Conservative vs. Aggressive Portfolios

David Alan Carter
November 1, 2020 [Updated January 2, 2024]

Are you a conservative investor, or aggressive? In other words, how much risk are you willing to take in return for potentially higher returns?

It’s generally assumed that folks approaching retirement age become more risk-averse and therefore more conservative in their investment choices. When risk equals the prospect of losing money, or losing greater sums of money, it’s easy to see why this might be the case.

After all, at retirement age and beyond there are fewer years to make up for significant losses to one’s portfolio. A stock market crash that takes 20-40% off the top of one’s retirement-age portfolio could end up translating into a significant lifestyle reduction.

But risk aversion isn’t limited by age. Anyone at any age with money on the line could be hardwired to choose the preservation of capital over the potential for a higher-than-average return.

At the other end of the spectrum are the guns blazing, pedal to the metal investors who are seeking huge gains and willing to throw caution to the wind to get there.

In the lineup of strategies at Trendline Profits, there is a monthly trading model for investors at either end of the spectrum – and something for those in between. Because I’ve been fielding an unusual number of questions lately regarding the riskiness of the models, and how to go about combining models to achieve diversity, I thought it would be a good idea to put some thoughts down in a post.

The Models Ranked By Risk

In the first place, it’s never a bad idea to be cautious. In this market especially, cash is the safe trade. As I’ve mentioned in recent newsletters, cash is - in fact - a position. It means you’re prepared to act when circumstances better align with your risk tolerance.

But on to the strategies. On the scale of risk, from lowest risk to highest, here's how I would rank the strategies. Note: This is based only on max drawdown - which can (and will) change over time. There are other risk metrics to consider as well (e.g. Sharpe ratios, volatility, etc.). But for this ranking, we'll stick with max drawdown.

Also note: the strategies undergo periodic modifications. An ETF may be delisted by its provider and need to be replaced. A blend of funds may no longer provide the hedge they used to. I may see an opportunity to adjust the parameters to improve returns or lessen the risk of the strategy. The performance figures and commentary below reflect the most recent modifications.

As of January 2, 2024, from lowest risk to highest...

STRATEGIES RANKED BY MAX DRAWDOWN	MaxDD for 2008-2023 (Knuckles 2011-2023)
1. Bond Bulls	-7.8%
2. American Muscle	-19.0%
3. Lean Muscle (an offshoot of American Muscle)	-19.6%
4. Global Trader	-19.7%
5. Zen Knuckle (an offshoot of White Knuckle)	-21.2%
6. The 12% Solution	-21.4%
7. Five Stocks	-39.3%
8. The White Knuckle	-41.5%

A Brief Note About Each Strategy

Bond Bulls was built to be low risk, with 80% of the portfolio in one or two of some type of bond fund. The remaining 20% is a hedge to the bonds funds, which can include currencies, utilities, or a cash equivalent.

Overall, Bond Bulls comes out lowest on the scale for max drawdowns, and lowest in terms of volatility by a wide margin. That’s not to say that some months won’t see the strategy miss the mark and go negative by multiple percentage points, especially if bonds temporarily lose their ability to hedge the broader equity market. Still, it remains the safest bet in the lineup.

American Muscle incorporates individual stocks into the mix. This tends to ratchet up volatility and max drawdown, but also improves returns over the long run.

What gives American Muscle (and Lean Muscle, below) an edge over some of the other models in terms of risk aversion is an ever-present component of the Treasury fund TLT. That component adjusts with each new month depending on perceived risk; some months it will occupy a larger percentage of the portfolio, some months less.

American Muscle has delivered an impressive 20% CAGR in backtests through 2008, bested only by Zen Knuckle, White Knuckle, and Five Stocks.

Lean Muscle is basically American Muscle but without the individual stock component. It’s all ETFs all the time. This is a good option for those investors who would rather not add stock risk to their portfolios. Returns are a bit lower than its cousin American Muscle, but still quite superior to the S&P 500 over the longer term.

Global Trader provides excellent exposure to international equities, and has done so with a relatively light max drawdown. While the model lacks a pure cash trigger, every component of the portfolio has the ability to hedge against global downturns by calling on currency plays, global utilities, U.S. Treasuries, or even the volatile silver ETF (SLV) at opportune times.

Zen Knuckle is a recent offshoot of The White Knuckle. This variation of the relatively scary White Knuckle makes a change to the mix of funds in the 'Risk-Parity' portion of the strategy, swapping out a leveraged bond fund for a volatility ETF. With that simple change, risk is reduced fairly dramatically, with max drawdown cut in half from -41.5% to -21.2%. Despite that reduced risk, the strategy has still managed to deliver a 26% CAGR in testing back to 2011.

Still, this cautionary note: any Knuckle - be it the original or this 'calmer, gentler' variation - was not designed to occupy more than a portion of one's total investment portfolio. Why? Because this model remains a vehicle for some of the most volatile names in the market: 3x leveraged ETFs, leveraged currency funds, and now a volatility ETF.

By design, some of these funds should act as a hedge to the others, providing a degree of balance in normal times. But in the stock market, as in the world at large, things are not always normal. So, keep allocations of this model reasonable within your portfolio.

Read more about this strategy in this White Paper.

The 12% Solution is a good strategy relative to risk for two reasons: 1) it holds an ever-present bond allocation representing 40% of the portfolio, and 2) the equity side of the equation is protected by a cash trigger. Readers who have read the book by the same name are quite familiar with the workings of this strategy and have access to it as a DIY model.

The 12% Solution experienced its largest drawdown to date during the 2022 bear market, when bonds (Treasuries especially) fell in lockstep with equities for a protracted period of time. That said, it continues to deliver a respectable 12% CAGR in testing back through 2008, beating Bond Bulls in terms of Total Return, and significantly outperforming the S&P 500 for the same time period.

Five Stocks is our stock-picking model; each month it selects up to five individual names from a curated portfolio of U.S. stocks listed on the Nasdaq and the NYSE, stocks that figure prominently in benchmark indices including the Nasdaq 100, the Dow Jones Industrial Average, and the S&P 500. It's an excellent way to play the momentum of the cream of the crop of U.S. stocks.

While it's capable of some tough drawdowns (i.e. -39.3% during the Great Recession), it includes a cash trigger that allows it to go up to 100% cash if markets dictate. Given parameters like that, it's a safer model than the White Knuckle.

The White Knuckle is the ‘guns blazing’ strategy of the bunch with high potential returns to match a scary high max drawdown (-41.5% as of January 2, 2024).

Because the other strategies all employ non-leveraged ETFs in the main (American Muscle can additionally employ up to two individual stocks), none of these other strategies have the ability to go down to zero. That is, to lose all their value. ETFs represent baskets of individual stocks (or bonds), in most cases hundreds of stocks (or bonds). For a model like Bond Bulls or Global Trader or either of the Muscles to go to zero, you’d be looking at an economic collapse on the order of an asteroid hit.

It's a little more dicey with The White Knuckle. Because it uses 3x leveraged ETFs, a severe crash or black swan event that takes down equities while simultaneously taking down Treasuries could technically result in the total collapse of the portfolio.

I don’t say this to scare you away from the strategy. I say it as a reminder as to why I recommend only a 5% - 10% - 15% or so allocation of this model in one’s overall investment portfolio, depending on one’s level of risk tolerance. Some folks might not want to mess with this model at all – and that’s fine. But it’s there for aggressive investors. Just employ it in moderation.

Combining Strategies to Achieve Your Target

Note: Unless otherwise noted, the following examples reflect data from 2008 through 2023. They do not incorporate 2024 YTD.

I will update the data below, and the representative graphics, once we have the full year 2024 behind us (sometime in January 2025). --David

While a single strategy like Bond Bulls or The 12% Solution might well satisfy the needs of the conservative investor, and both represent core strategies for that reason, a combination of strategies has the potential to achieve conservative risk targets – while providing increased diversity and the prospect of improved returns.

The Returns Calculator [available to subscribers] can be of help. For those with access to Excel spreadsheets, the calculator can be accessed via the blue “Download File” link on the page.

Starting with Bond Bulls (a relatively low-risk model), a 100% allocation from 2008 to 2023 (last full year) looks like this:

Click to enlarge.

With 100% Bond Bulls, we’ve been able to achieve an 9.4% CAGR with a max drawdown of only -7.8% over the course of 16 years. [As a side note, the calculations from this spreadsheet may not exactly match the figures on the Members Pages. They’re close, but not a mirror image. The difference being a matter of precision between the strategies’ algorithms vs. Excel spreadsheet formulas.]

Let’s experiment a bit, and bring in American Muscle for a good dose of U.S. powerhouse equities. Let’s go with a 60/40 mix of the two. We’re still overweight Bond Bulls. Here’s what that looks like:

Image: Moderately Conservative Portfolio

Click to enlarge.

Notice that we’ve increased our CAGR from 9.4% to 14.0%, although by doing so we increased our max drawdown by 4.5%.

Let’s experiment a bit further and bring in Global Trader for some international exposure. Let’s go with a 60/20/20 mix of the three. We’re still overweight Bond Bulls. Here’s what that looks like:

Image: Moderately Conservative Portfolio, II

Click to enlarge.

OK, we've taken CAGR down a bit from the previous chart to 13.3% (reduced by 0.7%) and max drawdown actually bumped up a fraction. Given that we’ve added some valuable international diversity, one could argue that we've strengthened the portfolio. Judgement call as to whether it was worth it. In any event, max drawdown continues to remain considerably less than that of SPY for the same time period (at -51.9%).

Next, let’s change things up a bit and reduce our allocation to Bond Bulls. Let's go with a 40/30/30 mix of the same three strategies. Here’s what that looks like:

Image: Conservative/Aggressive Portfolio Mix

Click to enlarge.

In this example, we’ve boosted CAGR to 15.1% at a “cost” of an additional 2.3% in max drawdown.

Now, there are a near infinite number of combinations you can play with. Change the percentage allocations further. Bring the mother strategy (The 12% Solution) into the mix. And if you go to the second sheet (the second tab at the bottom left of the spreadsheet), you can invite The White Knuckle (and Zen Knuckle) to the party.

Additional sheets (tabs) allow you to see the performances of various combinations for shorter time frames.

Click to enlarge.

Edging Up The Aggressive

The above examples were structured to have some appeal to conservative to moderate investors. For aggressive investors, the same concepts apply, only you might be using different strategies and proportions thereof.

Instead of 40/30/30 Bond Bulls to Global Trader to American Muscle, you might be flipping that on it's head.

In fact, let's do just that: let's flip the tables and reduce Bond Bulls to 30% of our portfolio while leaving Global Trader at 30% and boosting American Muscle to 40%. With this experiment, we're gently tipping the scales toward a more aggressive portfolio.

Here's what that looks like:

Click to enlarge.

In this exercise, we’ve boosted CAGR to 16.3% but at the “cost” of a near -16% max drawdown. Yes, those returns are sweet. But at this risk level, one thing is certain: this combination of strategies would have kept your attention during past market corrections. For some investors, that level of risk might be too much. For others, no problem.

For those in the latter camp, The White Knuckle strategy will likely hold some interest. Just keep in mind my cautionary note on that strategy – no more than 5% - 10% - 15% or so of your portfolio, depending on your tolerance for risk. This goes for the Zen Knuckle, as well.

[SIDEBAR: It should go without saying, but I'll say it anyway. If employing a combination of White Knuckle and Zen Knuckle, keep the combination to 5% - 10% - 15% or so, in total.]

Further regarding The White Knuckle: a combination that only incorporates American Muscle and The White Knuckle is not diversified – and extremely risky. If you’re going to use one of the Knuckles, better to pair it with Bond Bulls and/or Global Trader and/or The 12% Solution or such.

Let's look at two final charts. We'll click on the 2011-2023 tab in the lower left margin of the spreadsheet. Now we can access the Knuckles.

But before we do, let's see how our 30/30/40 portfolio (Bond Bulls, Global Trader, American Muscle) would have performed during this particular time frame.

Here's how that looks.

Click to enlarge.

You'll notice CAGR is down a bit from the prior chart. We're calculating with different years, so the returns are going to be different.

Now let's bring Zen Knuckle into the mix. We'll go with 30/30/30/10 - Bond Bulls, Global Trader, American Muscle and Zen Knuckle. So we've taken 10% away from American Muscle and put that percentage on Zen.

Here's how that looks...

Click to enlarge.

In this final example, and during this time frame, we've boosted our average annual return by 0.6% (to 15.6% CAGR) while increasing our max drawdown only a fraction (0.2%).

Keep in mind that when employing either of the Knuckle strategies, we can only backtest through 2011, so the Great Recession of 2008 is not represented. This explains why SPY's CAGR is higher than on previous charts, and the max drawdown is "only" -33.7%, considerably less than the -51.9% when the Great Recession is factored in.

[SIDEBAR: The new Five Stocks was introduced in April 2023, and while it is incorporated into the Returns Calculator, it is not reflected in any of the example combinations above. One year in particular - 2020 - saw outsized gains that tend to skew returns for combinations.

When experimenting with your own combinations, don't go crazy with Five Stocks. I would advise keeping an allocation to 5% or so to begin with. You can always increase that in the future once you're comfortable with the model.]

Allocation Calculator

If you do end up employing a combination of strategies, by all means check out the Allocation Calculator [available to subscribers] to make your life easier on rebalancing day.

One Final Note Regarding Drawdowns

The max drawdowns cited in this article and everywhere on the website are historical points of reference. They are the maximum drawdowns the strategies have experienced over the time frames cited. They are not floors, they are not safety nets. In fact, the actual largest drawdown for each and every one of the strategies is lurking out there in the future.

Keep that in mind when planning.

Best of luck,
David