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SubscribeStock Picking Strategies
Know your schedule
You need to commit to a period of time during which you leave those investments unchanged. A reasonable rate of return can only be expected with a long-term horizon.
When investments have a long time to appreciate, they are more likely to overcome the inevitable ups and downs of the stock market.
It might be possible to achieve a return in the short term, but this is unlikely. As legendary investor Warren Buffett puts it, "You cannot conceive a child in one month by carrying nine women."
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The magic of makeup
Another important reason to leave your investment untouched for several years is to take advantage of complications.
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When people cite the "snowball effect," they are talking about the power of makeup. When you start making money from the money your investments have already made, you are facing compound growth.
This is why people who start the investing game early in life can outperform a late beginner. They obtain the compound growth benefit over a longer period of time.
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Choose the appropriate asset classes
Asset allocation means dividing your investment into several types of investments, each of which represents a percentage of the whole.
For example, you can put half of your money in stocks and the other half in bonds. If you want a more diversified portfolio, you can expand beyond these two categories and include real estate investment funds (REITs), commodities, forex or international stocks.
To find the right allocation strategy for you, you need to understand your risk tolerance. If temporary losses keep you awake at night, focus on low-risk options like bonds. If you can weather setbacks in pursuit of strong long-term growth, look to stocks.
No decision either all or nothing. Even the most cautious investors should mingle with a few blue chip stocks or a stock index fund, knowing that those safe bonds will offset any losses. Even the bravest investors should add some bonds to temper the steep fall.
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Diversification rewards
Choosing between different asset classes is not just about managing risk. The biggest rewards come from diversification.
Nobel Prize winning economist Harry Markowitz referred to it as "the only free lunch in finance." You will earn more if you diversify your portfolio.
Here's an example of what Markowitz meant: An investment of $ 100 in the S&P 500 in 1970 had grown to $ 7,771 by the end of 2013. Investing the same amount over the same period in commodities (like the benchmark S&P GSCI index) would have made your money Grows to $ 4,829.
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Now, imagine that you adopt both strategies. If you had invested $ 50 in S&P 500 and another $ 50 in S&P GSCI, your total investment would have grown to $ 9,457 over the same period. This means your revenue would only have exceeded the S&P 500 portfolio by 20% and would be roughly twice the performance of the S&P GSCI.
The mixed approach works best.
Traditional and alternative assets
Most financial professionals broadly divide all investments into two classes, conventional assets and alternative assets.
Traditional assets include stocks, bonds, and cash. Cash is the cash in the bank, including savings accounts and certificates of deposit.
Alternative assets are everything else, including commodities, real estate, foreign currencies, arts, holdings, derivatives, venture capital, private insurance products, and private equity.
Most individual investors will find that a combination of stocks and bonds, plus a cash cushion, is ideal. Everything else requires very specialized knowledge. If you are an expert at antique porcelain, go for it. If not, you better stick to the basics.
Balancing stocks and bonds
If most investors can reach their targets with a mix of stocks and bonds, the final question is, how much should they choose from each category? Let history be a guide.
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If your goal is to achieve a higher return, and you can take the high risk, most stocks are the way to go. The truth is, total return on equity has historically been much higher than all other asset classes.
In his book Stocks for the Long Run, author Jeremy Siegel makes a strong case for designing a portfolio primarily made of stocks.
His logic: "For 210 years, I studied stock returns, the average real return on a widely diversified portfolio of stocks was 6.6 percent per year," Siegel says.
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A risk-averse investor may be uncomfortable with even short-term volatility and chooses the relative safety of bonds, but the return will be lower. Siegel notes that "at the end of 2012, the yield on the nominal bond was about 2 percent." The only way that bonds could deliver a real yield of 7.8 percent is if the CPI fell by about 6 percent annually over the next 30 years. However, a shrinkage of this magnitude has not been sustained by any country in the history of the world. "
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