Fundamentals of creating a diversified portfolio based on numbers?
Good question. There are plenty of investors who think they can simply rely on intuition, and although luck is always present it is not enough to construct a proper portfolio. First of all there are two basic types of portfolio management: Passive and Active. The majority of abnormal gains are made with active portfolio management although passive managers are less likely to suffer loses.  Both types must be created with some kind of qualitative and quantitative research, but an active portfolio requires constant adjustments (Market Timing) to preserve the desired levels of risk and return.  The topic is extremely broad and every manager has his own preferred methods of quantitative analysis. I will try to list here some most common, in my opinion, ways of stock-picking and portfolio management. Roy's Criterion: The best portfolio is that with the lowest probability that the return will be below a specified level.  This is achieved by maximising the number of standard deviations between the return on the portfolio and minimum specified level: Max k = (Rp-Rl)/Sp Where (Rp) - return on portfolio, (Rl) - specified minimum return, (Sp) - standard deviation of portfolio return. Kataoka's Criterion: Maximise the minimum return (Rl) subject to constraint that the chance of a return below (Rl) is less than or equal to a specified value (a). Maximise (Rl) Subject to Prob (Rp < Rl) =< a For example, assume that the specified value is 20% - this will be met provided (Rl) is at least 0.84 standard deviations below (Rp). Therefore the best portfolio is the one that maximises (Rl) where: Rl = Rp-0.84*Sp Telser's Criterion: Maximise expected return subject to the constraint that the chance of a return below the specified minimum is less than or equal to some specified minimum (a) Maximise (Rp) subject to Prob (Rp < Rl) =< a Assuming same data as previously:  Rl =< Rp-0.84*Sp and select the portfolio with highest expected return. Security Selection Now let's look at some methods of security selection. This is important when a manager believes some shares are mispriced. The required return on security 'i' is given by: Ri = Rf+(Rm-Rf)Bi Where (Rf) - is a risk-free rate, (Rm) - return on the market, (Bi) - security's beta. The difference between the required return and the actual return expected is known as the security's alpha (Ai). Ai = Rai - Ri, where (Rai) is actual return on security 'i'. Stock Picking One way of stock-picking is to select portfolios of securities with positive alphas. Alpha of a portfolio is simply the weighted average of the alphas of the securities in the portfolio. Ap = {(n*Ai) Where ({) is sigma (sorry for such weird typing, haven't figured out yet how to type proper-looking formulas), (n) - share of 'i'th security in portfolio. So another way of stock-picking is ranking securities by their excess return to beta (ERB): ERB = (Ri - Rf)/Bi The greater the ERB the more desirable the security and the greater the proportion it will make up of the portfolio. Thus portfolios produced by this technique will have greater proportion of some securities than the market portfolio and lower proportions of other securities.  The number of securities depends on a cut-off rate (C*) for the ERB, defined so that all securities with ERB>C* are included in portfolio while if ERB  The cut-off rate for a portfolio containing the first 'j' securities is given by (i'm inserting an image cut from Word below):  Here comes the tricky part: Basically what you do is first calculate ERB for each security, then calculate Cj for each security mix (gradually adding new securities one by one and recalculating Cj each time). Then you select an optimum portfolio by comparing Cj of each mix to ERB's of it's securities. Let me show you a simple example: Say you have securities A,B,C and D you calculated ERB's: ERB(a)=6, ERB(b)=6.5, ERB(c)=5, ERB(d)=4 also you calculated: C(a)=4.1, C(ab)=4.8, C(abc)=4.9, C(abcd)=4.5. Then you check: ERB(a),ERB(b),ERB(c) are greater than C(a), but C(a) only contains security A so C(a) is not an optimum mix. ERB(a),ERB(b),ERB(c) are greater than C(ab), but C(ab) only contains securities A and B ERB(a),ERB(b),ERB(c) are greater than C(abc), and C(abc) contains A B and C so it is an optimum. ERB(d) is lower than C(abcd) so C(abcd) is not an optimum portfolio. Finally the most important part: Below is a formula to find the share of each security in the portfolio:  Here you simply plug in already obtained values for each security to find it's proportion in your portfolio. I hope this somehow answers your question, however there is a lot more than this to consider if you decide to manage your portfolio yourself. Some of the most important areas are:  Market Timing Hedging Stocks vs Bonds  Good luck with your investments! And remember, the safest portfolio is the one that replicates the Global Market.  The cut-off rate for a portfolio containing the first 'j' securities is given by (i'm inserting an image cut from Word below):  Here comes the tricky part: Basically what you do is first calculate ERB for each security, then calculate Cj for each security mix (gradually adding new securities one by one and recalculating Cj each time). Then you select an optimum portfolio by comparing Cj of each mix to ERB's of it's securities. Let me show you a simple example: Say you have securities A,B,C and D you calculated ERB's: ERB(a)=6, ERB(b)=6.5, ERB(c)=5, ERB(d)=4 also you calculated: C(a)=4.1, C(ab)=4.8, C(abc)=4.9, C(abcd)=4.5. Then you check: ERB(a),ERB(b),ERB(c) are greater than C(a), but C(a) only contains security A so C(a) is not an optimum mix. ERB(a),ERB(b),ERB(c) are greater than C(ab), but C(ab) only contains securities A and B ERB(a),ERB(b),ERB(c) are greater than C(abc), and C(abc) contains A B and C so it is an optimum. ERB(d) is lower than C(abcd) so C(abcd) is not an optimum portfolio. Finally the most important part: Below is a formula to find the share of each security in the portfolio:  Here you simply plug in already obtained values for each security to find it's proportion in your portfolio. I hope this somehow answers your question, however there is a lot more than this to consider if you decide to manage your portfolio yourself. Some of the most important areas are: Good luck with your investments! And remember, the safest portfolio is the one that replicates the Global Market. Most of the “recommendations” are just total market allocations.  Within domestic stocks, the performance rotates. Sometimes large cap outperform, sometimes small cap outperform. You can see the chart here (examine year by year):  https://www.google.com/finance?chdnp=1&chdd=1&chds=1&chdv=1&chvs=maximized&chdeh=0&chfdeh=0&chdet=1428692400000&chddm=99646&chls=IntervalBasedLine&cmpto=NYSEARCA:VO;NYSEARCA:VB&cmptdms=0;0&q=NYSEARCA:VV&ntsp=0&ei=_sIqVbHYB4HDrgGA-oGoDA Conventional wisdom is to buy the entire market. If large cap currently make up 80% of the market, you would allocate 80% of domestic stocks to large cap.  Same case with International Stocks (Developed). If Japan and UK make up the largest market internationally, then so be it.  Similar case with domestic bonds, it is usually total bond market allocation in the beginning.  Then there is the question of when you want to withdraw the money. If you are withdrawing in a couple years, you do not want to expose too much to currency risks, thus you would allocate less to international markets. If you are investing for retirement, you will get the total world market.  Then there is the question of risk tolerance. Bonds are somewhat negatively correlated with Stocks. When stock dips by 5% in a month, bonds might go up by 2%. Under normal circumstances they both go upward. Bond/Stock allocation ratio is by age I’m sure you knew that already.  Then there is the case of Modern portfolio theory. There will be slight adjustments to the ETF weights if it is found that adjusting them would give a smaller portfolio variance, while sacrificing small gains. You can try it yourself using Excel solver.  There is a strategy called Sector Rotation. Google it and you will find examples of overweighting the winners periodically. It is difficult to time the rotation, but Healthcare has somehow consistently outperformed. Nonetheless, those “recommendations” you mentioned are likely to be market allocations again.  The “Robo-advisors” list out every asset allocation in detail to make you feel overwhelmed and resort to using their service. In extreme cases, they can even break down the holdings to 2/3/4 digit Standard Industrial Classification codes, or break down the bond duration etc.  Some “Robo-advisors” would suggest you as many ETF as possible to increase trade commissions (if it isn’t commission free). For example, suggesting you to buy VB, VO, VV instead a VTI. Your question is a complex one because knowledge of the investor's beliefs about the market is required.  For almost any quantitative portfolio, one must have a good estimate of the expected return vector and covariance matrix of the assets in question.  The expected return vector, in particular, is far from estimable.  No one agrees on it and there is no way to know who is right and who is wrong. In a world satisfying the conditions of the CAPM, you can bypass this problem because the main implication of the CAPM is that the market weights are optimal.  In that case the answer to your question is that you should determine the market weights of the various assets and use those along with saving in a risk-free account or borrowing, depending on your risk tolerance.  This portfolio has the added benefit that you don't need to rebalance much...the weights in your portfolio adjust at the same rate as the market weights. Any portfolio that has something besides this also includes some notion of expected return aside from CAPM fair pricing.  The question for you, then, is whether you have such a notion.  If you do, you can mix your information with the market weights to come up with a portfolio.  This is what the Black-Litterman method does, for example: get the expected return vector implied by market weights and the covariance matrix, mix with your expected return vector, then use mean-variance optimization to come up with your final weights.
"An asset allocation formula is useful because it provides a way to manage risk. Rebalancing preserves your asset allocation. The investment risk of a well-diversified portfolio (with a few ETFs or mutual funds in there to get a wide range of stocks, bonds, and international exposure) is mostly proportional to the asset class distribution. If you started out with half-stocks and half-bonds, and stocks surged 100% over the past few years while bonds have stayed flat, then you may be left with (say) 66% stocks and 33% bonds. Your portfolio is now more vulnerable to future stock market drops (the risk associated with stocks). (Most asset allocation recommendations are a little more specific than a stock/bond split, but I'm sure you can get the idea.) Rebalancing can be profitable because it's a formulaic way to enforce you to ""buy low, sell high"". Massive recessions notwithstanding, usually not everything in your portfolio will rise and fall at the same time, and some are actually negatively correlated (that's one idea behind diversification, anyway). If your stocks have surged, chances are that bonds are cheaper. This doesn't always work (repeatedly transferring money from bonds into stocks while the market was falling in 2008-2009 could have lost you even more money). Also, if you rebalance frequently, you might incur expenses from the trading (depending on what sort of financial instrument you're holding). It may be more effective to simply channel new money into the sector that you're light on, and limit the major rebalancing of the portfolio so that it's just an occasional thing. Talk to your financial adviser. :)" The other example I'd offer is the case for diversification. If one buys 10 well chosen stocks, i.e. stocks spread across different industries so their correlation to one another is low, they will have lower risk than each of the 10 folk who own one of those stocks per person. Same stocks, but lower risk when combined. Basically, diversifying narrows the spread of possible results, raising  the center of the returns bell-curve by reducing the likelihood of extreme results at either the high or low end.  It's largely a matter of basic statistics. Bet double-or-nothing on a single coin flip, and those are the only possible results, and your odds of a disaster (losing most or all of the money) are 50%. Bet half of it on each of two coin flips, and your odds of losing are reduced to 25% at the cost of reducing your odds of winning to 25%, with 50% odds that you retain your money and can try the game again. Three coins divides the space further; the extremes are reduced to 12.5% each, with the middle being most likely. If that was all there was, this would be a zero-sum game and pure gambling. But the stock market is actually positive-sum, since companies are delivering part of their profits to their stockholder owners. This moves the center of the bell curve up a bit from break-even, historically to about +8%. This is why index funds produce a profit with very little active decision; they treat the variation as mostly random (which seems to work statistically) and just try to capture average results of a (hopefully) slightly above-average bucket of stocks and/or bonds. This approach is boring. It will never double your money overnight. On the other hand, it will never wipe you out overnight. If you have patience and are willing to let compound interest work for you, and trust that most market swings regress to the mean in the long run, it quietly builds your savings while not driving you crazy worrying about it. If all you are looking for is better return than the banks, and you have a reasonable amount of time before you need to pull the funds out, it's one of the more reliably predictable risk/reward trade-off points. You may want to refine this by biasing the mix of what you're holding. The simplest adjustment is how much you keep in each of several major investment categories. Large cap stocks, small cap stocks, bonds, and real estate (in the form of REITs) each have different baseline risk/return curves, and move in different ways in response to news, so maintaining a selected ratio between these buckets and adding the resulting curves together is one simple way to make fairly predictable adjustments to the width (and centerline) of the total bell curve. If you think you can do better than this, go for it. But index funds have been outperforming professionally managed funds (after the management fees are accounted for), and unless you are interested in spending a lot of time researching and playing with your money the odds of your doing much better aren't great unless you're willing to risk doing much worse. For me, boring is good. I want my savings to work for me rather than the other way around, and I don't consider the market at all interesting as a game. Others will feel differently. "John Bensin's answer covers the math, but I like the plain-English examples of the theory from William Bernstein's fine book, The Intelligent Asset Allocator.  At the author's web site, you can find the complete chapter 1 and chapter 2, though not chapter 3, which is the one with the ""multiple coin toss"" portfolio example I want to highlight. I'll summarize Bernstein's multiple coin toss example here with some excerpts from the book.  (Another top user, @JoeTaxpayer, has also written about the coin flip on his blog, also mentioning Bernstein's book.) Bernstein begins Chapter 1 by describing an offer from a fictitious ""Uncle Fred"": Imagine that you work for your rich but eccentric Uncle Fred. [...] he   decides to let you in on the company pension plan. [...] you must pick   ahead of time one of two investment choices for the duration of your   employment: Certificates of deposit with a 3% annualized rate of return, or, A most peculiar option: At the end of each year Uncle Fred flips a coin. Heads you receive a 30% investment return for that year, tails a   minus 10% (loss) for the year. This will be hereafter referred to as   ""Uncle Fred’s coin toss,"" or simply, the ""coin toss."" In effect, choosing option 2 results in a higher expected return than option 1, but it is certainly riskier, having a high standard deviation and being especially prone to a series of bad tosses.  Chapters 1 and 2 continue to expand on the idea of risk, and take a look at various assets/markets over time.  Chapter 3 then begins by introducing the multiple coin toss example: Time passes. You have spent several more years in the employ of your   Uncle Fred, and have truly grown to dread the annual coin-toss   sessions. [...] He makes you another offer. At the end of each year,   he will divide your pension account into two equal parts and conduct a   separate coin toss for each half [...] there are four possible   outcomes [...]: [...]   Being handy with numbers, you calculate that your annualized return   for this two-coin-toss sequence is 9.08%, which is nearly a full   percentage point higher than your previous expected return of 8.17%   with only one coin toss. Even more amazingly, you realize that your   risk has been reduced — with the addition of two returns at the   mean of 10%, your calculated standard deviation is now only 14.14%, as   opposed to 20% for the single coin toss. [...] Dividing your portfolio between assets with uncorrelated results increases return while decreasing risk. [...]   If the second coin toss were perfectly inversely correlated   with the first and always gave the opposite result [hence, outcomes   1 and 4 above never occurring], then our return would always be 10%.   In this case, we would have a 10% annualized long-term return with zero risk! I hope that summarizes the example well.  Of course, in the real world, one of the tricks to building a good portfolio is finding assets that aren't well-correlated, and if you're interested in more on the subject I suggest you check out his books (including The Four Pillars of Investing) and read more about Modern Portfolio Theory (MPT)." Dollar cost averaging is an great way to diversify your investment risk.  There's mainly 2 things you want to achieve when you're saving for retirement: 1) Keep your principal investment; 2) Grow it.  The best methods recommended by most financial institutions are as follows:  1) Diversification;  2) Re-balance. There are a lot of additional recommendations, but these are my main take away.  When you dollar cost average, you're essentially diversifying your exchange risk between the value of the funds you're investing.   Including the ups and downs of the value of the underlying asset, may actually be re-balancing.  Picking your asset portfolio: 1) You generally want to include within your 401k or any other invest, classes of investments that do not always move in total correlation as this allows you to diversify risk; 2) I'm making a lot of assumptions here - since you may have already picked your asset classes.  Consider utilizing the following to tell you when to buy or sell your underlying investment: 1) Google re-balance excel sheet to find several examples of re-balance tools to help you always buy low and sell high;   2) Enter your portfolio investment; 3) Utilize the movement to invest in the underlying assets based on market movement; and 4) Execute in an emotionless way and stick to your plan.  Example -  Facts 1) I have 1 CAD and 1 USD in my 401k.  Plan I will invest 1 dollar in the ratio of 50/50 - forever.   Let's start in 2011 since we were closer to par: 2010 - 1 CAD (value 1 USD) and 1 USD (value 1 USD) = 50/50 ratio 2011 start  - 1 CAD ( value .8 USD) and 1 USD (value 1 USD) = 40/60 ratio 2011 - rebalance - invest 1 USD as follows purchase .75 CAD (.60 USD) and purchase .40 USD = total of 1 USD reinvested 2011 end - 1.75 CAD (value 1.4USD) and 1.4 USD (value 1.4 USD) - 50/50 ratio As long as the fundamentals of your underlying assets (i.e. you're not expecting hyperinflation or your asset to approach 0), this approach will always build value over time since you're always buying low and selling high while dollar averaging.  Keep in mind it does reduce your potential gains - but if you're looking to max gain, it may mean you're also max potential loss - unless you're able to find A symmetrical investments.  I hope this helps. The common advice you mentioned is just a guideline and has little to do with how your portfolio would look like when you construct it. In order to diversify you would be using correlations and some common sense. Recall the recent global financial crisis, ones of the first to crash were AAA-rated CDO's, stocks and so on. Because correlation is a statistical measure this can work fine when the economy is stable, but it doesn't account for real-life interrelations, especially when population is affected. Once consumers are affected this spans to the entire economy so that sectors that previously seemed unrelated have now been tied together by the fall in demand or reduced ability to pay-off. I always find it funny how US advisers tell you to hold 80% of US stocks and bonds, while UK ones tell you to stick to the UK securities. The same happens all over the world, I would assume. The safest portfolio is a Global Market portfolio, obviously I wouldn't be getting, say, Somalian bonds (if such exist at all), but there are plenty of markets to choose from. A chance of all of them crashing simultaneously is significantly lower. Why don't people include derivatives in their portfolios? Could be because these are mainly short-term, while most of the portfolios are being held for a significant amount of time thus capital and money markets are the key components. Derivatives are used to hedge these portfolios. As for the currencies - by having foreign stocks and bonds you are already exposed to FX risk so you, again, could be using it as a hedging instrument. "Years ago I wrote an article Risk, Reward, Coin Flipping which explains from a 'game theory' perspective how diversifying works to minimize standard deviation in one's returns.  It's long and tedious, not easy to summarize, but it holds up well, I'm pleased with how the analogy does its job.  Update - the above is too ""link-only"", written over 5 years ago. The article I wrote offers a mathematical approach via an understandable example of coin flipping. With just 2 options, a 'head' is a 10% loss, while a 'tail' is a 30% gain. This actually represents the market fairly well as it results in a 10% average gain and 28% standard deviation for just 2 flips. The article shows how by 'diversifying', choosing to make multiple smaller bets, the average 10% stays the same, but the standard deviation is brought down dramatically, 7.6% when we use a sample experiment with 7 coins." "I assume by that you mean gradually buying the same mix of funds over time.  If that's the case, there is no rational reason to do this.   Dollar-cost averaging is an artifact of the way most people fund their 401(k).  I would not consider it a viable ""strategy"".  (Neither does Wikipedia)  Let's say you have $100,000 that you add $10,000 at a time.  When you add money, one of three things can happen: Since you can't predict the future, there's no mathematical justification for buying in segments.  There's just as much chance that your funds will be worth more or less, so on average it should make little to no difference.   In fact, given the time value of money there is a slight  advantage to investing it all now so you can capture any future returns.  You can always rebalance later to capture gains on some funds and purchase funds that are down to (hopefully) catch them on a rebound." It sounds to me like you may not be defining fundamental investing very well, which is why it may seem like it doesn't matter.  Fundamental investing means valuing a stock based on your estimate of its future profitability (and thus cash flows and dividends).  One way to do this is to look at the multiples you have described.  But multiples are inherently backward-looking so for firms with good growth prospects, they can be very poor estimates of future profitability. When you see a firm with ratios way out of whack with other firms, you can conclude that the market thinks that firm has a lot of future growth possibilities.  That's all. It could be that the market is overestimating that growth, but you would need more information in order to conclude that.  We call Warren Buffet a fundamental investor because he tends to think the market has made a mistake and overvalued many firms with crazy ratios.  That may be in many cases, but it doesn't necessarily mean those investors are not using fundamental analysis to come up with their valuations. Fundamental investing is still very much relevant and is probably the primary determinant of stock prices.  It's just that fundamental investing encompasses estimating things like future growth and innovation, which is a lot more than just looking at the ratios you have described. What explains the most of the future returns of a portfolio is the allocation between asset classes. In the long term, stock investments are almost certain to return more than any other kinds of investments. For 40+ years, I would choose a portfolio of 100% stocks. How to construct the portfolio, then? Diversification is the key. You should diversify in time (don't put a large sum of money into your stock portfolio immediately; if you have a large sum to invest, spread it around several years). You should diversify based on company size (invest in both large and small companies). You should also diversify internationally (don't invest in just US companies). If you prefer to pick individual stocks, 20 very carefully selected stocks may provide enough diversification if you keep diversification in mind during stock picking. However, careful stock picking cannot be expected to yield excess returns, and if you pick stocks manually, you need to rebalance your portfolio occasionally. Thus, if you're lazy, I would recommend a mutual fund, or many mutual funds if you have difficulty finding a low-cost one that is internationally diversified. The most important consideration is the cost. You cannot expect careful fund selection to yield excess returns before expenses. However, the expenses are certain costs, so prefer low-cost funds. Almost always this means picking index funds. Avoid funds that have a small number of stocks, because they typically invest only in the largest companies, which means you fail to get diversification in company size. So, instead of Euro STOXX 50, select STOXX 600 when investing to the European market. ETFs may have lower costs than traditional mutual funds, so keep ETFs in mind when selecting the mutual funds in which to invest. For international diversification, do not forget emerging markets. It is not excessive to invest e.g. 20% to emerging markets. Emerging markets have a higher risk but they also have a higher return. A portfolio that does not include emerging markets is not in my opinion well diversified. When getting close to retirement age, I would consider increasing the percentage of bonds in the portfolio. This should be done primarily by putting additional money to bonds instead of selling existing investments to avoid additional taxes (not sure if this applies to other taxation systems than the Finnish one). Bond investments are best made though low-cost mutual funds as well. Keep bond investments in your local currency and risk-free assets (i.e. select US government bonds). Whatever you do, remember that historical return is no guarantee of future return. Actually, the opposite may be true: there is a mean reversion law. If a particular investment has returned well in the past, it often means its price has gone up, making it more likely that the price goes down in the future. So don't select a fund based on its historical return; instead, select a fund based on low costs. However, I'm 99% certain that over a period of 40 years, stocks will return better than other investments. In addition to fund costs, taxes are the other certain thing that will be deducted from your returns. Research what options you have to reduce the taxes you need to pay. 401-K was explained in another answer; this may be a good option. Some things recommended in other answers that I would avoid: The article links to William Bernstein’s plan that he outlined for Business Insider, which says: Modelling this investment strategy Picking three funds from Google and running some numbers. The international stock index only goes back to April 29th 1996, so a run of 21 years was modelled.  Based on 15% of a salary of $550 per month with various annual raises: Broadly speaking, this investment doubles the value of the contributions over two decades. Note:  Rebalancing fees are not included in the simulation. Below is the code used to run the simulation.  If you have Mathematica you can try with different funds.    Notice above how the bond index (VBMFX) preserves value during the 2008 crash.  This illustrates the rationale for diversifying across different fund types. Is it POSSIBLE? Of course. I don't even need to do any research to prove that. Just some mathematical reasoning: Take the S&P 500. Find the performance of each stock in that list over whatever time period you want to use for your experiment. Now select some number of the best-performing stocks from the list -- any number less than 500. By definition, the X best must be better than or equal to the average. Assuming all the stocks on the S&P did not have EXACTLY the same performance, these 10 must be better than average. You now have a diversified portfolio that performed better than the S&P 500 index fund. Of course as they always say in a prospectus, past performance is not a guarantee of future performance.  It's certainly possible to do. The question is, if YOU selected the stocks making up a diversified portfolio, would your selections do better than an index fund? "Yes, a diversified portfolio can generate greater returns than the S&P 500 by going OUTSIDE it. For instance, small stocks (on average) generate higher returns than the ""large caps"" found in the S&P 500. So if you own a diversified portfolio of stocks, some of which are smaller (in market cap) than the typical S&P 500 stock, you have a chance to outperform. You might also outperform by owning other asset classes than stocks such as gold, real estate, and timber (among others) at appropriate times. (You may also be able to get the relevant exposure by owning gold and timber stocks and REITS.) This was a lesson that David Swensen of the Yale endowment taught us." The steps you outlined are fine by themselves. Step 5, seeking criticism can be less helpful than one may think.  See stocktwits.com  There are a lot of opposing opinions all of which can be correct over different time-frames.  Try and quantify your confidence and develop different strategies for different confidence levels. I was never smart enough or patient with follow through to be a successful value investor. It was very frustrating to watch stocks trade sideways for years before the company's intrinsic value was better reflected in the market.  Also, you could make an excellent pick, but a macro change and slump could set you back a year and raise doubts. In my experience portfolio management techniques like asset allocation and dollar-cost-averaging is what made my version of value investing work. Your interest in 10k/10q is something to applaud.  Is there something specific about 10k/10q that you do not understand?  Context is key, these types of reports are more relevant and understandable when compared to competitors in the same sector.   It is good to assess over confidence!  It is also good to diversify your knowledge and the effort put into Securities Analysis 6th edition will help with other books in the field.  I see a bit of myself in your post, and if you are like me, than subsequent readings, and full mastery of the concepts in 'Securities & Analysis 6th ed.'  will lead to over confidence, or a false understanding as there are many factors at play in the market.  So many, that even the most scientific approaches to investing can just as equally be described as an 'art'. I'm not aware of the details of your situation, but in general, for you to fully realize the benefits from applying the principals of value investing shared by Graham and more recently Warren Buffett, you must invest on the level that requires use of the consolidation or equity method of accounting, e.g. > 20% ownership.   Sure, the same principals used by Buffett can work on a smaller scale, but a small scale investor is best served by wealth accumulation, which can take many forms. Not the addition of instant equity via acquisitions to their consolidated financials. Lastly, to test what you have learned about value investing, and order execution, try the inverse.  At least on paper.  Short a stock with low value and a high P/E.  TWTR may be a good example? Learn what it is like to have your resources at stake, and the anguish of market and security volatility. It would be a lot easier to wait it out as a long-term value investor from a beach house in Santa Barbara :) "One approach is to invest in ""allocation"" mutual funds that use various methods to vary their asset allocation. Some examples (these are not recommendations; just to show you what I am talking about): A good way to identify a useful allocation fund is to look at the ""R-squared"" (correlation) with indexes on Morningstar. If the allocation fund has a 90-plus R-squared with any index, it probably isn't doing a lot. If it's relatively uncorrelated, then the manager is not index-hugging, but is making decisions to give you different risks from the index. If you put 10% of your portfolio in a fund that varies allocation to stocks from 25% to 75%, then your allocation to stocks created by that 10% would be between 2.5% to 7.5% depending on the views of the fund manager. You can use that type of calculation to invest enough in allocation funds to allow your overall allocation to vary within a desired range, and then you could put the rest of your money in index funds or whatever you normally use. You can think of this as diversifying across investment discipline in addition to across asset class. Another approach is to simply rely on your already balanced portfolio and enjoy any downturns in stocks as an opportunity to rebalance and buy some stocks at a lower price. Then enjoy any run-up as an opportunity to rebalance and sell some stocks at a high price.  The difficulty of course is going through with the rebalance. This is one advantage of all-in-one funds (target date, ""lifecycle,"" balanced, they have many names), they will always go through with the rebalance for you - and you can't ""see"" each bucket in order to get stressed about it. i.e. it's important to think of your portfolio as a whole, not look at the loss in the stocks portion. An all-in-one fund keeps you from seeing the stocks-by-themselves loss number, which is a good way to trick yourself into behaving sensibly. If you want to rebalance ""more aggressively"" then look at value averaging (search for ""value averaging"" on this site for example). A questionable approach is flat-out market-timing, where you try to get out and back in at the right times; a variation on this would be to buy put options at certain times; the problem is that it's just too hard. I think it makes more sense to buy an allocation fund that does this for you. If you do market time, you want to go in and out gradually, and value averaging is one way to do that."