By Paul Shread
A money manager I know recently gave me a copy of Nick Murray’s “Behavioral Investment Counseling.” The book is aimed at financial planners, but almost anyone who invests in stocks could benefit from reading it. It’s surprisingly well written for a financial book, and it also makes an unusually persuasive case for buy-and-hold: That most investors chase performance, buy high and sell low, and in the process lag the performance of the average mutual fund or stock index by more than half.
It got me thinking: What would I feel comfortable buying and holding? Here’s my answer. First, I’m a fan of Dow stocks. In the small 30-stock universe of the DJIA lies enough diversity to fuel any portfolio. The index tends to have higher-quality stocks that won’t set the world on fire, but likely won’t go out of business on you either, although the financial crisis of 2008 marred the index’s long history of relatively safe component companies.
Second, I’ve never been a fan of the Dow’s price-weighted approach, where a $200 stock wields outsized influence, or the S&P’s cap-weighted approach. Studies have shown that equal weighting – buying stocks in the index in equal amounts – tends to modestly outperform the indexes, perhaps for the simple reason that it lessens the influence of stocks that have already had quite a run.
Third and last, I wasn’t a fan of financial stocks even before the 2008 crisis – I was short New Century Financial years before it became the first victim of the subprime mortgage crisis in 2007 – so let’s toss JP Morgan and Goldman Sachs while we’re at it, which has the added benefit of reducing the beta of our portfolio by getting rid of the two highest-beta stocks.
So there you have it, 28 Dow stocks bought in equal measure. It might even work well as a buy-and-hold strategy for when the stock market is on a Dow Theory buy signal, as has been the case since 2009.
I started tracking this portfolio strategy today, in part because I expect a correction between now and October and I want to see how this approach performs in down markets, which, after all, is where buy and hold investors face their greatest test. Theoretically, this strategy should have lower volatility than the Dow while offering similar performance, but only time will tell. I’ll post periodic updates in this space on the performance of this strategy and will rebalance the portfolio on the first trading day of each new year. If a stock is dropped from the Dow, I’ll drop it and add whatever replaces it.
Paul Shread is a Chartered Market Technician and member of the Market Technicians Association. He is a co-author of “Dow Theory Unplugged” and has been testing stock market trading and investing strategies for twenty years.