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.
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. There are other risk metrics to consider as well (e.g. Sharpe ratios, volatility, etc.).
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A Brief Note About Each Strategy |
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Combining Strategies to Achieve Your Target |
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. With Version 5.0 (and later), it now includes Lean Muscle in the lineup. 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 (the least risky model), a 100% allocation from 2008 to 2020 (last full year) looks like this: With 100% Bond Bulls, we’ve been able to achieve an 12.5% CAGR with a max drawdown of only -8.7% over the course of 13 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 Lean 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: Notice that we’ve increased our CAGR from 12.5% to 15.1% while only raising the max drawdown by a little over 1 percentage point.
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: CAGR has increased further, to 15.4%, but for that fractional increase we paid the price by increasing max drawdown by an additional 2.1 percentage points. Given that we’ve added some valuable diversity to our portfolio, that might be worth the increase in risk. 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 swap out Lean Muscle for American Muscle. We’ll keep the same 60/20/20 mix of the three. We’re still overweight Bond Bulls. Here’s what that looks like: In this last example, we’ve boosted CAGR to 15.9% at a “cost” of an additional -0.8% max drawdown.
Now, there are a near infinite number of combinations you can play with. Change the percentage allocations. Bring the low volatility 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 to the party.
Additional sheets (tabs) allow you to see the performances of various combinations for shorter time frames. |
Conservative vs. Aggressive |
The above examples were structured to have some appeal to conservative investors. For aggressive investors, the same concepts apply, only you might be using different strategies and proportions thereof.
Instead of 60% Bond Bulls, you might be reducing that to 40% or less. Instead of Lean Muscle you might be using American Muscle. In fact, let's do just that: let's flip the tables and reduce Bond Bulls to 40% of our portfolio while taking Global Trader and American Muscle to 30% each. With this experiment, we're gently tipping the scales toward a more aggressive portfolio. Here's what that looks like: In this final exercise, we’ve boosted CAGR to 17.6% but at the “cost” of a near -15.0% 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 10% to 20% of your portfolio, depending on your tolerance for risk.
Further regarding The White Knuckle: a combination that only incorporates American Muscle and The White Knuckle (or The Bare 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. |
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.
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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 |