Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

Regular AAC (Asset Allocation Composite), SAA and TAA portfolios are always rebalanced on the first trading day of a month. the next re-balance will be on Wednesday September 1, 2021. 

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.

Invest And Speculate: A Sensible Alternative To Buy And Hold

We coined ‘invest and speculate’ term and used it to name one of our advanced portfolios (see Advanced Strategies) in the following newsletters: 

We believe this way of thinking is pertinent to the current frenzy financial markets and will review this strategy in some details here.

Investors or speculators?

The term ‘speculators’ is shunned by most people as it has a bad connotation related to ‘gambling’. Most of us would rather call ourselves ‘investors’ instead. This is especially true for those who adopt passive or so called buy and hold investing strategies: they would just buy and hold stocks (or stock funds like S&P index fund VFINX or SPY) for a long time. The thinking is that in a long term, stocks should deliver a reasonable return. 

Of course, we have argued that it’s almost certain that if a diversified and solid stock index fund such as S&P 500 index fund (SPY) is held for a long enough time, it’s very likely to deliver an inflation beating return. However, there are two important caveats in this assertion: 

  1. ‘very likely’ or ‘almost certain’: though by looking at historical data and some of basic reasoning, one can claim ‘almost certain’ on certain assertions, no one can claim for certain or be100% sure about what’s going to happen in the future. This is obvious as, for example, a serious war or a more fundamental or radical regime change in history can completely change wealth ownership (such as World War II in Europe). However how unlikely one can claim the world will not change in this way this time around, it’s undeniable that there is indeed a possibility. 
  2. ‘long enough time’: practically, people might have different concept on ‘long time or long term’. As we have said before, for stocks, we believe a reasonable (not even conservative) requirement for a period to be qualified as ‘a long term’ is 20 years or longer. So anything shorter than this, the assertion of ‘stocks deliver a reasonable return’ becomes much less certain, or more speculative.

The above seems to be a nuance in semantics, but it’s actually important to understand. In fact, understanding the above will lead to a conclusion people are reluctant to accept: ultimately, like it or not, we are all speculators. This argument might deserve an even longer future missive. For now, let’s move on to our ‘investors and speculators’ combined concept. 

Investor and speculator combined

For those who insist on being an investor, a highly overvalued financial market can often present a clear dilemma: it’s very clear that given something like stocks are so expensive, returns in a reasonable future period even as long as 20 years might not be great. On the other hand, we are told that it’s no good to time a market. So any alternative?

One way is of course like what we advocate here: to invest in a tactical asset allocation portfolio using strategies like (Asset Allocation Composite (AAC) or See our investment methodology). But some might still be worried that these are more or less ‘speculative’ strategies. 

Intuitively, putting aside all of these ideological jargons, one can see that a sensible way is to become an ‘investor’ when markets are cheap enough as this will have a much higher certainty to deliver a good future return. On the other hand, when markets are expensive, one should become more risk conscious and more flexible in terms of ‘investments’, or put it another way, become a ‘prudent speculator’ in expensive markets. 

Unlike a tactical strategy that might even react when markets are dirt cheap as it depends on market action (up and down trends) to decide stock exposure, becoming an investor or buy and hold regardless of market actions when markets are cheap eliminates a major drawback of a typical tactical strategy: in a very volatile market (often seen in a long secular bear market), a tactical strategy that’s in and out of stocks too often might suffer from many small losses that can add up.  

On the other hand, when markets are expensive, one can make a conscious decision that risk overweights more over returns and thus, avoiding large loss (often seen in a final stage of a bull market) becomes the top priority. The current market environment fits to this scenario. 

The portfolio

P Invest and Speculate mentioned in the above newsletters, is a portfolio that adopts the following strategy:

From its entire period since 2001, this portfolio only went into an investor mode briefly in 2009. All other times, it was in the speculator mode:

The good thing is that it has outperformed S&P 500 by some big margin with much smaller interim loss (maximum drawdown):

as of 8/27/2021:
 Name Max Drawdown YTD
1Yr AR 3Yr AR 5Yr AR 10Yr AR 15Yr AR Since 2001
P Invest and Speculate 21% 21.1% 31.2% 10.5% 13.4% 13.6% 13.3% 12.3%
VFINX (Vanguard 500 Index Investor) 55% 21.1% 31.2% 17.9% 17.8% 16.6% 10.8% 8.3%

So for $10k invested in 2001, this portfolio would have returned $110k, compared with $51k from S&P 500 (VFINX, dividend reinvested). Not only you more than double your money, you achieve this with less than half of maximum interim loss in this whole period. 

In July 12, 2021: The Long Forgotten Bear Market Cycles, we pointed out that it’s very likely that after this longest bull market, the next market cycle might be a long secular bear market (after all, markets can not forever go up). During that time, when markets become sufficiently cheap (and it’s very likely as markets often undershoot a lot in a downtrend, just like right now they overshoot a lot in the current uptrend), it might be more advantageous to just buy and hold stocks when they are dirt cheap. We suspect in the next market cycle, unlike in the past 20 years, it’ll have much longer period(s) to go into investor mode (i.e. markets are cheap enough). Of course, at this moment, we are just speculating on this before anything becomes concrete. 

Market Overview

Now that investors seemed to be pleased with what the Federal reserve bank signaled: inflation is transitory and it will be a while before the central bank starts to raise interest rates, they again flocked back to stocks, pushing popular stock indexes again into all time highs. Another encouraging sign: mid cap stocks finally joined large cap stocks to surpass its previous all time high (though small cap stocks are still behind):

In terms of the Covid-19 pandemic, it looks again likely that the US has reached a temporary delta variant peak. For now, it looks like that the society as a whole is getting more and more used to this pandemic and barring from any big surprise, it will be under control. 

We reiterate our caution on the current markets and advocate the following practice:

  • For strategic allocation (buy and hold) investors, ignore the current market behavior. Remember, as what we have emphasized numerous times, when you choose and commit to a strategic portfolio, you essentially know and commit that your investment horizon (or the time you need to utilize this capital) is 20 years or longer. As we pointed out, if your investments are those diversified (index) funds such as an S&P 500 index fund (VFINX, for example), you know your money is in some solid ‘business’ that eventually (20 years later) will deliver some reasonable returns. As long as you are comfortable with this thesis, you should sit tight and forget about the current gyration.
  • For tactical investors, again, you have to ignore the current market noise. Furthermore, you should follow your strategy rigorously, especially in a time like this. Human emotion, both optimistic and pessimistic, and human desire, both greedy and fearful, are your worst enemies. This has been shown to be true time and time again.

Stock valuation is still extremely high by historical standard. For the moment, we believe it’s prudent to be cautious while riding on market uptrend. However how serious a correction might be, we have confidence in the US economy in the long term and thus in the stocks in aggregate. We just need to manage through interim losses carefully.  

We again would like to emphasize that for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

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