How can you assess market position to earn more money? Is it possible to beat the market?
As an investor, you can tilt the deck in your favor by taking the market’s tendencies into account when positioning your portfolio. Howard Marks illustrates how to do so via two steps: Correctly assess the market’s position in the cycle, and adjust your portfolio accordingly.
Here’s how to beat the market in only two steps.
Step #1: Correctly Assess the Cycle’s Position
The first step toward learning how to beat the market involves correctly determining the market’s position in that cycle. To do so, he first recommends that you evaluate quantitative metrics that can signify whether the market is bullish or bearish. For example, you can look at the S&P 500’s average price-earnings ratio—that is, the ratio of a company’s share price to its earnings-per-share—to see whether investors seem to be overpaying or underpaying relative to earnings.
(Shortform note: In addition to average price-earnings ratios, financial experts consult an array of metrics to assess market position. For example, stock price breadth records the percentage of stocks whose prices are increasing; a higher number indicates a bullish market, whereas a lower number indicates a bearish market. Further, market volatility indices allow investors to see how volatile the market will be month-to-month, with higher volatility normally associated with a fearful market.)
Marks also recommends performing a qualitative assessment by taking stock of the way investors are talking about the market. For instance, are prominent investing gurus lamenting the state of the stock market, or are they instead singing its praises and constantly issuing “buy” recommendations? By listening carefully, investors can determine the current location of the market in the various cycles described above.
(Shortform note: Experts list several other strategies for qualitatively assessing the stock market. For example, they point out that you can follow financial gurus on social media to receive real-time updates on the stock market, in addition to news aggregator sites like Google News, to ensure you’re hearing about the market from a diverse set of sources.)
Step #2: Adjust Your Portfolio Accordingly
Having determined the market’s position in the cycle, the next step involves correctly positioning your portfolio. According to Marks, this is a matter of choosing where your portfolio should lie on a spectrum between aggressiveness and defensiveness.
He relates that aggressive investing involves allocating a higher proportion of your portfolio to more volatile investments (like stocks) rather than safer investments (like bonds). Aggressive investing often includes riskier stocks from more volatile industries, rather than blue-chip stocks with steadier concerns. Aggressive investing is called for when the market is likely to rise—for example, if investors are mostly risk-averse, assets are underpriced, and foundational cycles point to an improvement in the market—then you should have an aggressive portfolio to capitalize on the rising market.
On the other hand, defensive investing involves allocating a higher proportion of your portfolio to less risky investments, such as bonds, instead of more volatile investments like stocks. Further, defensive investing involves focusing on assets that are more resilient to the market cycle’s fluctuations, such as stock in companies that sell commodities. Defensive investing is called for whenever the market is likely to drop—for instance, when investors are extremely risk-tolerant, assets are overpriced, and foundational cycles suggest the market may drop. In such cases, you should adopt a defensive portfolio that minimizes the risk of losing money.
| Additional Thoughts on Aggressive vs. Defensive Investing While Marks focuses on the market’s position when deciding how aggressively to invest, John C. Bogle, founder of the Vanguard Group and author of The Little Book of Common Sense Investing, instead focuses on your individual financial situation and innate risk aversion. According to Bogle, your personal financial situation—especially your liabilities (such as the cost of raising a child, buying a house, or retiring)—should inform your investment portfolio. For example, if you’re young and single with no looming liabilities, you can afford to have a more aggressive portfolio, whereas an older retiree might prefer a more defensive approach. Further, Bogle notes that some individuals have naturally high-risk aversion and can’t handle the increased volatility of an aggressive portfolio; for these people, he recommends a defensive portfolio. In practice, Bogle suggests that younger, more risk-tolerant investors could have a portfolio that’s split 80-20 between stocks and bonds—they may also invest in more volatile stocks, rather than stocks with consistent growth. By contrast, he clarifies that older, more risk-averse investors with many liabilities could instead adopt a 25-75 split between stocks and bonds, focusing especially on more established stocks that are less risky. |
