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Why Buy and Hold Makes Sense, at Least for Some of Your Investments

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Plus: Where to look for outperformance.

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How to Outperform the S&P 500 Index

The S&P 500 Index is a cap-weighted index, and there are many proponents of investing in other than cap-weighted indices. There is a perceived risk in tying index weighting to market price; at the least, this can make an index inefficient on the upside. If you are using the S&P 500 -- the most widely used benchmark -- as your benchmark, then the more you deviate from this index, the greater the chance there is of outperforming it, but also the greater chance there is of underperforming it.

A way of looking at the market is that the market is a zero-sum proposition, meaning that there is only so much gain available, and that for you to profit in the market, another investor must lose. A zero-sum game is a situation in which each person's gain or loss is exactly balanced by the losses or gains of the other people in the game. When the gains of people are added up and matched against other people's losses, they sum to zero. In other words, there is only so much pie to go around; if someone takes a bigger slice, the other or others must take a smaller slice or smaller slices. So if the market is judged against a benchmark such as the S&P 500, to outperform an investor must invest in other than the S&P 500 stocks and weighting. The most usual ways to attempt to beat the market is to invest in sectors, weighting methods, or cap sizes that will outperform.

Looking for Outperforming Asset Classes

One place you can look for possible outperformance is in foreign stocks. WisdomTree, the dividend-weighted and other non-cap weighted index ETF maker, is of the opinion that Asian stocks, as defined in as the MSCI AC Asia Pacific ex-Japan Index, are in a sweet spot as far as anticipated forward returns. Based on its studies of historical valuations of Asian equities, the company concluded that Asian equities are selling at relatively low valuations based on past ranges. WisdomTree broke down dividend yield periods from these stocks into three time periods: low-dividend yield years, mid-dividend yield years, and high dividend yield years. They found that the performance for the year following the middle 12-month dividend yield time has been the highest. The year after the middle dividend years returned on average 30.86%, which is more than 17% ahead of the average for years after the other dividend years.

As of February 2013, Asian equities had a trailing dividend of 2.85%, which placed them in the middle dividend year class. Using this formula, the next 12 months could be an outperforming time for this asset class. The WisdomTree Asia ex-Japan ETF (NYSEARCA:AXJL) sells at about 13 times earnings, pays a dividend of 3.3%, and exposure to Australia, Hong Kong, and Taiwan make up over 50% of the index.

Editor's Note: Max Isaacman is the author of Blizzard of Money, Winning with ETF Strategies, Investing with Intelligent ETFs, How to Be an Index Investor, and The NASDAQ Investor.
Max Isaacman holds AXJL at the time of this article's posting.
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