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Stock Strategist

The Fat-Pitch Approach to Stock Investing

To reach your goals, focus on absolute, not relative, returns.

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In last week's column, I made a case for stocks being a better relative value than bonds. I did this by converting nominal yields into real yields to show the expected increase (or decrease) in purchasing power over time among stocks, bonds, and cash. My conclusion: At today's prices, neither cash, bonds, nor stocks will probably do very well over the coming decade because the yields on all three are incredibly low.

This presents a big problem for people who need higher returns to reach their long-term financial goals. I'd argue that this includes just about everyone except those who are in "preservation" mode with their assets (retirees or those close to it). For those of us with a fairly long time horizon, the relative performance of bonds versus stocks isn't what matters. All that matters is an increase in purchasing power by the time we need to cash in our chips.

So, what can you do to solve this low-yield dilemma?

Investment Psychology
First and foremost, you'll need to adopt an absolute-return strategy. Your goal will be to generate positive returns in your stock portfolio no matter what the relative yields among different asset classes are.

While that seems obvious, it's anything but. Very few investors, including most equity mutual fund managers, use an absolute return strategy. For example, a mutual fund manager's goal is to beat his benchmark, not to generate good absolute returns. A fund manager is considered successful if his portfolio declines 15% in a year, as long as the benchmark (such as the S&P 500) declines even further. If you're going to pick your own stocks, that's not the way you should think about investing. Benchmarks don't matter; absolute returns do--specifically, non-negative absolute returns.

To do this, you'll need to get over a very common fear--the fear of missing a big rally in the stock market. I get letters and e-mail messages every day from people who are downright afraid that they've missed the beginning of the next bull market now that stocks have run up 25% from their lows.

Mark Sellers does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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