We want to look at two investment approaches that are viewed differently by many investors. First, we will look at the approach of building your own diversification by selecting a portfolio of individual stocks: When most new investors enter the investment arena, they are more drawn to investing in individual names. They are drawn to high profile companies with flashy stories showing the promise of great future returns. Often they feel strongly about an individual product, service, or commodity that draws their capital to an individual name. Many of these new investors have yet to witness a binary event derailing a perennial bluechip company that they thought was bulletproof. Older investors can remember when companies like General Electric, which made its revenue from a myriad of diversified recession-proof sectors, produced a 3%-5% dividend for decades while shares appreciated decade over decade. If you asked an investors 15 years ago if the company would ever teeter on the verge of bankruptcy and have to fire sell many of its assets and business divisions, the answer would be a resounding no. It would be the equivalent of asking an investor today if they could see Amazon suffering the same fate. There is a reason more experienced investors employ more ETF’s in their portfolios. They have experienced the sting of being wrong with an individual name and suffering significant consequences. However, the upside to selecting an individual name that outperforms the market is very obvious. The average benchmark returns that top-tier hedge funds attempt to beat each year is 12%-15%. When one examines returns of top tech, semiconductor, and biotech names the past 4 years the annual performance is often north of 20%. One caveat we always point out in today’s markets is that with all the algorithmic trading and high frequency trading, virtually all stocks trade in one giant basket, so it’s not good enough to do your research and pick a quality name or sector to invest in. You must also have an understanding of where markets are headed on a collective basis if you are a short term investor or a three to five year basis if you are more a long term investor. Effectively, you have to be right twice by picking overall market direction and investing in a company that experiences no company-specific risk. Many experienced investors have suffered company-specific risk in the past while they watched the broad indexes climb. Also, when markets go through a period of a 3-6 month 20%+ decline, many investors are more emotionally attached to a stock and unwilling to part with it or reduce their position to limit drawdowns. ETF’s are more quickly sold by investors with less emotional attachment. Many investors point to capital gains upon selling each time and prefer to sit long term and avoid any tax implications. If you possess a market timing skillset like many hedge funds, banks, and services like The Forecast, hedging and position reductions before these draw downs greatly outweighs the buy-and-hold mentality. Volatility is at an all time high due to the speed of high frequency trading. The swings are more violent and more frequent in major indexes and look to only increase in the years ahead. At the end of the day, each investor must choose their own path as there are many that lead to successful investing. However, we offer one that is a compromise between ETF’s and individual names. A hybrid approach of 70% of ones capital in ETF’s while positioning the other 30% in some favorite individual names is one that we favor and recommend investors to consider going forward to fill the needs of the average successful investor.
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