In my last article, I made the claim that anyone can be like Warren Buffett. You may not be able to top his record, but over time I believe you can certainly beat the market as measured by the S&P 500. A bold claim, yes, but one that I believe is achievable by anyone who is willing to put as much time into investing as the typical American spends watching reality television.
So let’s get started. You might think I am going to need 50 or more serialized installments to deliver what is sure to be a complicated discussion, but instead I can describe a market-beating result in just one sentence: equal-weight your portfolio.
Beat the S&P - and the Average Mutual Fund Manager - with an Equally-Weighted Portfolio
You don’t need a PhD in statistics. You don’t need to know the latest trends in ‘Smart Beta’ or non-Bayesian quantitative portfolio construction. All you need is a $5 calculator or a pencil and paper. Take the total of your investable assets – let’s say its $100,000 (you excellent saver, you). Now let’s say you have found ten stocks in which you want to invest. You divide your investable assets of $100,000 by the ten stocks you want to buy, or $10,000 per position, resulting in ten positions of $10,000 each.
Now that you know how much to allocate to each investment, you simply divide your equal-weight allocation by the price of each stock to find out how many whole shares to buy. Let’s use Apple Inc. (AAPL) as an example, which as of this writing is trading at $124.80 per share. If you have decided to hold ten stocks in a $100,000 portfolio, then under equal-weighting you are going to allocate $10,000 per position. Divide $10,000 by $124.80 per share, and you get 80.12 shares. We only look at the whole number and ignore any fractions, so in this case you would buy 80 shares of AAPL. Repeat this for your nine other holdings and you have a complete portfolio.
Yes, it really is that easy, but don’t for a minute think this isn’t a powerful approach to portfolio management. It is. As countless research studies have demonstrated, the average mutual fund manager is unable to beat the S&P 500 over time, but an equally-weighted portfolio of those same 500 stocks soundly outperforms the index.
Buy What's Cheap...it's Really that Simple
The reason is simple and intuitive. Most market indexes are capitalization-weighted, which means they buy more of a given stock as it gets more expensive in price. It shouldn’t come as a great surprise that buying more of what’s expensive and less of what’s cheap is a sure path to mediocrity.
Academic researchers have published findings that none of even the most complicated of allocation methods is statistically better than the simple equal-weighting described above. Even Nobel Prize winner Harry Markowitz, the father of mean-variance optimization, is said to have equal-weighted his own investments.
We practice what we preach, equal-weighting both the mutual funds and separate accounts we manage. You can use equal-weighting to construct your own portfolio, or you can find numerous mutual funds and ETFs that incorporate equal-weight methodologies. Either way, I believe it’s an approach worth exploring.
Alan Stevens is Managing Director of Research and Portfolio Management at Lyons Wealth Management LLC, a Florida-based subadvisor to several mutual funds. He serves as Portfolio Manager for Catalyst/Lyons Tactical Allocation Fund and is Co-Portfolio Manager for Catalyst/Lyons Hedged Premium Return Fund. He also manages several separate managed account strategies and alternative asset funds, including Lyons Tactical Overlay Program. He holds his MBA from Harvard Business School and a BA from Lake Forest College.
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