One of SMI’s core investing principles is that it’s crucial to trust and follow the system. This month’s cover article confirms our own observation that most big mistakes result from operating outside of a clearly-defined investing process. That’s why we’ve designed the SMI strategies to run on clear, mechanical rules, with little discretionary decision-making required after an investor selects an initial strategy mix and gets a portfolio established.
Implemented correctly — meaning that an individual selects an appropriate blend of strategies for his or her age and risk tolerance — the SMI strategies will handle most of the risk-management investors need automatically. This automatic approach to managing risk has been on display during this year’s bear market. Dynamic Asset Allocation (DAA) was ahead of the curve. It moved a significant portion of our portfolios to safety early on and delivered solid returns in asset classes outside the stock market. Even within Upgrading, an age-appropriate allocation to bonds has significantly diminished risk and boosted returns. (Read our second-quarter performance review of the SMI strategies.)
This “just follow the system” method works nearly all the time. However, there is one potential hitch in this risk-management process. Simply put, we know that our trend-following, momentum-based strategies will follow stocks ever higher — even at market extremes. Normally, this isn’t a problem because stocks rarely reach such extremes. (In the past half-century, only four obvious examples stand out: the market highs seen in 1973, 2000, 2007, and, now, 2020.)
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