Investing Lessons Learned from 2009

I am not big on New Year resolutions; they tend to be forgotten after the first few weeks of the year.

Instead, I've found it much more useful to look back on the last year - fully exploiting the 20/20 hindsight vision - and see what worked and what didn't. This "lessons learned" exercise provides a very useful operating framework for the New Year. This is as relevant for investing habits as it is for personal/private ones.

The best way to share these investing lessons is by telling you about the creation of our Zacks Top 10 for 2009 portfolio. Our team worked on this in December 2008 and early January 2009. Can you think of a scarier time in which to pick a portfolio of stocks to outperform in the year ahead?

Gladly we did many things right with this portfolio, given its market-topping +34.1% return. However, we also had our shortcomings. The goal of this article is to learn from both the good moves and the bad in order to invest even more successfully in 2010.

The Top/Down Approach

We used the Top/Down approach in constructing the portfolio. This means we scoured the big picture of the economic landscape first, getting a good sense of the potential health of corporate earnings. At this stage, we start to target groups that are most likely to outperform. By 'groups' I mean concepts like industry exposure, market cap bias, aggressive or defensive stocks, etc. Once this is in place, it becomes much easier to select the best stocks in the best groups to fill out the portfolio.

Lesson Learned: You may not always predict things correctly with this process, but no other method is as complete in order to construct a portfolio. Certainly this should be part of everyone's investment process in 2010 and beyond.

The Big Picture

When we were starting to build the 2009 portfolio at the end of 2008, the economy and the markets were in a freefall. It was difficult to look out even a few months, let alone a whole year. The air of doom and gloom hanging over the markets and the underlying economy was palpable. We had become used to terms describing the economy as 'falling off the cliff', or describing the onset of another 'Great Depression'.

While visibility was extremely poor, we were able to see the contours of a pending economic recovery in late 2009 or early 2010. Since the market generally predicts these events 4-6 months in advance, we believed that the market would bottom near mid-year and start to rally.

Lessons Learned: We certainly get high marks for predicting an economic and market rebound. Our timing call was late by 3 months, but it's hard for anyone to complain given the severely pessimistic outlook from most experts at the time. The main lesson is that you are never going to be 100% right when discussing the future market outlook. However, being in the ballpark is often good enough.

Target Groups Set to Outperform

To play this outlook, we structured our Top 10 portfolio as a combination of two mini-portfolios, with five stocks each.

Portfolio 1- Defense: A defensive mix of stocks to weather the storm at the outset of the year. This defense, or safety, was going to come from a concentration of quality large-cap stocks in less economically sensitive industries. Also we had an eye towards stocks with high dividend yields to provide some income.

Here are those stocks:

Portfolio 2- Offense: This more aggressive portfolio looked for stocks with growth and cyclical leverage to benefit from the eventual economic recovery. Yet we didn't want to be too speculative with these choices either. So we chose quality names that offered the best odds of success.

Here is a look at that group of stocks:

Lessons Learned: In the broad scheme of things, this strategy worked well given the +34.1% return to date. Yet still there were places for improvement.

1. Unfortunately the defensive stocks were a bit of a drag on the performance after March as the market rallied from the bottom. Since we felt strongly about a second-half turnaround, we should have been more confident putting an extra stock or two in the aggressive portfolio.

2. Would you believe that Exxon was amongst our favorite picks when we put these 10 stocks together? The combination of large cap, great balance sheet, dividend and earnings growth potential (assuming reflation of oil prices) made it seem like a sure winner. It's a great lesson that things don't always pan out as you expect. That's why it is so important to diversify your portfolio and never have more than 20% in any one position because it simply might not work out.

Looking Ahead to 2010

Gladly we seem to have averted the 2nd Great Depression. However, 2010 has its fair share of investment risks. Our Top 10 team is already hard at work surveying the landscape for next year. With that we are employing these lessons learned from the past. Most certainly we are employing the top/down approach that has worked so well in the past. Yet we are also mindful of the flaws in our process from 2009 and aim to avoid them in the year ahead.

The stocks for the Zacks Top 10 for 2010 will be released very soon. If you have not already signed up to get these picks, then I hope you will take the opportunity to do so now.

Learn More about Zacks Top 10 Stocks for 2010

Best,

Sheraz Mian

Sheraz is the Director of Research at Zacks. He oversees all the stock analysts who provide insights and stock reports on Zacks.com. He is also leading the stock picking team in charge of the Zacks Top 10 for 2010 service.

Zacks Investment Research