Timing the stock market is a losing proposition even for those who moonlight at the Psychic Network. A much easier and proven way to make money in the market is as easy as cooking your favorite meal. By following a simple recipe you can create not only a tasty dish, but also a well-performing portfolio.
Dishing up a balanced portfolio
Studies show that 90% of variability in portfolio returns is derived from asset allocation, not market timing or stock selection. So while stock selection can make a difference over the long haul, higher-level portfolio decisions overwhelming dictate your results.
Benchmarks offer us guidance in structuring our portfolio, keeping risk in check, and evaluating our performance over time. Benchmarking helps us make strategic decisions on sectors, while maintaining diversification, so we can manage risk appropriately. A properly benchmarked portfolio helps us mitigate uncertain market conditions since sectors perform differently over bull, bear, and flat markets.
Think of a benchmark as a set of instructions, like a recipe for cooking a meal. If you're preparing veal parmesan, you know that veal, cheese, bread crumbs, eggs, herbs, olive oil, and tomato sauce are required ingredients. The recipe spells out the ingredient list and the quantity of each necessary for crafting a palatable dish.
We'll use the MSCI World Index as an approximate benchmark for determining how much of each sector -- or ingredient -- you'll want to consider for your portfolio.
Source: Industry weightings adapted from MSCI World Index.
The industry weightings provide you with a starting point for making decisions. If your stock portfolio carries the same weightings as the index, then you are neutral from an industry standpoint; you'll prepare your veal parm as the recipe dictates. If you feel strongly about a particular industry and buy stocks only in that industry -- effectively overloading your dish with fistfuls of parsley and basil -- then you take on more risk. The flavors won't marry, and your meal will taste like an herb garden.
Grab your apron or order out
Once you've determined your strategy, execute on it. One method is buying broadly diversified mutual funds or exchange-traded funds (ETFs), effectively procuring premade veal parm. For those who prefer take-out, broadly diversified ETFs like Vanguard S&P 500 ETF and SPDR S&P 500 ETF do the trick.
Or get in the kitchen and roll up your sleeves. You can screen for stocks based on predefined criteria, like valuation, or look for companies with sustainable competitive advantages. Let's take a look at some stocks to consider for five of the sectors -- or ingredients -- mentioned above.
Chip giant Intel
Considered the McDonald's of Latin America, Arcos Dorados
Foolish bottom line
Now that you're equipped with a recipe and know the type and quantity of ingredients needed, you can better evaluate stock ideas that come your way. Take a look at your stock portfolio and see how it stacks up. Then focus on finding great stocks in sectors in which you are underweight.
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