(Part 3 of 4)
In the first two parts of this series, we explained how InvestableBenchmarks.com uses leading exchange-traded funds (ETFs) to deliver extraordinary performance. In fact, these efficient investment portfolios may enable you to grow a “free retirement nest egg!”
In this third part, we discuss another leading strategy that may enhance your protection from a stock market crash.
Four Steps to Investment Success
- Risk Control
- Leading Growth Stocks
Over the past decade, the investable benchmark portfolios delivered 7% to 19% annualized, or 92% to 463% in total return, with relatively low risk (see chart). The worst annual returns were just -4% to -17%, due to their strategic diversification.
Still, investors may need extra risk control at times.
No matter how impressive the historical performance has been, every investment portfolio and/or asset class has some risk of extreme “worst case scenarios” that may be unprecedented. Since 2000, the U.S. stock market, measured by the S&P 500, has already crashed by more than 50% twice, and the Japanese stock market recently fell by 80% over 23 years (‘89 to ‘12).
While developed country’s stock markets do not crash often, they do not always bounce back quickly either. Therefore, many experienced investors seek extra portfolio protection through a leading strategy called “Trend Following.”
Before I became a retail financial advisor, I worked as an institutional research analyst for Bear Stearns in Manhattan and as a hedge fund portfolio manager in Thousand Oaks. In those positions, I learned firsthand why many institutional investors employ trend following strategies.
During the Internet bubble, leading trend following investors successfully delivered gains as the bubble inflated (’95-’99), and again through the stock market crash that followed (’00-’02). Upon further research, I was even more intrigued to learn that trend following delivered gains in the crash of ‘87 as well.
Over the following three years (’03-’05), I developed an efficient trend following strategy for ETFs that enabled our firm, ETF Portfolio Management (ETF PM), to deliver gains for our clients in the stock market crash of 2008.
Trend following and indexing actually employ similar core principles. Both of these leading institutional strategies use reactive rules-based processes, or “algorithms,” to remove human emotion from investment decisions. Instead of trying to predict future asset prices, these strategies react efficiently to existing market trends based on relative price performance.
The main difference between the two strategies is that indexing makes portfolio changes very slowly and is always fully invested, while trend following can rotate to new investment trends quickly and/or shift to cash if needed. At ETF PM, our research concludes that an equal combination of passive indexing and active trend following has been ideal for long-term investors.
Broad diversification by asset class and by investment process helps to protect your investments from rare events, such as stock market crashes, earthquakes, tsunamis, wars, etc. To appreciate the combination of indexing and trend following, picture your investment portfolio as your belongings on a wonderful trip around the world.
The indexing items would include your core clothing, such as underwear, socks, shirts, pants, sweaters, shoes, etc., while the trend following components might add extra clothes and shoes, in addition to special items such as boots, bathing suits, hats, jackets, gloves, thermals, an umbrella, etc. Since the weather, like the financial markets, can vary widely and change quickly, it is best to maintain a diverse range of solutions that enable you to adapt efficiently as needed.
Leading Growth Stocks
In the June CVL issue, our fourth part in this series will cover leading growth stocks and our top picks for the second half of 2017.
While past performance is never a guarantee of future results, be sure to catch all four steps to investment success!
David Kreinces is the Founder & Portfolio Manager for ETF Portfolio Management (ETF PM), a Thousand Oaks-based financial advisor. To learn more, visit ETFPM.com or call 866.409.5844.