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Nearly 10 years ago, Warren Buffett, issued a challenge to the hedge fund industry — a $1 million bet that they could not put together a portfolio of hedge funds that would outperform an S&P 500 Index fund over a 10-year period.

The key Buffett’s bet against hedge funds was the math of the fund manager taking 2% of the capital under management as payment for his skills along with 20% of the profits to reward himself again for the gains. These compounding negative expenses wear on capital much like a triple leveraged ETF deteriorates during volatility due to the capital destruction of negative compounding.

Over the last 15 years, 92.2% of large-cap funds lagged a simple S&P 500 index fund. The percentages of mid-cap and small-cap funds lagging their benchmarks were even higher: 95.4% and 93.2%. If the S&P 500 is such a difficult investing vehicle to beat then how can we have a chance of beating it?

If you want to beat the S&P 500 index you have to do the things that outperform it.

  1. Trade it using the lowest possible vehicle like an ultra cheat S&P 500 index fund or the $SPY ETF.
  2. Use leverage to gain more alpha, a leveraged ETF like $SSO or in-the-money call options.
  3. Hedge your long position with put options during down trends to make gains while your position pulls back.
  4. Use moving averages to trade the trend, using back tested systems to go to cash during down trends to out perform through limiting losses and be long in bull markets.
  5. Diversify your portfolio through more weighting for the stronger trending sector ETFs.
  6. Weight your portfolio with market leaders.
  7. Change your leverage based on the market trend.

To beat the S&P 500 you must trade the trend, hedge the downside, and use safe leverage at the right time.