Re-balance Cycle Reminder

Based on our monthly re-balance calendar, the next re-balance time will be on Monday, August 6, 2012. You can also find the re-balance calendar of 2012 on ‘My Portfolios’ page.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Also please note that we now list the next re-balance date on every portfolio page.

Understand The Behavior of Investment Strategies

As what we repeatedly pointed out, any investment strategy has its up and down. Before you commit to using any strategy in your investment portfolios, it is critical to understand the nature of the strategy, especially its pros and cons.

Investors are often carried away with a period of the out performance of a particular strategy and then take a plunge into it. But soon, they will be disappointed when the strategy under performs. They then pull the plug, claiming the strategy does not work, often at the worst time to do so. This whole cycle repeats when they go to find another strategy. Years go by, their performance languishes or even suffers from great loss. This is even true for many professional investment advisors. That is why investing is so hard for many average investors and even many professionals. 

It is thus very costly for an investor to commit to an investment strategy without fully understanding its behavior, i.e. its strength and its weakness.

The key here is that the success of an investment strategy can only be observed in a large enough sample of data or event points, i.e. a relatively long period of time (such as at least 5 to 7 years). Sometimes, people prefer using a full market cycle that consists of a bear and a bull market.

But to stick to an investment strategy in such a long period, is extremely hard for many investors, considering the given nature of under performance in a period of time long enough to create excruciating feeling.

The number one step to counter this is to fully understand the behavior of the investment strategies, assuming these investment strategies possess the two most important qualities: strong intuition and reasonable expected returns (through back testing or historical performance).

That means understanding the pros and cons of the strategies.

In the following, let’s walk through the pros and cons of the two most used asset allocation strategies on Strategic Asset Allocation (SAA) and Tactical Asset Allocation (TAA).

SAA allocates capital into a diversified array of asset classes, such as US stocks, foreign stocks, emerging market stocks, Real Estate Investment Trusts (REITs), commodities and bonds. It then performs periodic rebalancing.

MyPlanIQ’s TAA uses asset price momentum to dynamically adjust risk asset (stocks and commodities) and fixed income (bonds) mixes monthly or quarterly.

The two qualities for each strategy:

  Intuitions Expected Returns
Strategic Asset Allocation Diversification Equities deliver above inflation returns while bonds are stabilizers
Tactical Asset Allocation Momentum exists in nature, in human behavior and social events It is recognized momentum factor can deliver market beating average return in many research results

Now let’s take a look at the pros and cons:

  Early Bull Late Bull Bear Side Way
Strategic Asset Allocation Good: rebalancing actually enables more exposure (allocation wise) to beaten down risk assets Good: always riding on risk assets and rebalancing actually takes some profit off the table Bad: holding falling assets can actually ride the falling trends all the way down

OK: no loss for risk assets but bonds can actually generate some income. Risk assets with dividends can cushion more

Tactical Asset Allocation Miss: It has a lag due to confirmation of rising trends Good: invest in high performing assets that can even outperform market indices Good: reduced risk asset allocation and exposure to other ‘safe’ assets such as treasury bonds Bad: frequent switching results in buy high sell low. These can amount to large loss over time

Since in a normal long term secular growth period, bear markets happen in smaller periods of time. One can see that SAA does better more often than TAA. In a long term secular stagnated period, TAA does better than SAA.

Moreover, each one can have an edge over the other in certain times.

As a side note, one can see that to do better in a side way market, using dividend paying assets such as dividend stocks or covered call option writings can be better than using plain vanilla growth stocks or stock market indices.

For example, 2011 was a side way market that has proven to be tough for many tactical allocation strategies and funds. This period may continue this year.

That also explains that following SAA (that is widely practiced in financial investment communities) is a lot easier than following a TAA: you can large herd of people who are supporting each other. Furthermore, when you are not doing well, you are not alone: majority of investors are with you. A status quo which might not be bad for average investors.

That is why we at MyPlanIQ advocate both SAA and TAA. Furthermore, we believe the best way is to allocate capitals into both strategies, a so called core satellite portfolio management practice. From the above table, one can see that by doing so, you can smooth out the return curve.

But on ther other hand, one has to realize that no matter which way you do it, unless you are totally indexing, you will not be in sync with market indices. That would mean that your investments will under perform in a period of time.

Now that we understand better the pros and cons of a strategy, one should be prepared for these events (especially under performance) beforehand. That is the first step to guarantee long term success.

Put it simply, the biggest edge you possess is the consistency with your strategies, as many others couldn’t adhere to this simple yet sometimes uncomfortable practice for a long time. To gain this edge, you need to understand the nature of the strategy you are using so that you are better prepared psychologically.

As an exercise, we encourage you to work out the scenarios for the four corner investment framework we outlined in our previous newsletters (April 23, 2012: All Weather Portfolio Construction, May 29, 2012: Four Corner Investment Framework Applications, June 11, 2012: Strategic, Tactical and Permanent: Putting All Together). Or you can work out the pros and cons of other strategies such as those listed on Advanced Users page.

Please share your thoughts through comments. We need healthy discussion.

Portfolio Reviews

We compare tactical portfolios for our lazy portfolio plans:

Portfolio Performance Comparison (as of 7/16/2012)

Portfolio/Fund Name 1 Week
1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe
David Swensen Six ETF Asset Individual Investor Plan Tactical Asset Allocation Moderate 0.6% 6.4% 13.5% 151.7% 13.1% 123.0% 6.9% 53.7%
The Coffee House Lazy Portfolio ETF Version Tactical Asset Allocation Moderate 0.3% 4.8% 3.6% 41.7% 11.0% 93.6% 6.8% 63.2%
FundAdvice Ultimate Buy and Hold Lazy Portfolio Tactical Asset Allocation Moderate 0.4% 4.4% 5.5% 69.6% 11.0% 109.8% 6.4% 55.8%
Permanent Portfolio ETF Plan Tactical Asset Allocation Moderate 0.3% 3.2% 1.5% 20.9% 11.6% 97.5% 7.1% 59.8%
Israelsen 7Twelve Tactical Asset Allocation Moderate 0.6% 5.0% 3.7% 44.0% 9.1% 85.1% 7.0% 53.9%
Wasik Nano Plan Tactical Asset Allocation Moderate 0.5% 5.9% 6.6% 79.2% 10.9% 99.5% 5.0% 44.3%


See up to date detailed comparison>>

Overall, these tactical portfolios have done well.

Current Markets

Near term, we are very cautious: based on many economic indicators and various research (such as John Hussman and ECRI), the US economy is either on the verge of entering a recession or has entered a recession. Though asset class trends are not uniformly pointing to risk asset downside, it is not a period to take excessive risk.

From 360° Market Overview, one can see that the US stocks (represented by VTI) are consistently ranked below the total bond index (BND), even after the surge late last week.

On the other hand, we would like to point out that the smart money managers are still keeping well balanced portfolio allocations. See SmartMoneyIQ Managers.

We are comfortable with our current portfolio positions.

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