also, while I agree with you that the Dow is meaningless (and your explanation why). In the investment industry, we don't only focus on the S&amp;P Index.. Many have a specific benchmark they aim to outperform that matches their investment strategy (i.e. Russell Mid Cap Value, Russell 3000, etc.). tl;dr: The CNN Money and Yahoo Finance charts are wildly inaccurate. The TD Ameritrade chart appears to be accurate and shows returns with reinvested dividends. Ignoring buggy data, CNN most likely shows reinvested dividends for quoted securities but not for the S&P 500 index. Yahoo most likely shows all returns without reinvested dividends. Thanks to a tip from Grade Eh Bacon, I was able to determine that TD Ameritrade reports returns with reinvested dividends (as it claims to do). Eyeballing the chart, it appears that S&P 500 grew by ~90% over the five year period the chart covers. Meanwhile, according to this S&P 500 return estimator, the five year return of S&P 500, with reinvested dividends, was 97.1% between July 2012 to July 2017 (vs. 78.4% raw returns). I have no idea what numbers CNN Money is working from, because it claims S&P 500 only grew about 35% over the last five years, which is less than half of the raw return. Ditto for Yahoo, which claims 45% growth. Even stranger still, the CNN chart for VFINX (an S&P 500 index fund) clearly shows the correct market growth (without reinvesting dividends from the S&P 500 index), so whatever problem exists is inconsistent:  Yahoo also agrees with itself for VFINX, but comes in a bit low even if your assume no reinvestment of dividends (68% vs. 78% expected); I'm not sure if it's ever right.  By way of comparison, TD's chart for VFINX seems to be consistent with its ABALX chart and with reality:  As a final sanity check, I pulled historical ^GSPC prices from Yahoo Finance. It closed at $1406.58 on 27 Aug 2012 and $2477.55 on 28 Aug 2017, or 76.1% growth overall. That agrees with TD and the return calculator above, and disagrees with CNN Money (on ABALX). Worse, Yahoo's own charts (both ABALX and VFINX) disagree with Yahoo's own historical data. "There is actually a recent paper that attempted to decompose Buffett's outperformance. I've quoted the abstract below: ""Berkshire Hathaway has realized a Sharpe ratio of 0.76, higher than any other stock or mutual fund with a history of more than 30 years, and Berkshire has a significant alpha to traditional risk factors. However, we find that the alpha becomes insignificant when controlling for exposures to Betting-Against-Beta and Quality-Minus-Junk factors. Further, we estimate that Buffett’s leverage is about 1.6-to-1 on average. Buffett’s returns appear to be neither luck nor magic, but, rather, reward for the use of leverage combined with a focus on cheap, safe, quality stocks. Decomposing Berkshires’ portfolio into ownership in publicly traded stocks versus wholly-owned private companies, we find that the former performs the best, suggesting that Buffett’s returns are more due to stock selection than to his effect on management. These results have broad implications for market efficiency and the implementability of academic factors.""" "I went to Morningstar's ""Performance"" page for FUSEX (Fideltiy's S&P 500 index fund) and used the ""compare"" tool to compare it with FOSFX and FWWFX, as well as FEMKX (Fidelity Emerging Markets fund).  According to the data there, FOSFX outperformed FUSEX in 2012, FEMKX outperformed FUSED in 2010, and FWWFX outperformed FUSEX in both 2010 and 2012.  When looking at 10- and 15-year trailing returns, both FEMKX and FWWFX outperformed FUSEX. What does this mean?  It means it matters what time period you're looking at.  US stocks have been on an almost unbroken increase since early 2009.  It's not surprising that if you look at recent returns, international markets will not stack up well.  If you go back further, though, you can find periods where international funds outperformed the US; and even within recent years, there have been individual years where international funds won. As for correlation, I guess it depends what you mean by ""low"".  According to this calculator, for instance, FOSFX and FUSEX had a correlation of about 0.84 over the last 15 years.  That may seem high, but it's still lower than, say, the 0.91 correlation between FUSEX and FSLCX (Fideltiy Small Cap).  It's difficult to find truly low correlations among equity funds, since the interconnectedness of the global economy means that bull and bear markets tend to spread from one country to another.  To get lower correlations you need to look at different asset classes (e.g., bonds). So the answer is basically that some of the funds you were already looking at may be the ones you were looking for.  The trick is that no category will outperform any other over all periods.  That's exactly what volatility means --- it means the same category that overperforms in some periods will underperform in others.  If international funds always outperformed, no one would ever buy US funds.  Ultimately, if you're trying to decide on investments for yourself, you need to take all this information into account and combine it with your own personal preferences, risk tolerance, etc. Anecdotally, I recently did some simulation-based analyses of Vanguard funds using data from the past 15 years.  Over this period, Vanguard's emerging markets fund (VEIEX) comes out far ahead of US funds, and is also the least-correlated with the S&P 500.  But, again, this analysis is based only on a particular slice of time." Like an S&amp;P 500 ETF?  So you're getting in some cash inflow each day, cash outflows each day.  And you have to buy and sell 500 different stocks, at the same time, in order for your total fund assets to match the S&amp;P 500 index proportions, as much as possible.  At any given time, the prices you get from the purchase/sale of stock is probably going to be somewhat different than the theoretical amounts you are supposed to get to match, so it's quite a tangle.  This is my understanding of things.  Some funds are simpler - a Dow 30 fund only has 30 stocks to balance out.  Maybe that's easier, or maybe it's harder because one wonky trade makes a bigger difference?  I'm not sure this is how it really operates.  The closest I've gotten is a team that has submitted products for indexing, and attempted to develop funds from those indexes.  Turns out finding the $25-50 million of initial investments isn't as easy as anyone would think. The reason diversification in general is a benefit is easily seen in your first graph.  While the purple line (Betterment 100% Stock) is always below the blue line (S&P), and the blue line is the superior return over the entire period, it's a bit different if you retired in 2009, isn't it?  In that case the orange line is superior: because its risk is much lower, so it didn't drop much during the major crash.  Lowering risk (and lowering return) is a benefit the closer you get to retirement as you won't see as big a cumulative return from the large percentage, but you could see a big temporary drop, and need your income to be relatively stable (if you're living off it or soon going to).   Now, you can certainly invest on your own in a diverse way, and if you're reasonably smart about it and have enough funds to avoid any fees, you can almost certainly do better than a managed solution - even a relatively lightly managed solution like Betterment.  They take .15% off the top, so if you just did exactly the same as them, you would end up .15% (per year) better off. However, not everyone is reasonably smart, and not everyone has much in the way of funds. Betterment's target audience are people who aren't terribly smart about investing and/or have very small amounts of funds to invest.  Plenty of people aren't able to work out how to do diversification on their own; while they probably mostly aren't asking questions on this site, they're a large percentage of the population.  It's also work to diversify your portfolio: you have to make minor changes every year at a minimum to ensure you have a nicely balanced portfolio.  This is why target retirement date portfolios are very popular; a bit higher cost (similar to Betterment, roughly) but no work required to diversify correctly and maintain that diversification. In general, the goal of an S&P 500 index fund is to replicate the performance of the S&P 500 Index.  To do this, the fund will buy the same stocks in the same proportions as the weighting of the Index. The S&P 500 Index is free-float capitalization weighted.  This means that the higher capitalization stocks (based on publicly traded shares only) are more heavily weighted and factor into the Index value more heavily than the smaller capitalization stocks, or the stocks that have a smaller publicly traded value.  For example, companies like Apple, ExxonMobil, and Microsoft have a much larger weight in the index value than smaller companies. Alternatively, there are some S&P index funds that are equal-weighted.  In these funds, the managers have chosen to purchase all 500 of the stocks in the index, but in equal proportions instead of the weighted proportions of the index.  These equal-weighted funds will not as closely match the index price as the traditionally weighted index funds.  Instead, they might do better or worse than the index, depending on how the individual stocks do. You'll need to look at the prospectus of the index funds you are interested in to see which approach the fund is taking. "Brendan, The short answer is no, there is no need to get into any other funds. For all intents and purposes the S&P 500 is ""The Stock Market"". The news media may quote the Dow when the market reaches new highs or crashes but all of the Dow 30 stocks are included in the S&P 500.  The S&P is also marketcap weighted, which means that it owns in higher proportion the big ""Blue Chip"" stocks more than the smaller less known companies. To explain, the top 10 holdings in the S&P represent 18% of the total index, while the bottom 10 only represent 0.17% (less than 1 percent). They do have an equal weighted S&P in which all 500 companies represent only 1/500th of the index and that is technically even more diversified but in actuality it makes it more volatile because it has a higher concentration of those smaller less known companies. So it will tend to perform better during up markets and worse during down markets. As far as diversification into different asset classes or other countries, that's non-sense. The S&P 500 has companies in it that give you that exposure. For example, it includes companies that directly benefit from rising oil prices, rising gold prices, etc known as the Energy and Materials sector. It also includes companies that own malls, apartment complexes, etc. known as the Real Estate sector. And as far as other countries, most of the companies in the S&P are multi-national companies, meaning that they do business over seas in many parts of the world. Apple and FaceBook for example sell their products in many different countries. So you don't need to invest any of your money into an Emerging Market fund or an Asia Fund because most of our companies are already doing business in those parts of the world. Likewise, you don't need to specifically invest into a real estate or gold fund.  As far as bonds go, if you're in your twenties you have no need for them either. Why, because the S&P 500 also pays you dividends and these dividends grow over time. So for example, if Microsoft increases its dividend payment by 100% over a ten year period , all of the shares you buy today at a 2.5% yield will, in 10 years, have a higher 5% yield. A bond on the other hand will never increase its yield over time. If it pays out 4%, that's all it will ever pay. You want to invest because you want to grow your money and if you want to invest passively the fastest way to do that is through index ETFs like the $SPY, $IVV, and $RSP. Also look into the $XIV, it's an inverse VIX ETF, it moves 5x faster than the S&P in the same direction. If you want to actively trade your money, you can grow it even faster by getting into things like options, highly volatile penny stocks, shorting stocks, and futures. Don't get involved in FX or currency trading, unless it through futures." Your initial premise (mid-cap and small-cap company stocks have outperformed the market) is partially correct - they have, over many 40 yr periods, provided higher returns than large caps (or bond funds). The important thing to consider here is that risk adjusted, the returns from a diversified portfolio are far more robust - with proper asset allocation you and expect high returns and reduce your risk simultaneously.  Imagine this scenario - you decide to stick to small / mid caps for 10 - 15 yrs and move into a more diversified portfolio then. Had you made that decision during a sustained period of poor small cap performance (late 80s or the 40's) you would have lost a boatload of return, as those were periods were small / mids underperformed the market as a whole, and large caps in particular. As an example, from 1946 to 1958 large caps outperformed small every single year. If 2016 were to be the first year of a similar trend, you've done yourself a major disservice.  Since the dot com crash small /mids have outperformed for sure, pretty much every year - but that doesn't mean that they will continue to do so. The reason asset allocation exists is precisely this - over a 40 yr period, no single asset class outperforms a diversified portfolio.  If you attempt to time the market, even if you do so with a multi-decade time horizon in mind, there a good chance that you will do more poorly. You are correct that over a short term there is no guarantee that one index will out perform another index. Every index goes through periods of feat and famine. That uis why the advice is to diversify your investments. Every index does have some small amount of management. For the parent index (the S&P 500 in this case) there is a process to divide all 500 stocks into growth and value, pure growth and pure value. This rebalancing of the 500 stocks occurs once a year. Rebalancing The S&P Style indices are rebalanced once a year in December. The   December rebalancing helps set the broad universe and benchmark for   active managers on an annual cycle consistent with active manager   performance evaluation cycles. The rebalancing date is the third   Friday of December, which coincides with the December quarterly share   changes for the S&P Composite 1500.  Style Scores,   market-capitalization weights, growth and value midpoint averages, and   the Pure Weight Factors (PWFs), where applicable across the various   Style indices, are reset only once a year at the December rebalancing. Other changes to the U.S. Style indices are made on an as-needed   basis, following the guidelines of the parent index. Changes in   response to corporate actions and market developments can be made at   any time. Constituent changes are typically announced for the parent   index two-to-five days before they are scheduled to be implemented. Please refer to the S&P U.S. Indices Methodology document for   information on standard index maintenance for the S&P 500, the S&P   MidCap 400,the S&P SmallCap 600 and all related indices. As to which is better: 500, growth,value or growth and value? That depends on what you the investor is trying to do. "Here's my attempt at ""Options for Kids"" ""Hey kid... So you have this video game that you paid $50 for that you want to sell two months from now"" ""Yes, Mr. Video Game Broker, but I want to lock in a price so I know how much to save for a new Tickle Me Elmo for my baby sister."" ""Ok, for $3, I'll sell you a 'Put' option so you can sell the game for $40 in two months."" .... One month later .... ""Hey, Mr. Video Game Broker, I can't wait to get this new Tickle Me Elmo for my little sister for Christmas, but its hard to get and I'm afraid prices will go up. I can only spend $100!"" ""Ok kid, for $4 I'll sell you a 'Call' option to buy a Tickle me Elmo on December 21st for $95. If you can find it cheaper, the option can expire, otherwise $95 is the most you will pay!"""