The Secret to Stock Market Gains

There are many ways to invest—and many potential ways to beat the market.

But one way, more than any other, will result in different returns than the market. Done right, it means beating the pants off of the index. Done wrong, it means underperforming.

This secret has to do with portfolio allocation.

While most investment professionals discuss the importance of diversification, they tend to do so to stress an investment that could go wrong. Having no more than 10 percent of your wealth in one position means never having to lose more than 10 percent if it goes to zero.

So far, so good. But if you’re focusing on investments with a great future, there may be times when having a larger allocation to a specific company or sector could get you a better return.

That’s the secret behind the wealth creation of Warren Buffett. A look just at the current stock positions in the Berkshire Hathaway portfolio shows that over 25 percent of the portfolio is in a single company—Apple. 

But on a sector basis, Buffett’s portfolio has over 35 percent invested in financials like big banks and credit card issuers. And that’s not including wholly-owned companies in the insurance space.

That large single stock position and sector position alone is over half of the portfolio of the greatest investor in history. That’s a level of concentration that many smaller investors may never reach—or if they do concentrate, it may be on smaller companies with higher volatility more likely to falter and lead to a forced sale at the worst possible time.

But the secret is right there, hiding in plain sight. For better market returns, focus your portfolio on areas with the best prospective future returns—especially where your specialized knowledge may come in handy as well.

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