The perfect portfolio is one that incorporates strategic ideas and positions in order to fairly balance out the correct amount of risk and reward as found subjectively tolerable to the individual investor. The following concepts are expressed in order to present unique solutions that may be custom fit to the reader. These ideas are not always recommended for every person at a given time, and it will often take experience to know how and when to use them. Like identifying tools in a tool chest, understanding the capabilities of each idea can ultimately better serve in their use.
1) Short Volatility.
Volatility is a relatively new concept that is gaining increased popularity both as a measure and as an investment in itself. The Chicago Board Options Exchange Market Volatility Index (VIX), is a popular statistic of the implied volatility of the S&P 500 index and is based on index option prices. The VIX itself is quoted in percentage points and roughly translates to the expected movement in the S&P 500 index over the next 30-day period and subsequently annualized. In general the VIX represents the expected swing of the market in either direction as an expressed percentage.
One method to exploit this measure is to consider shorting a related investment correlated to the volatility index. As the VIX itself can not be held as a holding, derivatives of the index are often used to formulate a position. The iPath S&P 500 VIX ST Futures ETN (VXX) is an exchange traded note that offers exposure to the daily rolling long position in the first and second month VIX futures contract. Yet as a consequence of contango, the perishable value of the premium attached to futures prices set above the expected delivery date, the VXX is almost inherently created to decline in value. As a result, the trend of the VXX itself is made abundantly clear in the graph shown below.
The danger of shorting this position is the sharp degree of correction that occurs once anxiety creeps into the market yet again. Yet since the market's trend is to eventually normalize, shorting the volatility index seen here is one of the more predictable trends to rely on thanks to the effects of contango. Investors could alternatively go long a VIX inverse investment such as the VelocityShares Daily Inverse VIX ST ETN (XIV) in order to capture a similar trend.
2) Maximize Your Stable Dividend Growth.
Investors often seek large dividends regardless of the company's ability to actually sustain these yields. Companies that promise enticing yields can often do so at the risk of being unable to sustain them. Yet as stability remains an important factor for investor confidence, monitoring the dividend growth history of a company can often serve as an enduring guideline to the overall trustworthiness of the dividend itself.
Additionally, dividend growth provides a key complementary element to the income component of an equity investment. With dividend growth, the distribution not only becomes a means to replace income, but it can also have the benefit of compounding it. For example, if a yield steadily grows 10% annually after 10 years the dividend component of a company's stock will have increased 159% instead of the expected 100%. Steadily compounding income remains one healthy means to combat the woes of inflation.
A look at the Coca-Cola Company's (KO) dividend history as seen above offers a prime example of a company that has year over year steadily increased its dividend rate. Since 1963, the company has sequentially raised its dividend thereby offering the impressive 50-year history of doing so. In 2002, the quarterly rate of the company was $0.10. Yet ten years later in 2012 and the quarterly rate was declared at $0.255 in clear illustration of a compounding dividend rate.
3) Invest In Disruptive Business Models.
To invest in growth is to capitalize on the future earnings capacity of a company not yet priced for it. Yet not all companies offer the same lasting opportunity for sustained growth, and many can quickly fade or maximize their potential in such a way as to not live up to the expectation. This can usually occur when a company offers a product that fails to change the game. When investing in growth, it can often be advantageous to identify companies who's businesses disrupt the current model of how things are done by offering a vast improvement.
The most successful companies of our day have often established themselves through disruptive changes. A company like Apple (AAPL) not only helped introduce the computer into society but did so by adding its unique culture of creativity and innovation to distinguish it from the competition. A company like Amazon (AMZN) is currently disrupting the traditional model of "going out to shop" by placing the ability into the hands of consumers through an online presence at their finger tips. Even a company like Starbucks (SBUX) offered a disruptive business model by forsaking advertising costs and establishing itself in a high profile manner. By understanding its target audience, offering uniformity, and providing centralized access, Starbucks reshaped our understanding of how coffee works.
Therefore as a strategy, merely investing in growing companies should never suffice. Rather, investors should swing for the fences by identifying the companies with business models capable of radically altering the way things are done. For example, a company like Solazyme (SZYM) can convert carbohydrates to customizable oils capable of profitably replacing petroleum, vegetables, and animal fats. The company offers the first platform to create specifically tailored oils that can be used in chemicals, food, cosmetics, and even jet fuel. By providing a green conversion solution, the company is redirecting our reliance on precious resources and allowing waste material to be used in the development of products capable of being used in existing infrastructure.
The same can be said about a company like EnerNOC (ENOC), an energy management company who's business model is to redesign the way society uses the energy grid today. By identifying the excess power use of businesses and coordinating control over this excess energy, the company sells the power back to utility companies and pays participating businesses. In doing so, the company effectively creates a power plant of its own. It now supports a capacity of 8.3 gigawatts capable of being used to support the grid.
Altogether, the above ideas are mentioned in order to let readers continually think outside of the box when it comes to managing their ideal holdings. Each of these concepts come with risk. Volatility plays are inherently volatile. Companies paying a dividend still carry price movements in their stocks. Disruptive companies may have a difficult time in their acceptance by society. Yet each of these investment ideas offer another approach for investors to consider as they balance their risk tolerance for their perfect portfolio.
Disclosure: I am long SZYM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am also short VXX