Small Stocks To Excel

by Alan Lavine and Gail Liberman

James P. O’Shaughnessy, senior managing director at Bear Stearns and author of “Predicting the Markets of Tomorrow,”  Penguin Group, NY,  says that small company stocks and undervalued stocks will outperform the overall stock market for years to come.

The analyst says that  stocks of larger, fast growing companies, like those in the S&P 500 outperformed every other type of stock investment category in the 1980s and 1990s. But there is a new investment cycle underway. The stocks of small and mid-sized companies will outperform the market. Undervalued large company stocks will also outperform large company growth stocks.

O’Shaughnessy did an analysis of stock market performance cycles over the past 100 years. He says the next 20 years of investing will be different than the past 20 years. So investors need to make some important changes.

 Here is what to do:

He says that most investors mistakenly keep 90 percent in large company growth and value stocks and 10 percent in small company stocks you can expect to earn  just 3 to 5 percent annually over the next 20 years.

A better alternative: Keep 35 percent in small company stocks and 50 percent in undervalued large company stocks and the rest in large company growth stocks. 

If you keep this stock investment mix, he say will earn 3 times a much as keep 90 percent in large company stocks that make up the S&P 500.

What about bonds?

He says that the outlook for bonds is “grim.” You should only invest in short-term bonds and inflation index bonds.

O’Shaughnessy does not recommend any individual stocks or mutual funds in the book. But investors that do their own stock picking should own at least 20 stocks. That way you are diversified if a few stocks perform poorly. He has some tips on how to pick the right stocks.

On the mutual fund side he recommends exchange traded funds (EFTs). Efts represents a basket of stocks. EFT is traded on the stock exchange. You can buy undervalued large company or small company EFTS, as well as large and small company growth stock EFTs.

He does not like actively managed mutual funds. The reason: The fund mangers often change their portfolio management strategies.

Alan Lavine and Gail Liberman are husband-wife personal finance columnists, journalists and authors. They are the authors of "Rags To Retirement," published by Alpha Books. Their columns appear in newspapers throughout New England and the Southeast, as well as online. Their commentary on mutual funds and personal finance is carried by 200 radio stations nationwide every Sunday over Business News Network's Charles DeRose Financial Advisor Show. Al and Gail’s new book is "Rags To Retirement:  Stories from people who retired well on much less than you think," published by Alpha Books.

More articles by Al and Gail can be found here.