Are there more ways than one (or two) to skin a cat?
Conventional wisdom says yes. Picking stocks is one way to beat the market—easy to say, and hard to do. It’s possible because identifying growth candidates or value plays depends on insight and hard work—commodities that never become obsolete. But is stock-picking the only way?
There are two other principal sources of market return. One is the market’s overall trajectory—the market itself. If you can successfully predict the market’s ups and downs, switching to cash when the market goes down and back into stocks when it goes up, you can turn market volatility into investment returns.
But we’ve discussed before how difficult this is. Not only do you have to be right about when to get out, you also have to be right about getting back in. And the way the market works, if you’re out of the market on its most positive days, you often miss out on half to three quarters of the that year’s returns.
Indeed, some of the most famous market-timing calls weren’t timing calls at all. They were value calls. In 1970 Warren Buffett famously closed his investment fund and returned the cash to shareholders because he could not find attractive investment candidates. Four years later, after the market had fallen 50%, he went all-in and saw tremendous returns. But it wasn’t chart-reading and trend-following that got him there; it was an assessment of Mr. Market’s mood-swings.
Market-timing can add value, but it’s almost impossible to pull off successfully. The third source of returns—sector allocation—is one we’ll look at tomorrow.