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Formula Based Investing, A Recipe For Success?

It seems a lot of people are confused as to what is the best investment move to make now.  The stock market has rallied around 20% since March’s lows.  Some investors sold out in a panic, while others have been paralyzed and done nothing.  Since many investors are making emotional moves right now, it is a good idea to get back to the basics of investing.

Remember to use Asset Allocation.  This means the proper distribution of investments among various investments vehicles, such as cash, bonds, stocks, etc.  Then diversify money among large, medium, small, and international companies.  Although diversification doesn’t guarantee against loss, studies have shown that as much as 85% of the success of long term investing is based upon proper asset allocation.  This formula also known as Modern Portfolio Theory could be very helpful in determining the right mix.  In fact, this process won the Nobel Prize in Economics.  Several great calculators can be found for free online if you Google Asset Allocation Tool or a financial professional can help you select the right mix.

Implement the Rule of 100 when reviewing all of the investment accounts.  This rule says to take 100 and minus an investor’s age, that is about how much money should be exposed to risk.  Start with building a solid foundation of safe and guaranteed money.  Then add in some investments that are diversified outside of the stock market that are medium risk investments.  Finally, add in risky investments on the top.  Often times investors exposed to too much risk end up getting hurt the most in an economic downturn.

Remove short term emotions.  The average investor has returned only 3.9% as compared to the 11.9% return of the S&P 500 index from 1986 to 2005 according to a study by Dalbar.  We understand it’s nearly impossible to not be emotional with your life’s savings.  Just remember, the average investor guesses wrong.  Automate financial decisions as much as possible to remove human emotions.

Don’t chase results.  Last years winners are typically not next year’s winners.  Look at performance over a one year and five year basis.  Don’t just focus on what the results were last month or last quarter.  The most successful investors of all times, like Warren Buffet and Peter Lynch didn’t chase performance.  Instead, a solid boring portfolio often wins over the long term.

Buy and do homework, not buy and hope with investments.  Just because a smart or dumb investment move was made, doesn’t mean hold on forever.  In almost everything in life, performance is measured against a benchmark.  Sports team players to teachers are expected to meet and exceed a benchmark.  The same should be true with investments.  So establish a benchmark and then measure performance over time.  Cut losses and take winnings when a predetermined level is reached.

Many investors would benefit from having a defined investment approach in place.  The Dow Jones Industrial Average has had an average annual return of 10.20% since 1972.  Now let’s see what happens when we apply a three step process to identify five stocks to own out of the Dow Jones which is made of up 30 stocks.  First, rank the stocks based upon dividend yield, highest dividend yield to lowest.  Then select the 10 highest paying dividend stocks and rank then based upon share price, lowest price to highest.  Finally, buy the 5 stocks with the best combined rankings and hold them for a period of 15 months.  Although past performance doesn’t guarantee future results.  A $10,000 investment in 1972 through the end of last month would have grown to $501,440 using this formula compared to $318,453 by just owning all 30 stocks in the DJIA.  To get a list of the 5 stocks that currently meet the formula or for additional formulas, browse on over to our website at www.RetirementGuysRadio.com

Put these formulas in place and put the financial plan on track.  Remember more financial noise will be on the horizon.  Don’t get caught up in the daily noise of Wall Street.  Avoid the daily noise, and use a defined formula to increase the odds of success.

For more information about today’s column and The Retirement Guys, tune-in every Saturday at 12pm on 1230 WCWA and every Sunday at 11am on 1370 WSPD or visit www.retirementguysradio.com.  Securities are offered through NEXT Financial Group Inc., Member FINRA / SIPC.  The Retirement Guys are not an affiliate of NEXT Financial Group.  1700 Woodlands Drive, Suite 100, Maumee, Ohio 43537

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