On page 167 of Mebane T. Faber and Eric W. Richardson’s book, “The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets” we read, “Our research has shown that returns are lower and volatility is higher when asset classes are below the 10-month moving average.” What investor is not interested in reducing portfolio volatility while increasing returns. And possibly more important, reducing losses. This philosophy is what is behind the ITA Risk Reduction (ITARR) model we are using with the ITA portfolios.*
The 10-month simple moving average Faber and Richardson discuss in their book is equivalent to the very familiar 200-Day Simple Moving Average. Instead of the 200-Day SMA, I use the slightly faster 195-Day Exponential Moving Average (EMA) for each asset classes used in the ITARR portfolios. Readers will find a detailed explanation of the EMA elsewhere. As a review, here are the ITARR rules. These simple rules can be implemented by any investor.
- Buy Rule: Buy the index ETF when the price of the ETF moves from below to above the 195-Day EMA of the ETF.
- Sell Rule: Sell the index ETF when the price of the ETF moves from above to below the 195-Day EMA of the ETF.
On the Sell Rule, proceeds will be moved to a money market fund or to a treasury holding such as SHY. After a Buy or Sell move, we do not pay any attention to that ETF (or other investment vehicle) until more than 30 days pass. Right now I use a 33-Day waiting period. This “neglect” rule is applied for several reasons. 1) We want to avoid the wash rule. 2) We can avoid TDAmeritrade’s high commission fee if we do not trade within a 30-day period. 3) We minimize the whipsaw problem if we neglect the ETF or index fund for at least 30 days. 4) The 33-Day waiting period rotates the portfolio review throughout the month so month-end results to not unduly influence portfolio results.
The Buy and Sell signals are included within the CWM spreadsheet, available to Platinum members. In general, we examine all ETFs held in a portfolio at the end of each review period to see where they are positioned. In addition to the ITARR model, we also use the SHY cutoff model. The SHY cutoff model is discussed in nearly every portfolio review blog.
If there are any questions related to the ITARR model, please drop them in the comments section.
* Two exceptions are the Schrodinger and Copernicus as they are passively managed.