How Many Holdings?
How the Number of Funds Held Affects the Final Outcome
-Using ETFs From the Mostly USA Portfolio-
with Market Timing
Percent Gains--Weekly--Hypothetical
6 years, June 21, 2002--April 4, 2008
See Comments below
THREE'S BEST
Whoa! Wait a minute. The 'rules' say,
Buy the two top-ranked funds. And while we're at it, why not just use the number 1, top-ranked fund alone. If it's top-ranked, it should have the the top ranking-performance, no? Logic says, Yes. But the correct answer is counter-intuitive. It's, Buy the top 3 ranked funds.
You can see from the red lines in the chart above that raising the number of funds held from 1 to 3 gives you not only substantially greater performance but cuts worst-cse drawdowns by more than half. The following table shows the outcomes of each level of funds held.
For example, in the table, if you hold 3 funds (top n colum) when the market is in an uptrend, your total return (% tot return) will be 283% which is 19% per year compounded, giving to best gains of any number of funds held. And better still, the maximum drawdown is less than half (-4.1%), the lowest of any other number of funds held.
|
%tot |
|
draw |
|
top n |
return |
%/yr |
down |
|
1 |
224 |
14.4 |
-8.7 |
|
2 |
266 |
17.8 |
-9.0 |
|
3 |
283 |
19.0 |
-4.1 |
|
4 |
240 |
15.8 |
-6.1 |
|
5 |
238 |
15.6 |
-6.1 |
|
6 |
227 |
14.7 |
-6.2 |
|
7 |
216 |
13.8 |
-6.3 |
|
8 |
204 |
12.7 |
-6.3 |
|
9 |
197 |
12.0 |
-6.5 |
|
SPY |
121 |
3.3 |
-27.5 |
The bottom row reports the 'market' results. The S&P500 Index (SPY--its ETF equivalent) has 500 holdings in it versus your 1 to 9. The table suggests that you earn 12 cents for a dollar of risk in the S&P500 versus $4.61 per dollar of risk when you hold the three top-ranked funds.
In a future issue of 'Systems Tips', I will show the results of different levels of leverage on thse portfolios.
The top blue curve in the chart above shows the best results when you buy the 3 top-ranked funds in an up market and sell short the single bottom-ranked fund when the market trend is down. Total return is 417%, compound annual return is 27.0%, and maximum drawdown is -12.6%. (The table shows results only for long positions with timing, no shorting.)
Yes, so where does that leave us? I will let the rule of '2' stand. When the system was developed, I wanted it to be as simple as possible and require the least work to use it, consonant with above average performance and risk reduction. '2' did this better than '3'. If I published '3' as the 'rule' of choice, I would have been creating 50% greater complexity and work time for review and transactions. Also, for accounts with smaller dollar assets, brokerage commissions could be too exorbitant to permit prudent use of the system.
But, the great benefit of this table is, it gives you detailed, precise choices to fit your pocketbook and personality. I am staying with the '2' rule, for the time being. I don't want, nor have the time for, extra work in my own accounts, especially when I use the system in three of them.
Real-time returns records will continue to report on the basis of top-2 and bottom-1 funds for all purchases and short sales with timing.
Caveat. This study and these conclusions pertain only to Mostly USA ETFs. They do not apply to the Worldwide ETFs Portfolio.
Comments
4/18/2008 16:31 p.m. EDT
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