Foolproof? Maybe, maybe not, but as close as you can get, I would think. The three indexes are the S&P500, Nasdaq100, and the Dow-Jones Industrials. All are tradeable through ETFs designed to match dollar-for-dollar the price behavior of their source bases. The first two (SPY and QQQQ) are the most heavily traded, liquid funds in the world. The Dow (DIA) is not far behind. They have perpetual life. All are qualified above reproach as prudent investments for the most scrupulous of trustees.
But they can and do lead to annoying or devastating grief for investors. To sidestep those possibilities, some guidance and control mechanics are needed if available. Two will do the job. Pick the best fund to invest in, and invest only when the market trend is up. By developing and applying a provable, successful method for each task, you have established risk control and opportunity.
The system above in the chart is ultrasimple. It consists of two steps. Step 1: pick the highest ranked of the three index funds. Step 2: note whether the market trend is up or down. Buy the top fund when the market trend is up. Sell the top fund and buy Treasury Bills when the market trend is down.
The weekly rankings and trend in the Mostly USA ETFs portfolio display the data necessary for the two-step decision process.
The chart above shows system results vs. each index held continuously; 66% system total return vs. 30% for the QQQQ and 19% each for both the SPY and DIA. These are not big returns, but lovely and desirable for effortless trusteed retirement funds, as we shall see in a moment. Maximum safety with maximum return with the least amount of work.
Negatives and Dangers. The test time frame seems short for highest confidence. The earliest data to work with does not go back further. But why should this system not work satisfactorily over decades? The mechanics of selection are simplicity itself. There may be drift over time to other more giant, more liquid indexes in the future. Then just change to them. The larger risk is slippage in the trend iindicator. That can be measured periodically and offset by adaptive modification as required.
The largest advantage of the system is its apparent immunity to bad drawdowns. The system's worst in the chart above is -16.9% toward the end of 2002. During the same period, the QQQQ drawdown was -38.2%, and SPY was -26.7%. Note too, the deep, repetitive, cyclical drawdowns in the indexes while the system plows placidly ahead on shortened sails during stormy weather. 58% of the time, you are invested in U.S. Treasury Bills. 42% of the time you hold the top-ranked index fund--a truly major balance in favor of safety, with no sacrifice in gaining more than two to three times the indexes' earnings.
The other advantage is a serious increment of return over the broad market. Broad-market index return has been about 10% per year compounded since 1926 (S&P 500). Based on test results, system return is about twice that, roughly 20% per year compounded. Where else can you get that while you are invested most of the time in Treasury Bills?
This little system can be a template for any number of other small, two- or three-fund portfolios and provide a springboard to more sophisticated and powerful systems creation and applications in the future. One of which comes immediately to mind ...
Retirement Certifiable? The essence of retirement funds is that they must 'be there' when retirement arrives. Without fail. Broad-based stock indexes are the only reliable way I can see to do that. There is a widespread perception that stocks are risky. Dear reader, they are less risky than bonds (proof below) and have the best assurance of greater growth and flexible exit when the time comes.
Milton Friedman looked over my research on this topic some years ago (bonds vs stocks, and related matters). He wrote to me, "Your article is fascinating and the conclusion suggested by your calculations striking. I must say that they show greater superiority of stocks as an investment vehicle than I would have imagined. I congratulate you on a very informative set of calculations."
See the article he refers to here.
Comments
2/21/2008 6:20 p.m. EDT
(a few more statistics)
Read here a later update and expansion, with new methods to maximize return and reduce risks.
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