What's more important: Having an investment strategy that performs strongly when the overall market is up or having an investment strategy that guards against downside risk when the overall market is trending down, while keeping you in the hunt for inflation-beating, long-term profits?Before you answer, consider the following:
- If you invested $1,000 in the Standard & Poor's 500 Index in 1950, it would have grown to $613,013 by December 2007.
- If you had tried to "time" the market and missed the 30 best months in that 57-year period, the value of your initial $1,000 investment would have risen to just $35,404 -- a difference of $577,609.
- But if you tried to time the market and missed the 30 worst months in that time, your $1,000 would have grown to $9,509,094!
That's right -- more than $9.5 million! (Obviously the study is a little dated given recent events but the net effect isn't all that different.)
So, which is more important? Being there for the gains, or missing the worst the markets have to offer?
Picking stocks that skyrocket in good markets -- but are vulnerable to wrenching plunges when markets roll over or holding positions that generate profits in good markets and that protect you in bad ones.
I don't know about you, but I'll opt for the latter every time.
There's a reality about investing and here it is: While the occasional quick hit long does pay off, investors are far better off building a well-balanced portfolio that protects them from sporadic stock plugnes than they are packing a portfolio with speculative stocks that have more downside than they do upside.
Think you already have a well-diversified portfolio? Think again.
Diversification, as promoted by Wall Street, is a perfect recipe for failure when everything goes wrong. Simply taking your assets and spreading them out among some stocks, a few bonds, a little real estate, a dollop of precious metals and a splash of cash isn't enough. That's like ordering a variety of meals at a fast-food chain -- some parts may be better for you than others, but the whole is hardly healthy.
So what's the solution?
The 50-40-10 Pyramid Investment Strategy
The true answer lies not in how you spread your money around, but in how you concentrate it. You must first invest to ensure the security of your returns and second to maximize your profits relative to the risks you do decide to take.
That's why I recommend -- and personally use -- what's known as the "50-40-10 Pyramid" strategy. This is a portfolio structure I developed many years ago and have advocated ever since -- and is one that ensures I always have both minimum risks and a "positive expectancy" in my investments wherever and whenever possible.
If you're not familiar with the term "positive expectancy," it simply means the investment offers a return greater than the amount of money that's actually put at risk. Always remember: Successful investing isn't about winning all the time… it's about winning over time. Picking more winning stocks than losing stocks; it's about making more money than you lose over time.
That's why to that end, I constantly harp on consistent risk management is more important than profits over long periods of time. So, if you control the risks, the returns will come -- and that's what the 50-40-10 Pyramid does.
Here's how it works:
- The "50" refers to what I call "base-builder investments" and should generally account for 50% of your portfolio holdings. The base-builders make up the "safety-and-balance" portion of the portfolio. They consist of defensive positions that will hold their value better than other choices in nearly all market conditions, which will protect you from severe economic declines such as the ongoing European debt contagion. Of course, that doesn't mean these investments are immune to loss. But they will generally take much less of a beating and be much less volatile than other investments when the going gets tough.
- This 50% of your portfolio should be generally focused on income and dividend-paying issues. Many people are dismissive of income investments, but in good times they can produce annual gains of 20% or more. Plus, the value of dividends can never be understated: Some studies show that Since 1871, dividend payments and reinvestments have been responsible for the dominant portion of total stock market returns -- in some cases 90% or more.
- The "40" is the percentage of the portfolio devoted to "global growth and income positions." These holdings are the "Global Titans" -- companies with dominant market positions around the world. They're firms poised to benefit the most from rapidly emerging economies in Asia and elsewhere (with a focus on China). In that role, these holdings will derive their strength from riding one or more of the major developing global trends. The most dynamic growth will likely come in the energy, commodity, environmental and infrastructure sectors. Increasing dividend payouts are an added attraction, boosting returns and safety.
- The "10" comprises accounts for what I call the "rocket riders." These investments -- which often involve initial public offerings (IPOs), takeover targets, aggressive stocks in special situations, or even the buying or selling of options and other more speculative vehicles -- offer spectacular upside potential and can lift overall portfolio performance well above market averages during good times, even though they constitute, at most, 10% of your holdings.
A 10% return on your entire portfolio can be exactly matched by a 100% return on just 10% of your portfolio -- and the consequences of being wrong are far less severe.In fact, that's the single most important benefit of adopting the 50-40-10 Pyramid structure for your portfolio -- you preserve all the upside potential of your investments while still retaining the freedom to make an occasional misstep. With only 10% on the speculative line, a single miscalculation won't devastate your entire portfolio. It frees you from the pressure of having to be perfect.
You have the freedom to screw up!
Adhering to the Pyramid also helps keep emotions out of your investing equation. If you structure your holdings according to the 50-40-10 formula -- and adjust them regularly to reflect shorter-term gains and losses -- you'll be positioned for the optimum upside at all times, even as you protect yourself against major trouble when the markets decline.
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