Loooong Term (or how to make money in a market going nowhere)

[pedro01]

I am looking to take control of my pension, cash part of it in and manage it myself. The management will be more passive than anything else.

This has nothing to do with my trading. For my long-term money, I do not want to be actively trading it, even with swing trades. I don't quite trust myself. I have had other people managing my money and have decided that I don't trust them either !

The time horizon I am looking at is 20 years.

Asset allocation will be part of my strategy and I will get into that later but also I am looking at forms of money management to help in my quest.

As this will be mostly a passive approach. ETFs will be used and they will be passive tracker-type ETFs for each asset class I choose (e.g. property, fixed income, equity, commodity etc).

There is a fundamental issue with this approach and it can be summed up as follows:

Basically the S&P is now at the same level it is at 10 years ago. That's 10 years with zero return, in fact less than zero when you consider inflation.

So - how do you overcome this ? If you allocate across 5 asset classes and one of them does this, that means 20% of your portfolio could go nowhere for 10 years.

Now look at the following, with a little bit of "Money Management Mystique" thrown in, the following results are possible for the same time period:

That leaves us with a current balance of $136,376.58 on an investment of $100,000 and also leaves us with 1,111 shares. Note that if you'd put $100,000 into the SPY on the start date above, you'd be sitting on roughly $100,000 and 1,000 shares. That's 36% more money & 10% more shares on hand.

So - how exactly was this done ? Basically, it is using a money management technique known as AIM.

Let's say you have $100,000 to invest. AIM dictates that you actually only put a percentage of that into the investment (in this example, 50%) and then put 50% into an interest bearing account. Then once a month/quarter, you review the value and buy/sell stocks as AIM rules dictate. You are not trying to time the market, you are just doing some math once a month and either moving stocks to cash or vice-versa.

The actual rules are here : Core Position Trading™ (CPT), Robert Lichello's Automatic Investment Management (AIM) Basics (Stocks, ETFs, and Mutual Funds)

Spreadsheet for the above is also attached. Note that I am using an adjusted version of AIM which does not allow you to buy more than your cash reserve. AIM isn't perfect.

There are some variations on AIM and I have ordered a few books on similar topics but there isn't much out there. I am currently unsure as to which model is best but I think the following points are relevant:

1 - All models will probably reduce returns of an instrument that goes straight up for 20 years.
2 - No model will provide a positive return of an instrument that goes straight down for 20 years
3 - No model, will provide a positive return of an instrument that flatlines for 20 years (of course 'buy & write' would do this but it isn't passive)
4 - Dollar cost averaging will not be considered

Anyway - at this point, if any of you have any models you think are worth considering, let me know. Otherwise, I'll start researching.

 

[dcraig1]

You also need to consider currency risk if you are investing in stocks denominated in currencies other than the currency of the country you intend to retire in. And you probably do need to look at international markets. Brokers such as IB have made it very easy to cheaply access wold markets in the last 10 years and this must be game changing to some extent.

The rally in the US market doesn't look nearly so flash denominated in euros. Likewise the rally in the AUS market would be fairly impressive denominated in USD.

It seems to me that in the long term, you really need to look at countries with high economic growth for some portion of the portfolio - and IMHO the US is not one of those countries.

In the end, choosing the right markets (countries) may be just as important as strategy.

 

[pedro01]

Dcraig - I agree - but like I said, I won't cover the asset allocation portion yet.

Right now, I am just looking at money management to see if anything other than buying & holding is appropriate.

FYI = my money is currently in :

MAN AHL Diversified Futures
Baring Eastern Europe Fund
Baring High Yield Bond Fund
Blackrock World Gold Fund
DWS Global Agribusiness Fund
Investec Global Energy Fund
Morgan Stanley SICAV Asian property Fund

As you can see - minimal exposure to US currency right now.

 

[N Rothschild]

four forge ting the yield from stock dividends..

also u couldnt pay me to hold stocks now!

 

[pedro01]

four forge ting the yield from stock dividends..

also u couldnt pay me to hold stocks now!

This is true indeed. I will need to bring dividends into the comparison. In the above example, the buy & hold would have yielded higher dividends as it was fully invested in the ETF from the start.

I guess the next step is to work dividend payments into this based on the holdings at payment time which is different in the 2 models. I used Tradestation to build the spreadsheet - I need to see if I can get dividend info from it... Probably not...

Thanks for that. :smart:

As for stocks - I agree entirely - I would not see me making this switch for another 3 or 4 months as it'll take me that long to be sure of which way to play it. Also, even though I will go for an asset allocation model, I'll be a little naughty and get in over time when I think the time is 'right' to get into that asset class.

For instance, as you say, it would be a bit unwise to put 20% of your assets into equities right now as they may be due a drop.

I would say though - that when I choose the any of the allocations, they may not be a US based. I will choose different asset classes but it doesn't have to be US-centric.

I may go for another country with more growth potential or a multi-country index. Perhaps an Asia index. It really depends how I invest, I want to be passive and not keep switching to last years 'hottest' region.

 

[everyonerich]

if im not mistaken.. (lol)
great bull market run is gonna happen in China. so dump all your money in major china stock.

 

[GladiatorX]

if im not mistaken.. (lol)
great bull market run is gonna happen in China. so dump all your money in major china stock.

China has recently had a relatively large fall compared to the other world indices; The Shanghai stock exchange composite index has fallen from a high of 3,500 to 2,683;
So with that sort of sell-off; if the general stock market trend continues i think in the short term China could aggressively catch up...

When you look at China from a 9-10 year perspective; its very similar to North America too... When the tech bubble accelerated, China did too. So its not like its lagging and waiting for its big break (Like Japan for example who just doesn't do anything)

x

Current stock markets that have a strong uptrend that isn't being affected by the current decline in US indices;
- Agrentina
- Brazil
- India
- Thailand
- Israel

 

[arabianights]

Need to consider management fees. They are going to be your biggest problem.

For long term investment ETFs do not tend to be the best option for this reason; there are cheaper trackers for the retail investor.

 

[tomorton]

Because 20 years is too far out for any meaningful predictions as to individual share prices, sector behaviour, stock markets or even national eceonomies, LTBH only makes sense for the dividend from a basket of blue chips, especially if the dividend is re-invested in early years so as to compound the appreciation.

 

[pedro01]

Need to consider management fees. They are going to be your biggest problem.

For long term investment ETFs do not tend to be the best option for this reason; there are cheaper trackers for the retail investor.

such as ?

 

[pedro01]

Because 20 years is too far out for any meaningful predictions as to individual share prices, sector behaviour, stock markets or even national eceonomies, LTBH only makes sense for the dividend from a basket of blue chips, especially if the dividend is re-invested in early years so as to compound the appreciation.

Agreed, that is exactly why I am looking at asset allocation as well as methods of making money from volatility as opposed to appreciation.

Hence, my interest in this Core Position Trading™ (CPT), Robert Lichello's Automatic Investment Management (AIM) Basics (Stocks, ETFs, and Mutual Funds) as an alternative to LTBH.

 

[pedro01]

OK - so which bugger mentioned dividends ???

I did some tests and found the following :

Buy and Hold of SPY with re-investment of dividend payment would have worked out as follows with a $100,000 investment (Oct 08 -> Oct 09)

Intial number of shares = 999
Final number of shares = 1188
Final Value = $125,191.48

AIM Method with dividend value added to the cash balance (which is used to re-invest as dictated by AIM rules). Note there is also a 3% per year interest rate factored into the cash balance too.

Initial number of shares = 499
Final number of shares = 1107 (some shares were sold in Sept 09)
Final cash balance = $37,639
Final share value = $116,611
Final Share + Cash = $154,251

It would seem then, in this case at least that AIM beats buy & hold when dividends are factored in. Note how AIM portfolio value never dips down past the initial investment

All of these numbers are from programs I wrote in TS using their price data plus dividend data from Yahoo Finance.

I guess now I need to run some other comparisons to see if these results are consistent across other instruments. Also - as I mentioned, I have a book coming soon which promises to resolve a few of the 'inefficiencies' of AIM.

If anyone wants me to post up the TS code - let me know.

Spreadsheets with the results attached.

 

[tomorton]

Hi pedro01 - a 54% gain on $100,000 over 10 years, with dividends re-invested, is only the equivalent of 4.43% annual compound interest. Even today, there are many savings accounts that will pay the best part of this rate. Doesn't sound like you'll be getting much of a risk premium.

 

[pedro01]

Tom

You are missing the point here somewhat. This thread is about looking at money management techniques that can enhance returns. I have PURPOSELY picked a market that went NOWHERE in 10 years to see what the money management technique would do.

Fair enough if you see no value in that because of the actual return - but the actual return is not the point at all. The point is in finding the good/bad from different ways of managing the money in a passive investment strategy and see if there is merit.

Do you think I'd be able to research this stuff, code it up, get the dividends, create the charts etc and in some way miss the fact that total return was less than a bank account ?

AIM did enhance the results on this particular market. Now I need to find other markets that moved in other ways over a 10 year period to see how AIM affects their results.

Cheers

Pete

 

[GladiatorX]

Hi pedro01 - a 54% gain on $100,000 over 10 years, with dividends re-invested, is only the equivalent of 4.43% annual compound interest. Even today, there are many savings accounts that will pay the best part of this rate. Doesn't sound like you'll be getting much of a risk premium.

Thats not the point is it; It means in a flat market you profit... In a rising market you would profit significantly more - AIM allows you to profit even when the market doesn't move.... PLUS opening you to the possibility of significantly higher gains...

A bank bond provides you with a flat rate with no opportunity for higher gains.

 

[tomorton]

What you both say is true, a rising market provides asset appreciation, good money management can only improve the results obtained, and an investment with no upside risk is a poor one. I also applaud the choice of a 10-year flat period for backtesting, so many vendors just pick a bull market to demonstrate their flippin' MA crossover stuff.

But the reason I mention risk premium is because of the downside risk. There is a real risk that any 10-year period will be affected by a bear that is bad enough to eat up any money management and any appreciation accrued to that point. That's why holding equities etc. should attract a risk premium, and I think your results show more clearly that the risk premium is inadequate under your parameters, than that the profit is acceptable.

 

[pedro01]

Tom - I understand what you are saying totally and agree with you. However, my research at this point is purely on what money management techniques are available and how they impact returns.

I did not pick the S&P going nowhere for 10 years to prove it would make more than a bank account. I chose it because it went nowhere and I believed it would be a good test of AIM. Indeed it was a very good test of AIM.

The results show only that AIM improves the results in investing in a market that is volatile and oscillating around the initial entry price but ultimately goes nowhere, which is a risk of any long term buy & hold strategy. Also - fact is (and no-one has mentioned it yet), the underlying currency of this investment has lost value over this time too and that also must be a consideration but for now it is largely irrelevant as we need to focus on one thing at a time.

There maybe other cases of going nowhere - U shape and n shape where AIM fails. I will look for these soon.

Next we'll look at some markets that just go up & just go down to see what AIM does to them. My guess is AIM will reduce the returns of markets that goes up without pause. I'm not sure about markets that go up with major retracements - but it should be an improvement. For markets that just go down, no money management technique will help.

 

[pedro01]

OK - so the next one I am going to look at is the spot gold price. In this case, we will compare buying & holding Gold since June 2001 to the present date. Due to the nature of the move in Gold in that period, we should expect this to give any money management technique a bit of a rough time.

In reality, I have been holding Gold for pretty much the same period. Please don't interpret this to be my investment plan. It is just intended to illustrate strength/weakness in AIM.

The chart :

So - the results for Buy & Hold Gold $100,000

Number of ounces : 376
End Gold value : $378,055
End Cash Value : $269.05 ( the amount left over after initial purchase)

Now for AIM
Initial Investment : $100,000
Number of Ounces at end : 66
End Gold Value : $66,313
End Cash Value : $132,892
End Portfolio Value : $199,205

So - it seems that in a market of this nature, AIM still provides for a positive expectancy but it does reduce the overall expectancy.

This is of course, an extreme example and is intended to be. Some thoughts to consider.

- AIM did actually move money out of the market after a sustained rally in theory keeping it safe (AIM never realized the US might try to print it's way out of debt !)
- There are some modifications to AIM such as AIM-HI which play with the 'SAFE' and 'Portfolio Control' aspects as well as the balance between cash/market. From what I can see these modifications were retrospective and look like curve fitting but I will look into them
- There are other MM Methods to consider & other markets to apply AIM to.
- AIM may enhance or in fact negate some of the benefits of traditional asset allocation models for long term investing

I am thinking next of going for a rising but volatile market and then a falling market for comparison.

If someone wants to suggest a martek/time period, I will do that. Otherwise I will choose my own. I was thinking for the next test - Property/REIT, Asian ETF, Eastern Europe ETF, Bond/High Yield Bond ETF.

Note also that if we do settle on an MM model, I will then look at asset allocation and see how the MM model can be applied across a portfolio. For instance, in the case of AIM, you could choose a cash bank for each investment OR you could choose one to be shared across all 5 or 6 asset classes.

 

[pedro01]

One note & something I should have mentioned earlier.

I am sure we have all seen a financial consultant show a chart which PROVES how great dollar cost averaging is.

In this case, the chart being used by the consultant is rigged. Of course dollar cost averaging increases returns when the market moves in a particular way. Fact is though, more often than not it fails.

AIM was intended as a 'solution' to the issues of dollar cost averaging but after reading Lichello's book - I wanted to see if in fact, he was also rigging the charts.

Remember - the alternative here is me actively managing my whole retirement portfolio for the next 20 years AND beating the markets over that time....

This is not a case where I can afford a wipe out and it's not a case of "I'm gonna be a zillionaire from trading in 5 months" either, although there is money allocated to my zillionaire account...

 

[tomorton]

This is thorough and professional research.