What REALLY Happens When You Ignore Wall Street

Investors hear a lot of talk about index funds and diversifying risk. And on its face, diversification seems like a reasonable strategy for long-term investing.

I disagree.

As a matter of fact, I’ve found that the opposite is true. Sometimes it’s best to ignore Wall Street.

If you have a clear strategy and can focus on specific types of stocks, you can beat the “slow and steady wins the race” strategy without resorting to trading or aggressive bets.

The other problem with traditional buy-and-hold strategies in this type of market is they just doesn’t work. Stocks have run and fallen so many times that if they were a little boy he’d be wrapped head to toe in bandages.

The S&P 500, the poster child of a diversified portfolio of quality stocks, has a three-year average annualized return of -6.2%. That’s not exactly going to get your retirement nest egg comfortably fluffy.

You can either continue to extend the long-term diversification mantra “it will be fine over time,” or you can focus like a laser beam on quality opportunities and stick with them until they run their course.

Here’s the approach I take in Stock of the Month:

  • Compare each holding to the performance of the S&P 500. When I select an investment, one of my primary goals is to outperform the market. A security could be up or down since I purchased it. But I want to specifically know whether my assumptions about its potential to outperform the market were sound.
  • Review and assess any negative material changes for each of my holdings. Before I buy a security, I nearly research it to death. I assess its opportunity to outperform based on its fundamentals, competition, financials and economic trends. But conditions change. In a downturn, I take a harsher view of anything new that is liable to negatively impact performance.
  • Search for the new silver linings. No matter how dark a market storm cloud, there are always opportunities. Revisit your watch list. Sometimes I can find an underpriced chestnut. Sometimes I can find an investment that outperforms in stormy weather.

Because I follow this approach, on average, my open positions are outperforming the S&P 500 by more than 10 percentage points.

Two other trends are working in my focused favor:

1. Companies are now sitting on high levels of cash. During the recession, companies battened down the hatches, cut costs and paid down debt. As a result, company balance sheets are healthy. The non-financial companies in the S&P 500 are sitting on $837 billion in cash — which is much higher than normal and 26% more than they had last year. And that’s just a subset of the S&P 500. Overall, $3 trillion of cash is sitting on company balance sheets.

But cash on the balance sheet doesn’t help a company grow. Companies could hire more employees to expand their businesses, but so far that has not been a course they have been willing to take. They could buy existing businesses with strong growth potential. And that appears to be the case.

Small companies are still having problems borrowing money to expand their businesses. Lenders, however, are very comfortable loaning money to big companies with strong balance sheets. Therefore, marriages between big and small companies seem like matches made in financial heaven.

2. Merger activity is heating up. August is usually a slow month for deals. But the pace of mergers and acquisitions this month is set to be the highest of the year.

Global takeovers exceed $1.3 trillion so far this year, up almost +25% from the same time last year. That’s great news for funds that profit from Wall Street’s deal making. What’s even better is that these funds tend to be steady growers. While they may lag a little in raging bull markets, they consistently outperform in inconsistent or bear markets.

Action to Take –> One of my recent portfolio additions is a fund that takes advantage of this M&A trend. It’s typical of searching out timely opportunities and holding them just long enough to get every last ounce of profit from them and then move on. But because I’m buying trends and not earnings or story stocks, these are investments, not trades.

I take what market will give me, and right now, playing the “hold-and-hope” game just isn’t working. But I’ve found a strategy that is.

P.S. If you’re interested in seeing how a focused investment strategy can help boost your portfolio and pad that nest egg, come see what I’m doing at Stock of the Month. I think you’ll be pleasantly surprised that there are ways to beat Wall Street at its own game.