When I think of investing basics, two key principles quickly come to mind and I have yet to meet anyone who disagrees with these fundamental rules.
- Save as much as you can as early as you can. This is The Golden Rule of Investing. All else pales compared to this investing “law.”
- Keep expenses low. Any business knows this premise works right to the bottom line and investing is no different.
After these two fundamental ideas we fan out in our approaches to investing. Some investors will take the passive route and we have three portfolios (Schrodinger, Copernicus, and Pasteur) that use this investing model. Passive investing is the most tax efficient model, but it is a long-term approach to investing. Young investors with little time to devote to portfolio management are encouraged to consider passive investing.
Investors in their retirement years prefer more down-side protection than comes with a broadly diversified portfolio that is following a Strategic Asset Allocation plan. I happen to be in that situation so I personally am looking for more protection.
At the opposite end of the investing spectrum from passive investing is the Hawking Portfolio where options are used to hedge and provide portfolio insurance. Investors interested in this approach will find detailed explanations as to how this portfolio is managed.
A middle ground, but still requiring active management, is the momentum model. Here at ITA a lot of attention is devoted to this investing model. The “brains” behind the momentum model is the SAS 7.1.x spreadsheet. The current ETF ranking spreadsheet is 7.1.3, but a major research project is underway and a revised version is in the offing.
The momentum model has several good things going for it and one is down-side protection. In our model we use SHY as the cutoff or “circuit breaker” ETF. Simply put, we sell ETFs when they rank below SHY. For purposes of calculating the ITA Index, I keep a minimum number of shares in the “critical” ETFs used to populate the various asset classes.
Another benefit of the momentum model is to gain a performance or return edge while reducing portfolio volatility. There are many moving parts to the SAS 7.1.x spreadsheet and those moving parts are currently undergoing extensive back-testing in an effort to improve on the default settings. Critical variables under investigation are the following.
- Look-back periods. The current defaults are 91 days and 182 days. What changes if any will improve performance?
- Should we use mean-variation or semi-variation for the volatility variable?
- How frequently should the portfolio be reviewed?
- What ETFs make sense for possible portfolio construction?
- Should we use raw data or Exponential Moving Average Smoothing for our look-back periods.
- After ranking of possible investments, how many securities should be used to populate the portfolio?
Once these questions are answered to a reasonable degree and a new SAS spreadsheet becomes available, we will begin to test the new parameters with numerous portfolios. Then it is time to follow the trends to see if positive returns are forth-coming.