Construct a portfolio in this environment?
Posted: May 4th, 2010 | Author: Wayne Weddington | Filed under: Opinion |
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If speaking to an audience of experienced investors, I would have a detailed series of metrics that one might consider when stock picking. But given that the average person is simply trying to find their way to an informed investment strategy without being a professional, the answer lies in pragmatism, which is far more clever than having a mnemonic for insightful stock picking.
First lets examine why stock picking for the individual investor is folly:
The average investor does not have a multi-million dollar large nest egg, which so there is a real scale issue. For the average person I recommend top-down analysis such as sector etfs. Here is why:
Suppose you want to buy a diversified portfolio of attractive stocks. A diversified portfolio is attractive because the more stocks you have in your portfolio the less susceptible it is to the change in value of any one particular company. And it is known that in general a diversified portfolio over time will outperform a concentrated portfolio. The problem is that a truly diversified portfolio requires a lot of money, and is out of reach for the average investor.
For example, the average price of a NYSE stock is about $40. If you wanted to buy a portfolio of 50 stocks and 100 shares of each stock, that would require $200,000 cash minimum. That is well beyond the cash availability for most people.
ETFs give the average investor the chance to invest smaller sums of money while still achieving a diversified portfolio. Since ETFs have no real minimums and invest themselves in diversified pools of high quality equities, even $5,000 could “participate” in the performance of a portfolio costing many times more. The ETF is a convenient way to give the smaller investor access to multiple stock positions and, for that matter, the benefit of a professional money manager.
For active ‘traders’ ETFs make intraday trading possible which is an advantage over mutual funds. If you are looking for short term exposure intra-day you can do it. Also investors can short ETFs if they seek to take advantage of sectors or stocks that they believe will be out of favor.