Investing Basics: Examining the Fundamental Principles

From time to time it is useful to go back to the basics and make sure we have an investment plan that makes sense and has a high probability of adding value, or as we like to say, adds alpha to the portfolio. Here are a few basic guidelines.

• Follow The Golden Rule of Investing by living below your means and save as much as you can as early as you can.  Even if you are limiting in your saving plan, stick with it and stay disciplined.
• By all means, use index mutual funds or non-managed index ETFs.  My preference is to use ETFs.  ITA Wealth Management is loaded with examples of security tickers such as VTI, VEA, VWO, VNQ, TLT, RWX, PCY, etc.
• Lay out an asset allocation plan.  Readers will find examples when the various portfolios come up for review.  Twelve (12) to eighteen (18) asset classes should be sufficient to provide global diversification.  Two examples are provided in the screenshots below.
• Within the asset allocation plan determine what percentage you plan to invest in each asset class.  I still think this is one of the most difficult decisions an investor makes.  If using a Momentum Model, one deviates away from this principle.
• Read a few investment books I recommend throughout this blog.  Hear what other investors have to say.  Be aware that my book recommendations have a bias toward index investing and my investing style is rather conservative.  It may not seem conservative with all this discussion on momentum and risk reduction – but it is.

Einstein Dashboard:  The following screenshot was extracted from the Einstein TLH Spreadsheet and is an example of the Einstein asset allocation plan.  It is more colorful than one might expect as I am deviating from the asset allocation plan by employing a Momentum Model overlay with this portfolio.  The SHY cutoff is activated with the Momentum Model and in addition, I pay attention to the ITA Risk Reduction (ITARR) model as I am adamant about preserving capital.  This does not mean there will not be daily losses.  The SHY cutoff and ITARR models are designed to keep us out of major bear markets, not small day to day losses.

Another example of an asset allocation plan is one I use with the Schrodinger.

Schrodinger Dashboard:  In this portfolio the asset classes are in balance.  The Schrodinger is the “flag ship” of passive management. After laying out an asset allocation plan stick with it and keep the various asset classes in balance.  If the following Strategic Asset Allocation plan does not fit your risk concerns, adjust as needed.  Even if you are retired and in your 60s, don’t be too conservative as you may have another 30 years to invest.

Based on the research from “HedgeHunter” I think it is prudent to employ a risk overlay such as the SHY “circuit breaker” or ITARR model.  What I am less sure about is the 195-Day EMA.  I need to do more research on EMAs as I recall reading an academic paper where a little faster moving EMA is preferred.  My recollection is that a 150-Day Exponential Moving Average is superior to the 195-Day EMA.  The problem with choosing one over the other is that the decision is based on back testing and there is no guarantee that is what will work best in the future.

If you are looking for an approach that requires about one hour of work per year, set your portfolio up similar to the Schrodinger.  It you want to be a little more active, then consider a momentum model with the SHY cutoff and/or ITARR overlay.  Examples of these approaches are on display each month as the various portfolios come up for review.  To gain access to all the details requires a Platinum membership so keep that option in mind if you are not a member.