With the stock market waiting on both earnings and the economy to improve in order to justify current valuation levels, it would appear that traders are basically trying to decide which way to go from here. (IMO, a meaningful break below 2320 would embolden the bears while a move above 2400 would reinvigorate the bulls.) As such, this appears to be as good a time as any to continue our discussion on portfolio design.

So far, we’ve talked about establishing goals, selecting time frames, and identifying the correct benchmarks. We’ve reviewed my take on the three ways to generate alpha (timing, selection, and leverage). Now it’s time to get to question of how one goes about trying to outperform.

To be clear, what I’m about to present is merely one man’s opinion on the subject. It is worth noting that every active manager in the game attempts to provide outperformance with their methodology. As such, there are any number of ways to try and skin the outperformance cat. But what follows is my take.

First and foremost, it is important to understand that I’m a risk manager – I always have been, I always will be. And cutting to the chase, to me, this is where outperformance and long-term investing success is born.

I agree that “markets work.” I also “get” that investors need to “stay in their seats” and ride out the vast majority of volatility events in the markets. However, I firmly believe that investors would prefer not to see their portfolios lose 30%, 40%, or 50% the next time a really big, really bad bear market hits.

Go ahead, do your own survey. Go out and ask 10 investors the following question: If you had a choice, would you choose to stay fully invested in stocks during the next big, bad bear market? In my experience, the answer is, “Uh no.”

Therefore, I believe that there are times when the best offense a portfolio can have is to employ a good defense.

But to be clear, I’m talking about the big-picture market cycles here. I’m not talking about trading in and out of the market every week. No, my goal is to get it “mostly right, most of the time” in terms of the really big, really important bull/bear cycles.