Conservative vs. Aggressive Portfolios

David Alan Carter
November 1, 2020 [Updated September 23, 2022]
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.

As of September 23, 2022: (from lowest risk to highest)

  1. Zen Knuckle (an offshoot of The White Knuckle)
  2. American Muscle
  3. The 12% Solution
  4. Bond Bulls
  5. Lean Muscle (an offshoot of American Muscle)
  6. Global Trader
  7. The White Knuckle
  8. Five Stocks (coming soon)
  9. The Bare Knuckle (an offshoot of The White Knuckle)

A Brief Note About Each Strategy
  1. Zen Knuckle is a recent offshoot of The White Knuckle (see note below). 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 -31.6% to -15.0%. And vaults this model to the top of our chart in terms of reduced risk.

    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.

  2. 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 delivers the third highest Total Returns of the bunch, bested only by The White Knuckle and its cousin, Zen Knuckle.

  3. 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 ranks third in terms of the least max drawdown. In terms of Total Returns, it outperforms Bond Bulls, but underperforms the other strategies long term. And of course, it beats the socks off the S&P 500 over that long term.

  4. 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, and occasionally silver. This hedge, while normally pretty laid back, can get volatile when silver (SLV) is selected. Even then, the one or two bond funds making up the 80% will tend to keep SLV in check. 

    Overall, Bond Bulls comes out reasonably low 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 one of the safer bets in the lineup. 

  5. 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 single-security 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 long term (2008-present).

  6. Global Trader provides excellent exposure to international equities, but has done so with a slightly higher max drawdown than five of the strategies. While the model lacks a cash trigger, 50% of the portfolio has the ability to act as a hedge against those international equities, providing currency plays, global utilities, or even the volatile silver ETF (SLV) at opportune times. 

    While max drawdown has been as high as -22.2% since 2008 (namely during the height of the pandemic in March 2020), its Total Returns are pushing up against those of American Muscle.

  7. The White Knuckle (and its even scarier cousin The Bare Knuckle) is the ‘guns blazing’ strategy of the bunch with a max drawdown of -31.6% (as of September 23, 2022).

    Because the other strategies all employ non-leveraged ETFs in the main (American Muscle can additionally employ one or two individual stocks in up to 60% of the portfolio), 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. Ditto with The Bare Knuckle. 

    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.

  8. Five Stocks (coming soon) 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.

  9. The Bare Knuckle is a variation of The White Knuckle, but without the part-time hedge that periodically brings a currency ETF or inflation-protection fund into play to help cushion volatility and drawdowns. The Bare Knuckle is designed for investors who wish to avoid such hedges and employ a pure risk-parity play between the three leveraged funds SPXL, TMF, and TQQQ.

    This is scary stuff, with a max drawdown of -64.7% as of September 23, 2022. As such, it's not an option I'd recommend for most investors.

Combining Strategies to Achieve Your Target
Note: The following examples reflect data from 2008 to 2021. They do not incorporate 2022 YTD. The year 2022 has seen declines in all the models as the market in general has suffered a major correction. The data below, and the representative graphics, will be brought up to date after the first of the year (January 2023). --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. With Version 8.0 (and later), it now includes Zen Knuckle 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 (a relatively low-risk model), a 100% allocation from 2008 to 2021 (last full year) looks like this:
With 100% Bond Bulls, we’ve been able to achieve an 11.9% CAGR with a max drawdown of only -12.1% over the course of 14 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:
Notice that we’ve increased our CAGR from 11.9% to 15.8% 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:
OK, we've actually taken CAGR down a notch to 15.5% while at the same time increasing max drawdown by an additional -1.3 percentage points. Given that we’ve added some valuable diversity to our portfolio, that might outweigh the slightly reduced numbers. Judgement call. 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:
In this last example, we’ve boosted CAGR to 17.2% at a “cost” of an additional -1.3% max drawdown.
Now, there are a near infinite number of combinations you can play with. Change the percentage allocations further. 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 (and Zen 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 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:
In this final exercise, we’ve boosted CAGR to 18.1% but at the “cost” of a near -17% 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. [There's a little more leeway on Zen Knuckle.]
 
Further regarding The White Knuckle: a combination that only incorporates American Muscle and The White Knuckle (or God forbid, 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.

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
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