Stocks go up and down. There’s opportunity in that, but long-term investors have to resist the temptation to time markets and stocks with the hope of benefiting specifically from price swings. A better approach is to build a portfolio from the bottom up with a variety of stocks that can, on the whole, provide consistent results over time. That makes the better question to ask pretty obvious: How can you build that ideal portfolio?
A lot of Wall Street experts get famous because they manage to pick a market turning point. They are hailed, for a time, as gurus, and their words are splashed across websites, newspapers, and television. More often than not their “hot hands” prove temporary as they miss the next turning point. Simply put, it is just about impossible to consistently pick out market bottoms and/or tops.
And this is for people who are entirely focused on the markets. If you have a job and a life outside of Wall Street, it’s going to be even more difficult for you to call market transitions. It isn’t likely to be worth the effort. But there’s another approach you might want to consider. Instead of trying to jump in and out of the market, you can try to create a portfolio that is resilient enough to survive Wall Street’s ups and downs.
The most basic and simple way to do that is to buy a balanced mutual fund. For those who like to stick to index offerings, there’s the Vanguard Balanced Index Fund (NASDAQMUTFUND: VBINX). It splits its portfolio into two index mutual funds, with roughly 60% of assets in a broad stock index fund and roughly 40% in a broad bond index fund. Vanguard Balanced Index Fund has a 0.07% expense ratio. It’s a fairly low-cost investment that should manage well over time; it has an 8% annualized return over the past decade. There are plenty of active mutual funds that take a balanced approach, as well.
This fund isn’t likely to keep up with the market because it has a sizable bond component. However, that bond exposure helps to reduce risk. If you would rather go all in on stocks, you can always just buy an S&P 500 index fund, like SPDR S&P 500 ETF (NYSEMKT: SPY). You won’t beat the market, but you won’t underperform it, either. You’ll just have to accept that your chosen index fund will rise and fall along with the market. But there will always be some stocks that are doing well in the mix when others are doing poorly. And if you take advantage of dividend reinvesting and/or dollar-cost averaging, you will buy more shares when the market is falling in value and fewer when the market is rising.
What’s important about both of the ideas above, a balanced fund or a broad index fund, is that they both have a lot of different assets in the mix. Thus there is diversification. That’s what you are looking for, but you don’t have to use a mutual fund to get it. You can build your own diversified portfolio by selecting individual stocks that you like. And you can buy them when they look historically cheap, if you have a value bias.
As an example, you could focus on stocks with long histories of annual dividend increases and buy them when they have historically high dividend yields. Hormel Foods (NYSE: HRL), Medtronic (NYSE: MDT), and Texas Instruments (NASDAQ: TXN) would all fit that bill today, and they are all from very different industries.
Just make sure you include stocks from both growth-oriented sectors and more stable ones, like real estate and utilities. A couple of ideas here are Realty Income (NYSE: O) and Black Hills Corporation (NYSE: BKH). The goal is to provide a stable foundation for stocks like health-care focused Medtronic and chipmaker Texas Instruments that are likely to be more volatile over time because of the industries they are in.
If you go the individual-stock approach, as some investors like to do, you probably shouldn’t try to build a portfolio overnight. A better approach would be to decide how many stocks you want to own, say 20, and divide that into the assets you have to invest. The resulting number is how much you should put into each stock. Then hold cash until you find a stock that looks attractive to you and historically cheap. Just hold cash until you find something you think is worth buying, always keeping in mind that you want to keep the mix of stocks broadly diversified.
The reason for diversification is that you will not be correct with every stock. And even when you are correct from a long-term perspective, business performance goes up and down over time. So there will always be some stocks you own that are doing well while others are doing less well, or downright badly. Over time, that good and bad should balance out and result in solid long-term performance if you have a diversified portfolio.
You won’t be hailed as the next market guru if you take a balanced approach like this, but you will be able to sleep better at night and build wealth, slowly, over time. And if you don’t want to go through the effort of picking individual stocks, just go with a broad-based balanced fund or an index fund that tracks a major index, like the S&P 500.
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Reuben Gregg Brewer has positions in Black Hills, Hormel Foods, Medtronic, Realty Income, and Texas Instruments. The Motley Fool has positions in and recommends Texas Instruments. The Motley Fool recommends Realty Income. The Motley Fool has a disclosure policy.
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