For 25 years, SMI has provided investors with easy-to-use strategies to manage their portfolios.
Just-the-Basics is our oldest and simplest approach, using index funds in an attempt to roughly duplicate the market’s overall returns. Fund Upgrading has been our most popular strategy over the past 15 years or so. It is based on the idea that superior performance is possible by shifting one’s portfolio among various mutual funds in a disciplined manner based on their recent performance “momentum.” Dynamic Asset Allocation (DAA) is our newest strategy, debuting in January 2013. It is a more defensive strategy that shifts between asset classes as market cycles unfold, enabling DAA investors to own what’s profitable at any given time while avoiding those assets currently caught in downturns.
We refer to these three approaches as core strategies, meaning that each is suitable to be used as an investor’s primary (or only) strategy. SMI also offers a popular “add-on” strategy called Sector Rotation, which is a high-risk, high-reward system of investing in narrowly-focused slices of the stock market by using sector funds. Sector Rotation is designed to play a supporting, rather than central, role in an investor’s portfolio. (SMI offers other strategies not discussed in this article. The ones discussed here are by far our most popular offerings.)
One can be a successful long-term investor by simply using a solid core strategy (i.e., JtB, Upgrading, or DAA) without adding any other strategies. This is the simplest approach. However, just as diversification among different types of investments can help smooth out the ups and downs of a portfolio, diversifying among different strategies can yield similar benefits.
The primary goal of diversifying a portfolio among different types of investments is to get a mix that “marches to different drummers.” For example, we hope bonds will do well when stocks are faltering, and vice versa. Or that foreign stocks will be up when domestic stocks are down. In this way, we try to smooth our investing journey — and suffer fewer emotional ups and downs — by always owning some investments that are performing well. Diversifying among strategies is based on the same idea. By utilizing different strategies, we hope that when one strategy is having a down year, another might pick up the slack with a good year.
The table below illustrates how this diversification idea translates into actual experience. Each colored box below shows the annual performance for one of the SMI strategies discussed earlier. (Note that we’ve divided our Upgrading strategy into its separate stock and bond components.) The performance of the U.S. Market, as represented by the Wilshire 5000 index, is provided to give additional context to the data. And we’ve also shown the annual performance of a “50-40-10” diversified portfolio, where 50% of the portfolio is invested in DAA, 40% in Stock Upgrading, and 10% in Sector Rotation. Each of the past 10 years is shown as a column, starting with 2005 on the far left.
The most important point to recognize from the table is how the relative performance of the strategies varies widely from year to year.
It’s common for a strategy to be at the top of the rankings one year, then near the bottom the next year, and vice versa. For example, note the performance of Sector Rotation in the first three columns of the table. SR goes from first place in 2005, to last in 2006, and back to first in 2007! Of the seven approaches represented in the table, only DAA and the blended 50-40-10 portfolio avoided finishing last in at least one year.
The relative and varied performance shown in the table helps us visualize how combining more than one of these strategies leads to a less volatile investing journey. Over the past two years, SMI has written several times about the virtues of the 50-40-10 approach. By combining the volatility-suppressing characteristics of DAA with the more aggressive Stock Upgrading and Sector Rotation strategies, this 50-40-10 approach has produced solid returns with a less bumpy ride than the individual strategies have provided.
In fact, looking at the table, the 50-40-10 portfolio never finished in the bottom two rows. Among the seven options shown in the table, a 50-40-10 blend finished either 2nd, 3rd, or 4th in eight of the ten years, with the other two years placing 5th. More importantly, it generated that relatively smooth path while finishing the 10-year period with an annualized gain of 11.9% — nearly half-again as much as the 8.0% earned by the U.S. market. In other words: excellent returns with year-to-year variation that was smooth enough for investors to stick with through both good and bad markets.
Bond Upgrading deserves a brief comment as well. Obviously, we wouldn’t expect a bond-oriented strategy to perform as well as a stock-oriented one during periods when the stock market is strong. But the diversification benefit of including bonds becomes obvious when the stock market turns lower. Note how bonds shot to the top of the performance list in 2008 and 2011, which were bad years for stocks.
While we’ve singled out the 50-40-10 blend as a good starting point for most readers, there’s no magic formula when it comes to diversifying among strategies. The important thing is to combine strategies that are accomplishing different things. For example, Stock Upgrading and JtB are both stock-investment strategies with little downside risk protection, so pairing those will offer less diversification benefit than adding a strategy such as DAA or Bond Upgrading would. We like 50-40-10 because it’s a simple combination that makes sense for a wide spectrum of readers, but if you’re more comfortable with some other combination, that’s fine.
And of course, there’s no pressure to add additional strategies if you prefer to keep it simple. If you do decide to utilize only one strategy, we recommend DAA, because it has the most diversification and downside protection built into it. Remember, the goal of diversification isn’t to make things complicated. It’s to level out the emotional journey as the market experiences its ups and downs — while still generating the long-term investment gains you need.