Perspective is an interesting thing. Many people seem to feel that the world is becoming a worse place by the day. Certainly the things that divide Americans seem more pronounced than they did a decade or two ago. And it's pretty easy to look around the world and see massive problems today that weren't on most peoples' radar 20 years ago.

But in many respects, the world is a dramatically better place today than it has been for much of history. Take the following chart, which shows the massive escape from extreme poverty for much of the world's population in recent decades.

SMI has frequently discussed what "normal" market volatility looks like. Typically this takes the form of quoting statistics regarding the market averaging a 10% correction roughly once per year, and so on. We feel like it's easier for investors to handle volatility when it comes if they're prepared for it in advance.

There is one change to the DAA lineup for October. Read on for the full details.

DAA is a core portfolio strategy that is designed to help SMI readers share in some of a bull market’s gains, while minimizing (or even preventing) losses during bear markets. The strategy involves using exchange-traded funds to rotate among six asset classes, holding three at any one time. DAA is a defensive, low-volatility strategy that nonetheless has generated impressive back-tested results, demonstrating the power of “winning by not losing.”

The recommended categories/ETFs for October are (in order of current momentum):

Sector Rotation is a high-risk/high-volatility strategy. While its peaks and valleys have been more extreme than SMI's other strategies, it has generated especially impressive long-term returns, as discussed in Sector Rotation is Risky, But Highly Rewarding.

There is no change being made to the official SR recommendation for October. Here are the details.

There are no changes to Stock or Bond Upgrading this month.

This Level 3 “Broadening Your Portfolio” column frequently deals with specific investments you can add in an effort to increase diversification. But occasionally it’s good to pull back and take a wider view: establishing the value of — and need for — diversification in the first place.

The chart below is a variation of what is often called the “Periodic Table of Investment Returns.” We’ve modified it to include only the five major stock-risk categories tracked by SMI’s Stock Upgrading strategy. The columns show the returns for each risk category for a particular year, with the best-performing group at the top and the worst at the bottom. For example, the first column shows returns from 2008. The average small/value fund tracked by Morningstar lost -32.5% that year. Each square below that shows the returns of another risk category until you finally reach the foreign funds, which were the worst performers during the depths of the financial crisis, losing -44.4% that year.

Why Upgrade?

SMI offers two primary investing strategies for “basic” members. They are different in philosophy, the amount of attention they require, and the rate of return expected from each. Our preferred investing strategy is called Fund Upgrading, and is based on the idea that if you are willing to regularly monitor your mutual-fund holdings and replace laggards periodically, you can improve your returns. While Upgrading is relatively low-maintenance, it does require you to check your fund holdings each month and replace funds occasionally. If you don’t wish to do this yourself, a professionally-managed version of Upgrading is available.

SMI also offers an investing strategy based on index funds called Just-the-Basics (JtB). JtB requires attention only once per year. The returns expected from JtB are lower over time than what we expect (and have received) from Upgrading. JtB makes the most sense for those in 401(k) plans that lack a sufficient number of quality fund options to make successful Upgrading within the plan possible. Here are the funds and percentage allocations we recommend for our Just-the-Basics indexing strategy.

We had an excellent question come in via the MoneyGuidePro^® section of the SMI Forums recently, and I wanted to address it here to put it in front of a wider audience. It's central to effectively following the instructions in the September feature article, Facing Your Fears: Modeling the Impact of a Significant Bear Market on Your Financial Plan, so hopefully addressing it here will help other people wondering about the same issue.

Here's the question:

I am currently using Fund Upgrading, DAA, Bond Upgrading, and Sector Rotation in our portfolio, and I am working with the full-featured final version of MGP.  I went to the “What Are You Afraid of?” screen, selected “Great Recession Loss”, and that’s where my question arose.  You wrote that “the key to using this feature correctly is knowing what loss number to enter using the slider bar”, and also that “The hypothetical couple was using a 50/40/10 portfolio, with a 60/40 blend of Upgrading.”  Setting the slider at 16 produced for them a much more optimistic outcome.  And it was somewhat cut and dried, since they were using only one of the several SMI strategies. 

My question:  How do I know or calculate what number to set the slider on if my portfolio assets are being managed under multiple SMI strategies?  I know I need to make some adjustments, and I am confident that MGP is an excellent tool to use in the process.  But I am stuck until I get this one question answered.  I know I must be missing something.

The key information we need to answer this question comes from the "Facing Your Fears" article linked to above. In the article, we included an "SMI Strategies Loss Table" that broke down the returns of each SMI strategy during the Great Recession time period. I've included that table here at right. We can use that information to calculate the correct loss number to enter using the slider bar in the "What are you afraid of?" section of the software.

Here's an example of how that might look using the strategies you mentioned. You'll need to substitute your own percentages to reflect the amount you allocate to each strategy, but hopefully, this will help you figure out an appropriate loss to enter.

If you are using DAA, Upgrading, SR in a roughly 50/40/10 ratio, we've already done the work for you and listed those results in the table.

If you're using some combination other than 50/40/10, here's how to run your own numbers.

Let's say a person's portfolio is weighted as follows:

40% DAA
30% Stock Upgrading
  5% Sector Rotation
25% Bond Upgrading

They would look at the loss table and find the corresponding results for each strategy:

DAA -1%
Stock Upgrading -50%
Sector Rotation -39%
Bond Upgrading +5%

Multiplying each strategy result by that strategy's weighting within your portfolio will provide us with a weighted average for the portfolio as a whole. (First, convert each portfolio allocation to a decimal: i.e., 40% becomes 0.4.)

The calculations for our example look like this:

DAA: 0.4 x -1 = -0.4
Stock Upgrading: 0.3 x -50 = -15
Sector Rotation: .05 x -39 = -1.95
Bond Upgrading: .25 x +5 = +1.25

When we add up those results, we find that this portfolio would have lost -16.1% between Nov 2007-Feb 2009. So you'd enter -16% as the portfolio loss using the slider bar.

As we noted in the article, it would be worthwhile to go back to this input at some point to test it with a slightly worse result, like -20%. There's no guarantee the next bear market will look exactly like the last one, so testing your plan with a range of outcomes makes sense.

If you have a cash allocation in your portfolio, you can probably safely assume a zero return on that portion of the portfolio. That means you can ignore it for the purposes of this calculation. While cash did earn a positive return back in 2007-2009, it's likely that the Fed would drop interest rates quickly back toward zero if another bear market were to take hold.

Gold and other precious metals are trickier. During the Nov 2007-Feb 2009 period that we're modeling, GLD (the main gold ETF) was up 17.9%. However this masks some pretty serious movement in both directions — for example, GLD was down -16.1% in October 2008 alone. So it wasn't as clear-cut as "gold did well when the stock market fell" (although that was the ultimate result). The other thing that makes this a tough call is that this performance occurred within the context of a much longer bull market for gold that ended in 2011. But gold has declined from those 2011 highs considerably. So it's probably an open question whether gold would perform similarly the next time around when it isn't in the midst of decade-long bull market of its own.

If your gold holdings aren't particularly sizeable relative to the rest of your portfolio, you could probably leave them out and not have it impact the result much. Otherwise, gold can be added as another "strategy" and calculated the same way we did the others, using either the historical return (+17.9%) or some other more modest figure.

Hopefully, this helps clarify how to use the Loss Table in the article and how to arrive at a custom "Great Recession" loss number to use in your personal plan.

We've been pointing out for some time that stocks are trading at extremely elevated prices — by some measures, they've only been more expensive at the peak of the dot-com bubble. But we've also noted that stock valuations are a notoriously poor guide to the timing of market trend changes. Stocks can continue to get even more expensive for an extended period of time (as they did in that dot-com era).

One factor that has been surprisingly absent as stock prices have tripled over the past 8½ years has been investor bullishness. In fact, it's become popular to label this bull market some variation of "the most hated bull market of all time." It's impossible to know if that's really true, but it is indisputable that investors have, by and large, doubted this bull market all the way along, from its earliest days until recently.

 And there's been plenty to worry about, as the chart below from Michael Batnick of The Irrelevant Investor shows: