Picking the Right Stocks and Good Timing Aren’t the Keys to Investing. Here’s How to Invest Safely and Profitably

Anyone who says that “picking the right stocks” and “good timing” are the keys to investing is completely wrong.

Indeed, two authoritative studies paint a completely different picture. They show that selecting the right types of investments and the correct geographic areas in which to invest are among the keys to generating high profits.?

Specifically, in a 1986 study, Brinson, Hood, and Beebower examined the multiyear performance of 91 major American pension funds. The researchers found that types of investments and the geographic location of assets accounted for 93.6% of the difference in the plans’ returns.?

On the other hand, the selection of which specific securities to buy accounted for just 4.7% of the variation of the funds’ returns, while the timing of investment purchases was only responsible for 2.1% of the differences in the funds’ profits.??

Confirming the previous study’s finding, a subsequent analysis by Brinson, Singer, and Beebower, carried out in 1991, determined that the types of investments and the geographic location of assets was responsible for 91.5% of pension plans’ profits.

Top-Down Investing Versus Bottom-Up Investing

Top-down investing and bottom-up investing are two, contrasting theories of how to choose the best assets to purchase.

With the top-down approach, the selection of the type of asset in which to invest and the sector to which it belongs are two important considerations. A third crucial point is the geographic area in which the investment is located.?

Among the different types of assets are equities (also known as stocks), bonds, and alternative investments, such as real estate, precious metals, and private equity funds.

Of course, all the assets listed above could be based in any geographic area of the world, such as North America, Asia, or Europe.??

And equities and bonds can be in many different sectors, such as commodities, housing, consumer staples, energy, corporate, and government.?

On the other hand, bottom-up investing emphasizes the importance of picking good, individual stocks at the correct time.?

As a result, bottom-up investors pay a great deal of attention to individual companies’ past financial data, their financial stability, and their overall outlook.?

And in an effort to determine firms’ future performance, using a variety of factors, bottom-up investors will also likely attempt to gauge whether each company is well-positioned to take market share from their competitors or at least maintain their current market share.???

Bottom-up investors use various statistical and technical methods to determine the best time to buy assets.

A Diverse, Non-Correlated Portfolio Is Crucial

In investing, as well as in much of life in general, it’s very important to prepare for unexpected events. When we buy car insurance and determine what steps to take if our electricity goes out, we are getting ready for events that will probably not, but could potentially, happen.

To prepare for the unexpected, your portfolio should always include many different types of investments whose values do not tend to go up and down together. In other words, you should have a diverse, non-correlated portfolio.

One example of the need for diversity and non-correlation was seen during much of 2021 and the first quarter of 2022, when most tech stocks with high valuations plummeted. Anyone whose portfolio consisted entirely or mostly of those types of stocks lost much of their investment during that period.

But, due to unexpected situations, even assets that many people think of as relatively safe can lose much of their value. For example, before February 2022, many investors probably thought of the stocks of large, Western European banks as secure and well-positioned.?

But due to the unexpected Russian invasion, the value of these banks’ shares plunged. As a result, anyone whose portfolio consisted primarily of the stocks of those banks lost a great deal of money.

Another good analogy of why and how to prepare for unexpected situations comes from baseball. Let’s say that, in the first six innings of a nine-inning game, no balls have been hit to a team’s right fielder. Does that mean that the team, in the seventh inning, should no longer use a right fielder?

Absolutely not. Because, in a crucial situation in the seventh inning, a left-handed hitter, who had struck out in all his previous at-bats, could unexpectedly hit a ball hard to right field. Without a right fielder, the team in the field will have big problems.

For investors, the best way to prepare for unanticipated situations is by owning assets whose values do not tend to go up and down together. So, for example, in 2021 and early 2022, an investor whose portfolio consisted of 20% real estate, 20% commodities, 20% investments in leading private equity funds, 20% of an S&P 500 ETF, and 20% high-growth tech stocks probably did rather well. In any event, he or she almost definitely did not lose money.

But, you might be thinking, the investor lost a significant amount of money on the tech stocks, and, from November 2021 to early 2022, the S&P 500 also retreated meaningfully.

Those are valid points. But because this portfolio was diversified and non-correlated, it managed to do well even when the unexpected happened. Specifically, due to the portfolio’s holdings in real estate and commodities, it was well-positioned for the tremendous surge in inflation and Russia’s invasion of Ukraine, both of which were unanticipated in early 2021. In other words, the investor’s right fielder was in position and ready.

So, if you have a good portfolio that’s prepared for the unexpected, all your investments should not go up simultaneously. Actually, some of your investments should always be flat or going down. And when the macroeconomic or geopolitical situation changes unexpectedly, those investments will prevent you from losing a great deal of money.

The Bottom Line

Research shows that top-down investing is far superior to bottom-up investing. And history, along with common sense, illustrates the importance of a non-correlated, highly diversified portfolio.?

Let?Ed and his team at Chapwood Investments do a?forensic review?of your portfolio. They will let you know what you have. Then they’ll tell you what you need so you can get to where you want to be now and in the?future. Contact Ed?here?to set up a meeting.