Focus on a Stock or Sector You Like
If reducing your overall risk by investing in a mix of stocks and bonds doesn’t float your boat, what about juicing your return by trying to invest with a more focused and active strategy?
This is actually easier than it sounds. All you have to do is buy a stock fund or a bond fund like we discussed earlier, and then leave a portion of your money set aside to bet on a specific stock or sector you like most.
Are you a gadget geek who owns everything that Apple makes and believe the company will change the world with the iPhone 5 and the next iPad? Then get “overweight” in the stock and tip the scales of your portfolio toward Apple.
It’s as easy as placing a little bit in this company to bet on its future independent of what you put in a broader index fund. That way you get the stability of a diversified portfolio but have 5% or 15% or whatever you choose in the specific investment of your choice.
The same goes for broad-based sector bets. If you believe health care is set for big growth in the future as baby boomers age, you may want to tip the scales toward health care with an investment like the iShares Dow Jones US Healthcare ETF (NYSE:IYH), which contains big names like Johnson & Johnson (NYSE:JNJ), Pfizer (NYSE:PFE) and Merck (NYSE:MRK).
It’s riskier to make this kind of weighted bet on a sector or a stock, of course. But it can pay off big-time if you pick right. Consider that if you invested $10,000 in the S&P 500 five years ago, you would have $9,200 now — a loss of $800. But if you invested $9,000 in the S&P and then $1,000 in Apple stock, you’d have $11,370 — a profit of $1,370 in the same period.
If you trust your instincts and are willing to take a little more risk, this is the way to go. I would never advise putting all of your money in a single investment, but getting “overweight” in a company you believe in can be a great way to beat the market.
Customize Your Portfolio
If you already have a 401(k) with a diversified portfolio of stocks and bonds, or if you feel like you have the sophistication to build your own investment portfolio, it’s really quite simple to make your own moves — and potentially beat even the “smart money” on Wall Street.
Start by picking a handful of stocks you believe in, preferably in different sectors for diversification and stability. Then just divide your $10,000 nest egg and build your own hedge fund!
Intimidated? Don’t be.
Consider that the Dow Jones Industrials is made up of 30 stocks that collectively have a five-year return of -5%, thanks to the financial crisis. If you decided to cherry-pick your favorite five Dow components, presuming they were in the top half of that list, you would have significantly outperformed the market.
By way of example, let’s say that in 2007 your favorite Dow components were financial stock JPMorgan (NYSE:JPM), tech stock IBM, retailer Wal-Mart (NYSE:WMT), energy giant Exxon and pharma giant Pfizer. That’s a pretty diversified portfolio of big-name stocks, giving you a wide swath of the market. So you put $2,000 in each pick for $10,000 total.
Collectively, these stocks have returned 25% in the last five years — turning your nest egg into $12,500. That’s impressive in itself, but even better since the broader Dow Jones is in the red in the same period!
Obviously, the risk here is that you pick the wrong stocks and actually underperform the market. But as this example shows, it’s not like you have to find some little-known company that’s a huge risk. Simply by being smart about the sectors and companies you invest in, you can significantly outperform the broader stock market.
Think Beyond Stocks and Bonds
Of course, it’s worth noting that there’s no need to limit yourself to investing only in the stock market or bond funds. Many good ways to “invest” a $10,000 windfall have nothing to do with capital markets.
What if you want to go back to school for an advanced degree or get training for a new career? That’s a great way to invest in yourself — and presuming you’re happier or better paid in your new vocation, the returns will be very substantial on that investment.
What about paying down your existing debts? If you’re getting charged 3% annually on a car loan or 10% annually on credit card debt, by paying off that balance you’ll not just eliminate a monthly bill but you’ll save the interest charges. Those are real returns that shouldn’t be overlooked.
Or how about something more abstract, like using the money to start your own business? If you want to set out as a contractor remodeling bathrooms and kitchens, you might need some more tools. If you want to start a catering business, you may need new kitchenware and a bigger oven. If you want to sell just about anything online, you may need a Web designer to build you an e-commerce platform.
Buying mutual funds or stocks is the traditional way to invest, but many other options are out there for you. And unlike capital markets, many of these investments could get you more in touch with your interests professionally. That’s a win-win.
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.