A Wealth of Common Sense: How to Eliminate Negative Alpha

Investors seek alpha. That’s a simple term used to denote the profits made above and beyond the risk involved. Earning 30% in a portfolio of common stocks in a year the index returns 20% generates significant alpha.

But investors need to be aware of negative alpha. That means being in the wrong stocks at the wrong time. And underperforming the overall market as a result.

Generally, most investors tend to follow the market. If stocks have been rising, they throw caution to the wind and increase stock positions. Or, worse, take riskier positions.

When stocks fall, investors move to the sidelines after a decline. That’s also a recipe for poor returns.

Instead, investors may want to employ a strategy that moves contrary to the market. That means buying stocks when they’re down and fear is on the rise. Or selling stocks when prices are soaring higher.

Investors tend to think of cash as a poor investment decision. Over the long-run, that’s certainly true as inflation eats away savings. However, during a bear market, when stocks fall 20% or more, cash’s relatively flat return can prove a lifesaver.

And when stocks start to trend higher again, traders who lean into a rebound can see increased returns. This leads to improved gains and the avoidance of negative alpha during a market cycle.

To listen to the full strategy to eliminate negative alpha, click here.