Our Investment Philosophy

Strong Risk Management: Our investment philosophy is to optimize the risk-adjusted return of our generic Model Portfolios. We believe that long term success at investing is largely about good management of risk relative to potential returns. So we have designed four different generic strategies that aim to provide very strong risk-adjusted returns for investors with different levels of risk tolerance and investment sophistication.

Some people would say that our methods are similar to those of “hedge funds”. There is some truth to this, particularly in the sense that our strategies aim to deliver positive returns in our Model Portfolios during both good times and bad – a strong distinction from traditional “buy and hold” investing that requires years of patience from investors as they suffer through the inevitable bad periods.

Absolute Return Investing: Other people would say our methods are an example of the new trend toward “absolute return investing.” And they would be right. This new approach to investing is about using more sophisticated methods to deliver higher absolute returns in each year of investing. This generally means trying to avoid taking significant losses because of how harmful losses can be mathematically to achieving higher average annualized rates of return. Absolute return investing is much more likely to deliver some kind of positive return even during years of bear market conditions.

Traditional mutual funds practice “relative return investing.” Mutual fund managers try to beat a market index such as the S&P 500 Index. They benchmark their quarterly performance against that index and the managers get incentive payments for performing better than the index. So what they are concerned about is how well they perform relative to the index … which is why it is called “relative return investing.” The problem with this approach is that the mutual fund manager still gets a large bonus even if their fund loses money, as long as it loses less than the index! Notice the distinction: they are not worried about losing money, they are only worried about doing better than the index, even if it drops by 40%.

Is that what you want? Probably not if you have decided to consider our strategies.

Disciplined Investing: Our investment philosophy is also all about disciplined investing. Our strategies are mechanical in nature, driven by statistically tested, mathematical market timing logic. They are not influenced by the biases of conventional wisdom nor are they affected by troublesome human emotions. On the contrary, our strategies provide a disciplined vehicle for the average growth investor.

To round out this discussion of investment philosophy, here are the key investment principals that we follow with all of our Model Portfolios. They all reflect our core philosophy:

We invest for the long haul, not for one-time spectacular gains: We are not searching for the next Microsoft or Google. Our method seeks broad diversification of risk and works to take as much gain from the broad market averages as they will give us over time. Our strategies depend upon minimizing losses and compounding positive returns in each year to deliver truly superior cumulative returns in the long run.

We invest in mutual funds, not in stocks: Risk management is vastly simplified by investing in mutual funds (i.e., index funds and exchange traded funds) rather than individual stocks. It also saves you, the investor, a great deal of time. For additional discussion of this, read “Why We Don’t Recommend Stocks”.

We tightly manage risk to minimize losses relative to potential gains: We tightly manage risk for two reasons. First, reducing losses contributes significantly to the mathematical compounding of gains over the years and leads to much higher long-term cumulative returns. Second, controlling the degree of losses makes it much easier for you, the investor, to stick with the program and maintain your investment discipline. Studies have repeatedly shown that the average investor’s behavior in response to losses and risk is highly counterproductive for their long-term success. To see measurements of how risky our strategies have been compared with traditional buy and hold, see “What are Your Risk-Adjusted Returns?”.

We seek to make a positive return in every year, even during bear markets: We won’t always be successful at this, but when we do have a down year it should be a small loss compared with the market. Historically, our strategies have been very successful at avoiding losses in any year (see our year-by-year track record on “How Have Your Strategies Performed?”) We have been able to accomplish this track record in three ways: 1) During certain bear market years, bonds did well and we were able to overcome any minor stock market losses through bond market gains (although this won’t always be the case). 2) In some other cases, our models switched into market sectors such as Small Cap stocks that performed much better than the S&P 500 Index. This generated a level of over-performance in certain years that cushioned us against large market declines when they came in the same year. 3) Our “Performance Extension Series” models were able to make money during declining markets by investing in “Inverse Funds” (otherwise known as Bear Funds) and in some cases made money on the Real Estate, Energy or Precious Metals funds when they were trending in the opposite direction of the broad market.

We use a dynamic approach to asset allocation: Unlike a traditional financial portfolio allocation plan, our strategies dynamically shift allocations as market conditions change. They can shift from a 100% cash allocation to a fully invested, 100% stock market allocation in a matter of weeks (and vice versa). Typically, however, our recommended allocation changes are more gradual – more on the order of a 20% or 30% change. But it depends on the market. This dynamic approach to portfolio asset allocation is how we’re able to get out of the market early before a major correction or bear market can wreak its havoc; and also successfully get into the market early when a new bull market is just beginning. For more discussion of this, see “Dynamic and Tactical Asset Allocation.”

We take maximum advantage of the stock market during bull markets: Most investment advisors tell you to reduce your allocation to the stock market to reduce the potential losses your portfolio could take. They do this because they have no way to advise you on a timely basis of when to get out. But we do. So our market timing based strategies aim to enable you to take on much higher allocations to stocks when the market is strong, knowing we can control the risk with a timely trigger to exit the market. We can take maximal advantage of stock market investing without adding to risk. In fact, we’ve even been able to reduce overall risk compared with a typical asset allocation plan of 60% stocks and 40% bonds.

How Our Strategies Work

Our Model Portfolio strategies are mechanical investment systems. They are based upon a pre-defined set of logical rules driven by quantifiable market statistics. As such, each model is a “closed system” in that it operates like a “black box”. The logical rules behind each strategy are based upon the statistical analysis of historical market data back to 1970 and designed to be consistent with a particular type of investment objective and level of risk tolerance. At the core of this technology is a long-term market timing model that was developed in the early 1990’s and has been used live since the mid-90’s.

In a nutshell, each strategy uses the Long-Term Market Timing model to gauge the current level of risk that the market could move into, or continue in, a declining bear market trend. This determination drives a dynamic asset allocation model which sets the percentage amount of exposure to each type of investment. In addition, a Relative Sector Strength Optimization model determines which sectors are the best choices to include in the portfolio at a given time. Finally, each strategy incorporates a hard "stop loss" trigger that seeks to keep overall portfolio losses inside of a predetermined level.

For a more in-depth discussion, see “How Do Your Strategies Work?.” And for even more detail, see the following pages:

What to Expect

Since our approach is probably new to you, we would like to give you a clear idea of what to expect from the performance of our generic Model Portfolios. The following points should help orient you:

Portfolio Allocation Shifts Once or Twice a Month: Each one of our Model Portfolio strategies is somewhat different and will trigger allocation changes more or less frequently. To see how they are different, look at the table at the bottom of the page “Which Strategy is Best for Me?.” The table shows an estimate of the average annual frequency of trades for each Model Portfolio.

Lower Volatility in the Long Run: Our strategies have achieved a significant reduction in volatility over the long-run because of their ability to exit the market on a timely basis to avoid severe losses. (The one exception to this is our more volatile Max Xtender strategy). So, during times when a typical “Buy and Hold” portfolio might go down 20%, 30% or 50% in value, our strategies are designed to decline in value no more than somewhere between 5% to 12%. To check out the largest “peak to valley” decline suffered in the last 6 years by any of our strategies (which we call the “Maximum Drawdown” statistic) look at the table at the bottom of the page “Which Strategy is Best for Me?” and examine the Maximum Drawdown statistic.

Slightly Higher Volatility in the Short Run: Each strategy is designed to limit volatility and cumulative losses to a particular level … such as no more than a 5% loss or 10%, for example. This is what allows us to reduce longer-term volatility. But in the short run, our strategies are oftentimes more volatile than a broadly based stock portfolio similar in mix to the S&P 500 Index. The reason is because our strategies often have significant exposure to the Small Cap and Mid Cap sectors which are inherently more volatile ... and our Performance Xtender model often has some exposure to "sector funds" which are inherently more volatile. As a result, our Model Portfolios will often experience a sharper degree of short-term loss during a short-term market correction … but a short-term loss that is still within the strategies’ volatility limit, such as 5% or 10%. The negative effect of short-term volatility is overcome in the long run by our ability to avoid the big losses. Moreover, our ability to move in and out of the more volatile Small Cap and Mid Cap sectors allows us to capture their superior performance in strong bull tends and materially enhance long-term performance.

Out-Perform the Market During Bull Markets: Our strategies tend to beat the market during bull market periods, particularly when the market is trending strongly. The only general exception to this is our Conservative Portfolio. During some bull market periods, this strategy will capture most of the market’s gain, but not beat it.

Out-Perform the Market During Bear Markets: Our strategies have historically beat the market significantly during declining bear markets. This is because of our ability to exit the market and avoid the market’s losses; and also because our "Performance Extension Series" models have the ability to make money during bear markets by investing in certain “defensive” sectors as well as in an "Inverse Fund" ( a type of index fund that goes up in value when the market goes down.

Under-Perform the Market During Intermediate Corrections: Our models haven't been as effective during periods of “correction” that are characterized by see-saw, up-and-down market action. These seemingly “trendless” periods are difficult for the mathematical logic to follow exactly. The logic tends to get whipsawed by the zigs and zags which will penalize performance in the short run. So don’t be surprised or concerned if our models under-perform somewhat during these “sideways” phases in the market. They will do much better when the market begins trending again.

Substantial Out-Performance Over Multiple Market Cycles: On a cumulative return basis, our market timing based strategies have substantially out-performed the market over multiple cycles of bull markets and bear markets. In general, they have been able to capture gains in excess of the market’s return during bull markets, and then lock-in those gains and avoid significant loss during the bear markets. With each cycle, our total account balance is higher than it would have been following a traditional “buy and hold” strategy. As a result, the size of our account balance is higher at the beginning of each new bull market cycle than it would have been ... and therefore we make more money during each bull phase. And the multiplicative effect of compounding accelerates our account growth over the years.