Where To Focus Your Alpha Energy

Category: Finance, Financial Planning.

A current theme among Wall Street wealth managers is for individual investors to have index funds as their core holdings and to focus the remainder of their assets in high alpha investments, which will produce returns not correlated with the market.

In traditional finance, return not correlated with a broad market index, such as the S& P 500, is referred to as alpha. A quick digression for those of you who aren t familiar with alpha and beta. The return which is correlated to the market is beta. You can t outperform the major indices, so don t waste your time. An index fund should have the same return( positive or negative) as the index it mimics. (One of the controversies surrounding some ETFs is their performance has not tracked their underlying index. ) The theory behind Alpha and Index Funds is multi fold: the major indices are a good place for an investor to be, both from a risk and return perspective. Find those investment niches with high alphas to increase your return and reduce the overall risk in your portfolio. They will tell you something about the correlation and diversification of your portfolio.

Even if you don t subscribe to this theory, you might find it an interesting exercise to review the alphas- - every investment has one- - of your current holdings. Where to focus your alpha energy? The Wall Street pros also recommend stock fund mangers who have unique strategies and can demonstrate a high alpha relative to the market( and, positive relative performance, of course) . Investments in real estate, and energy are, commodities less correlated with the stock market( although I ve never thought commodities were suitable for individual investors) . Ask your investment adviser for suggestions. Alpha and index fund investing makes a great deal of sense.

The alphas for individual mutual funds( and individual stocks) are available from some brokers and online premium services. You know what to expect in terms of risk and return when you invest in an index fund. Picking high alpha investments, which by their nature are less correlated with the stock market, should reduce the risk/ volatility of your portfolio and, depending upon the investment, provide above market returns. Having a portion of your portfolio in index funds leaves you free to concentrate your investment time and energy( think alpha waves) on those investments which can make a difference.