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[TradeSmith Daily logo] June 28, 2024 The Best Long-Term Portfolio for Good Times and Bad [Portrait of Keith Kaplan] BY Keith Kaplan
CEO, TradeSmith Peter Lynch was the author of the mega-bestseller One Up on Wall Street. He popularized the mantra: âInvest in what you know.â But his real claim to fame was due to his really impressive performance in the stock market... as the manager of Magellan, the flagship of mutual fund giant Fidelity Investments. Between 1977 and 1990 â under Lynchâs stewardship â Magellan generated an average annual return of 29%. That was enough to transform every $1,000 invested at the start into more than $27,000 by the end of that 13-year run. Itâs one of the best long-term track records in the history of professional investing. And itâs practically unheard of in the otherwise mediocre world of mutual funds. Youâd probably assume that anyone smart enough to invest in Lynchâs fund made a killing. But youâd be wrong. Fidelity itself did some research. And the companyâs findings were almost as stunning as Lynchâs track record. Not only did the typical investor NOT make 29% a year â they didnât make anything at all. You read that correctly. During a stretch that saw the fund double every two or three years, the average Magellan investor lost money. And this is just one example of an overwhelmingly consistent trend. Most individual investors earn far less than the âaverage returnsâ of the stock market benchmarks. The reason why is simple: emotions. Most investors struggle with volatility... especially those who buy individual stocks. Rather than âbuy low and sell high,â as the old investing maxim tells us, most folks do just the opposite: - They ignore stocks when itâs the best time to buy them â when theyâre cheap, like in 2022.
- They experience âFOMOâ (fear of missing out) when stocks start to run.
- Then, they ride stocks down to the point of maximum pain (and maximum losses) and end up selling at a loss. There are variations of this scenario, but you get the general idea. Besides, all these various pathways end at the same destination â market underperformance. And the likelihood that an investor will repeat these mistakes may even be higher now than it was during Peter Lynchâs fund-managing days. Thanks to the internet and apps, itâs easier than ever to trade the market, including trading derivatives like options. But what if I told you there was an easy way to exit this emotional rollercoaster forever? With a simple investment approach that has returned nearly 10% a year on average for the past 100 years with surprisingly little volatility⦠and requires just 15 minutes a month to manage. If youâre a conservative investor who doesnât want to spend any more time than necessary managing your investments, this approach may be all you ever need. But Iâll also show you how TradeSmith subscribers use it to make even better returns, too. It all has to do with an investing mindset I refer to as âportfolio thinkingâ â a look at how different assets and asset classes work together to create an overall investment portfolio. SPONSORED AD [Legendary Stock Picker: âBuy This Sub-$1 Play on Elonâs Project Apolloâ]( Between now and June 30... Luke Lango predicts Elon Musk will shock the world with [âProject Apollo.â]( He believes it will mint new millionaires because... According to Elon, â[Project Apollo] has the fastest rate of innovation maybe ever for any internet company.â [Click here to see the details on this sub-$1 play](
The Standard 60/40 The concept of portfolio thinking dates back to the 1950s. Thatâs when U.S. economist Harry Markowitz showed that investing in a combination of different asset classes â like stocks and bonds â can produce better risk-adjusted returns than youâd get by investing in either one alone. (A ârisk-adjusted returnâ is just what it sounds like: a measure of how much risk youâre taking to achieve a given amount of return.) Markowitzâs research ultimately led to the â60/40 portfolioâ that many investment managers still recommend today. In this portfolio, you allocate 60% of your cash to stocks and the other 40% to bonds. Again, this allocation is usually an improvement over owning either one of those assets alone. It produces far better average returns than a portfolio of 100% bonds, with less risk than a portfolio of 100% stocks. But it does have some severe shortcomings. First, the 60/40 portfolio is still riskier than most investors can comfortably manage. Because stocks are historically about three times riskier than bonds, this portfolio still has the majority of its risk concentrated in stocks. If the stock market tanks, this portfolio is likely to experience a significant hit, too. Second, this portfolio assumes that stocks and bonds are always âinversely correlated.â Thatâs a fancy way of saying that they generally move opposite of each other. When one does poorly, the other tends to do well, and vice versa. And thatâs not always the case. In fact, the 60/40 strategy has come under a lot of fire lately for just that reason. In fall 2022, a 60/40 model portfolio was down a wrenching 20% for the year. And while that mix of stocks and bonds had been a top performer â generating a market-beating 11.1% average annual return for the previous decade â researchers were quick to note that this isnât always the case. During the so-called âLost Decadeâ to begin the 2000s, the 60/40 portfolio generated a 2.3% annual return, meaning investors would actually have lost money on an inflation-adjusted basis. In short, despite its âbalancedâ reputation, the 60/40 portfolio tends to outperform when stocks do well, and it tends to underperform when stocks struggle. At best, we can say that stocks and bonds can experience a dynamic correlation over time. SPONSORED AD [Elonâs New A.I. Device Is About to Shock the World]( Using this device you see above... Elon Musk just tested a new type of A.I. that, according to Wired Magazine, will usher in... âThe next step in human evolution.â [Click here to see the details because a lot of people could get rich from this new invention](. A Billionaireâs Secret Here is where a man named Ray Dalio comes in. Dalio is probably the best investor most folks donât know. Heâs the founder of Bridgewater Associates, the largest hedge fund on the planet with more than $120 billion in assets under management (AUM). And heâs No. 124 on the Forbes World Billionaire Index. Dalio is also one of the first investors to truly closely study the problems with traditional portfolio strategies. And he made some fantastic insights that have greatly influenced our work here at TradeSmith. One of his key contributions: A concept known as ârisk parity.â He demonstrated that the most successful investors donât allocate their portfolios based on the amount of money invested in each asset or position. Instead, they allocate their portfolios based on the amount of risk in each asset or position. Dalio also identified four primary market environments â or âseasonsâ â that move asset prices. These are: - Rising prices (inflation).
- Falling prices (deflation).
- Rising economic growth.
- Falling economic growth. He then mapped out the major asset classes by the season in which they perform best, like so: Dalio combined these ideas of ârisk parityâ and âmarket seasonsâ to create what he called the âAll Weatherâ strategy. He designed it to manage his familyâs investments. But he eventually opened it up to his wealthy hedge fund clients as well. This strategy consists of a diversified, global portfolio of up to 40 different investments, with risk spread strategically to make the most of each of the four seasons above. The portfolio consists of 55% U.S. bonds (long- and intermediate-term), 30% U.S. stocks, and 15% hard assets (gold and other commodities). The idea behind the strategy is both simple⦠and brilliant. If there are only four primary economic seasons that drive asset performance â but itâs difficult (even impossible) to predict when any specific season is likely to arrive â a well-balanced portfolio should be able to perform well in any of them. Dalio designed the All Weather strategy to do just that. And it has certainly delivered so far. From its inception in 1996 to 2020, this strategy generated close to 10% average annualized returns. Thatâs virtually identical to the returns of a conventional 60/40 portfolio over the same period. But it has done so with roughly half the volatility and with significantly smaller drawdowns than the traditional portfolio. And testing that reaches further back underscores its consistency. From 1978 until March 2022, a hypothetical $10,000 investment in the Ray Dalio All Weather Portfolio would have grown to $520,000. With a compound annual growth rate (CAGR) of 9.34%, the portfolio outperformed its risk (7.94%) by 140 basis points. Unfortunately, folks like you and I canât invest directly in Dalioâs portfolio. Bridgewater is no longer accepting new investors in the All Weather strategy, but you needed at least $100 million in investable assets to qualify even when it did. And the specific asset allocation used in the strategy has never been made public. However, several years ago, in an interview for Tony Robbinsâs book Money: Master the Game, Dalio did reveal a simple, âdo-it-yourselfâ version of the All Weather strategy that any investor could follow. The performance of this âAll Seasonsâ portfolio, as it has since become known, has been impressive as well. It, too, has generated an average annual return of nearly 10% from 1927 to 2020. Yet, it has done so with significantly less volatility â and smaller drawdowns â than either the market or a conventional 60/40 portfolio. For example, over those 93 years, the All Seasons portfolio suffered just 17 losing years (18%) â versus 25 losing years (27%) in the S&P 500. And the average loss in those years was less than 4%, compared to more than 13% in the S&P 500. And despite its elite status, itâs not too hard to replicate the All Seasons portfolio yourself in your brokerage account. To replicate the 55% U.S. bond exposure, you can own a mix of the iShares 20+ Year Treasury Bond ETF (TLT) and the iShares 7-10 Year Treasury Bond ETF (IEI). For the 30% in U.S. stocks, you can own the SPDR S&P 500 ETF (SPY). And for an even mix of gold and other commodities, the remaining 15%, you can own the SPDR Gold Trust (GLD) and the Invesco DB Commodity Index Tracking Fund (DBC). This is a portfolio designed to stand the test of time. Itâs a great way to capture the long-term average return of the market without having to sit through the normal level of volatility. Before you think about trading, or specific stocks, or income strategies, you should consider having a good chunk of your retirement plan in a portfolio like this. All the best, [Keith Kaplan] Keith Kaplan
CEO, TradeSmith P.S. Iâd love to hear what you think about these ideas at feedback@TradeSmithDaily.com. As always, I canât personally respond to every letter, but I read them all. Get Instant Access
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