This is a comprehensive guide to my investment strategies. If you have an IRA, Roth, 401k or other investment account, you'll love this article.
In this post I'm going to show you the four basic investing strategies I use for my financial planning clients.
You'll see exactly which investments I use and how they are managed.
This is a long and detailed post.
To help you get the most out of it, here are some guidelines:
Questions? Use the comment section at the bottom of the page.
Here are my 4 investing strategies for 2018.
Over long periods of time, the world's economy has a consistent pattern of growth. But it's difficult to know where or when the fastest growth will happen.
Maybe the growth will happen in the U.S. Maybe in Asia. You never know.
So instead of trying to pick the 'right' area, you can just pick ALL the areas.
That's why I call this the 'everything' strategy.
One thing that makes the Everything strategy attractive is that you don't need a lot of money to start.
In fact, you can start with a $0 balance. Just start contributing monthly.
And it works great for large accounts, especially when combined with one or more of the other strategies below.
With this strategy you will invest your money so that you have a little bit spread all around the world.
This is sometimes referred to as 'asset allocation', but I like to just say 'Everything'.
You buy and hold these investments from all over and let the global economy grow.
It can take some time (years or decades) but it really works.
For the everything strategy I like to use exchange traded funds (ETFs). They are similar to mutual funds, but structured to be more flexible and tax-efficient than mutual funds.
This group of ETFs covers almost the entire global economy. That's what makes it so effective. And simple.
No trying to pick and choose. Invest in everything and you're sure to get some growth, no matter where it comes from.
You know you're going to own 'everything', but how much for each part?
This is know as your asset allocation.
You allocation will depend on things like how long you have before retirement, how much risk you can emotionally handle, and what returns you need to reach your goals.
If you're more aggressive, you can have more money in the stock parts (as opposed to bonds). And within that stock area, putting more money in international and emerging markets will make it more aggressive (and more volatile).
If you're more risk-averse, you would do the opposite. More money in the bond section. And within that more government and domestic bonds would be more conservative (and less volatile).
Here's a sample allocation from my partner Betterment. This is a 70/30 stock to bond allocation that would be considered conservative for someone in their 40's.
Sample ETF allocation:
One of the benefits of using a partner like Betterment is that their technology is superior. Betterment is able to buy, sell, rebalance and tax-loss harvest faster and cheaper than most services.
You are able to start easily and know that important changes will happen automatically. You just need to keep adding money and they take care of the rest.
And with a low service cost and inexpensive funds, they are my go to for beginning investors.
The 'everything' strategy is easy to understand. The world economy should grow over time.
You own everything and don't have to guess at where growth will come from.
With our partner Betterment, you can also see how easy and hands-off this portfolio can be.
You can easily automate your savings and investing for peace of mind.
Compounding is the 'secret' to long term investing. Buy income producing assets. Use the income to buy more income producing assets. Rinse. Repeat.
Many years later you have a small fortune to retire on.
And there's no easier asset to compound than dividend stocks.
Keep reading to learn how I build and manage my Dividend portfolio.
To start this Dividend strategy, I recommend you have at least $300,000 (overall) to invest. You should also be adding money monthly if possible.
If you have under $70,000, start with the Everything strategy above and add more strategies as your wealth grows.
The Dividend strategy uses individual dividend paying stocks. Not ETFs or mutual funds.
Too keep things simple I use only stocks that are in the Standard & Poor's 100 index. This is a list of 100 of the biggest and most well known stocks in the world.
You would know almost all of them by name.
The simple rules for picking stocks in the Dividend portfolio are:
So you take the S&P 100 list of stocks and rank them by dividend yield. The dividend yield is just the dividend per share divided by the stock price.
For example, AT&T stock (symbol T) has an annual dividend of $2.00 per share and the stock price is $32.17.
So ($2.00 / $32.17) x 100 = 6.22% dividend yield.
After ranking the 100 stocks by yield, you take the top 15 highest yielding.
You then buy 6.66% in each stock. So for a $100,000 portfolio, each stock equals $6,666.00.
At the end of each calendar quarter, you would re-rank the S&P 100 stocks by yield. Buy or sell any stocks that have changed and rebalance them all back to 6.66%.
So you end up with the current top 15 yielding stocks.
Why is 15 as the number of stocks in this strategy?
We want a diversified group of stocks, but not so many that it becomes hard to manage.
Simple and done is better than perfect in my book.
I use a flat fee, low cost brokerage firm to manage the Dividend portfolio.
They charge a 0.25% annual fee for unlimited trades. So each time we buy, sell or rebalance, we're not getting hit with a trade charge.
This is a huge benefit. Especially considering we may have 3 or 4 of these strategies in the same account.
I would not recommend this strategy unless you have $50,000 to $70,000 to start. Less than that I would stick to the Everything strategy above.
Compounding is the 'secret' to long term investing success. Dividend stocks are the easiest way to compound your money.
Now you have a simple way to own and manage a compounding dividend stock strategy.
Everyone likes high returns. But the swings in the stock market can make you crazy and stressed out.
With the Growth strategy, we try for high potential returns without all the volatility.
I use individual stocks and add some simple risk management rules to avoid those big drops.
Like the Dividend strategy, you should have at least $300,000 (overall) to start investing in this strategy.
It can also help you emotionally to have money invested somewhere less risky. Like the Everything strategy.
Or in a recurring income personal business.
For the Growth strategy, we want stocks with more return potential.
I primarily use the Nasdaq 100 list of stocks. There are more technology names than the S&P 100.
Most of the 'headline' stocks are in there: Apple, Google, Microsoft, Amazon, Netflix, etc.
You may not recognize all the stock names, but you're probably familiar with their products and services.
I sometimes go outside of this list of 100. But only if stocks have high trading volume and are not penny stocks.
This ensures we can buy and sell easily if needed. And the Nasdaq 100 stocks are well known, proven business. Not fly-by-night startups.
For the Growth strategy, I buy between 10 and 20 stocks.
Enough to be diversified, but also few enough that you can get a good return when things go well.
Let's get into some details...
>> WARNING: Stock nerdery ahead! <<
There are only a few rules with this strategy:
The Growth strategy is my most discretionary strategy. Meaning you may have a lot of choices of stocks that meet the simple rules.
That is fine. You just have to choose between 10 and 20 stocks that qualify.
You will never know ahead of time which stocks are "right". Don't let that stop you. You don't have to be "right" about all your stocks to make money.
I've learned that I have no idea which stock(s) may be the huge winner(s) in the future. You will often be surprised.
But the rules will allow those stocks to run, run, run!
The Bullish Support Line on a point and figure chart is just an indication that the stock is in an uptrend.
Point and figure charts are just stock price charts drawn differently. There's no need to become an expert.
Anyway, you want to choose stocks that are above the blue line. This means the stocks is in an up-trend.
You want to own (and keep owning) stocks that are in an uptrend and keep going. You avoid stocks that are not in an uptrend.
Here is a point and figure chart of EBAY, showing the Bullish Support Line:
You can get free point and figure charts at Stockcharts.com.
As long as a stock stays above the BSL, we'll let it run. That's where the big returns come from. The only changes are to trim a little if the stock holding size gets too big (see below).
An up-trend may last for days, weeks, months or years.
In the EBAY example above, the stock started it's up-trend in 2011 at around $13 per share. And in the chart you see it's still in the up-trend at around $37 per share.
The quick return math on that is: ($37 - $13)/ $13 = 184% gain.
Not too bad!
When a stock falls below it's Bullish Support Line, we get out.
I like to sell half of the stock immediately (same or next day). I will then sell the other half within a few days, especially if the price rises.
You should be completely out in a week or less.
The easy way to run the Growth strategy is to own the same amount in each stock. So if you buy 10 stocks, each one is 10% of the portfolio. If you buy 20, each one is 5% of the total.
If you buy the same amount of each stock, it won't stay that way.
Since the stocks will all have different returns, the percentages in each will change. It's OK to give them some room to run.
But don't let an individual stocks to get too big. That adds risk.
Keep a stock's size to below 15% of the total portfolio. If it goes above 15%, trim it back.
Another way to manage the size of each stock is using what's called "open risk".
Open risk is the difference between where the stock is now and where it would cross below the blue Bullish Support Line.
To make the risk (amount of possible loss) the same in each stock, you would own different amounts of each.
If a stock is a long way above it's blue line, you would own less, because there's more risk. If it's close to the blue line, you could own more. Just don't let it get above 15%.
If a stock falls below the blue line, sell it.
With the money to get from selling, you can either invest more in another of your stocks (if it's less than 15% of the total), or hedge as I'll discuss now.
Sometimes the market can go down a lot. Shocking, I know.
To help protect yourself, you can hedge your portfolio. This means buying something that should go up when the other stocks go down.
I like using the inverse S&P 500 ETF (symbol SH). It does the opposite of what the S&P 500 index does on a daily basis. If the S&P 500 is up 0.5%, the SH should be down 0.5%. Or close to it.
So if the stock market overall is down, the SH should be up.
Don't buy more than 25% of your portfolio in the SH. If the market rebounds, you don't want to hedge out all of your gains.
For timing, I like to use my Momentum strategy as a guide. If the Momentum strategy has a current bond holding (either short-term bonds, or gov't bonds), that can be a good indication that hedging is appropriate.
2 examples of when to hedge:
If you're unsure about hedging with the SH, you can just leave money in cash. It won't go up when the market goes down, but it also won't go down.
Hedging is meant as a volatility reducer, not a return producer. Your portfolio can and will still lose money during rough periods.
If you can't handle the thought of losing money in the stock market, you should not be investing.
Just don't let your losses be so much that you get crazy and do something dumb at the wrong time.
Another benefit of using an inverse ETF is that it's much simpler than trying to actually short sell stocks. A short sell is when you borrow a stock, sell it in the stocks market, then buy it back later to return it.
Sound complicated? It is. Don't short stocks.
Use higher return potential stocks for more gains when things go well.
Use simple risk management to keep you from going crazy and doing something dumb.
The Growth strategy is really pretty simple once you get into it.
Don't make it more complicated by adding filters or results from backtesting. You will never get it just right.
But the long term benefits of owning a more concentrated group of stocks with a little risk management can be huge.
Remember that almost all the great public market investors (like Warren Buffett) built massive wealth using individual stocks.
There's no guarantee, but it's possible.
Momentum is the tendency for investments that have risen to keep rising for the next short period. Momentum has been called the premier market anomaly by some really smart people.
It should't happen in a perfectly rational market, but it does. And it has been pretty consistent over time.
Think of it as Newton's first law where things in motions tend to stay in motion. But for investing.
Momentum is also referred to as 'trend following'.
For my Momentum strategy, I borrow from a great paper that I read years ago. Hopefully you find it interesting.
The whole idea of the Momentum strategy is to invest in areas that are showing momentum (moving up) and avoid those areas moving down or sideways.
I'll cover the simple rules below and discuss some drawbacks too.
This is a good strategy to use with the Dividend and Growth strategies.
Because of that, you should have $300,000 (overall) to start.
This strategy is also a nice addition to the Everything strategy.
Using both strategies, you would be globally diversified but be able to 'lean' more aggressive or conservative based on the rules.
I start with a globally diversified group of ETFs. We're just not going to own all of them at once.
Specifically the areas and assets we use are:
As you can see, this is a very diversified list. But you only invest in the ETFs showing the most momentum. Not all of them.
Now let's talk about the basic rules.
The rules for this strategy are simple:
To measure the momentum, just look at the total return over a specific time period. It can be 6 months, 9 months, 12 months, or even 18 months.
I just put all the ETFs on a return chart and see which are doing best.
Shorter time frames will get you into and out of trends quicker. But can also result in more 'whiplash'.
That's when you get out of an ETF, only to get right back in a month later. It can be frustrating. And may cause tax issues.
On the other hand, when the trend of something you own goes down, you'll be quicker to get out.
Longer time periods can help you stay in an up-trend longer, but at the risk of taking longer to get out when trends change.
No right or wrong answer, just personal (emotional) preference.
Just understand that there are benefits and drawbacks of each time period.
Once you have the returns for your chosen time period, you buy the top 2 ETFs and weight them 50% each.
If, and only if, the third best return ETF is one of the bond ETFs (short or intermediate), you buy the top 3. One third each.
Having the 3 holdings was found to reduce the volatility of the strategy. It it not meant to improve the overall return.
Sometimes seeing is better than reading.
Below are two chart examples of Momentum. I've annotated to show which ETFs you would buy. Click to enlarge:
In this first chart you would buy 3 ETFs and hold for the next month.
The reason is because a bond ETF (the pink line) is ranked 3rd in momentum (total return). When that happens we buy the top 3, one third each.
At the end of next month you update using the NEW 6 month chart. So it's a 6 month window that keeps shifting. Drop the oldest month, add the new one.
Here's a different example:
In this second chart you would only buy 2 ETFs. That's because the bond ETFs (pink & purple) are not in the top 3.
So you'd buy the white and orange ETFs. Each at 50%.
The Momentum strategy can be very volatile when used alone.
Imagine being invested 50% U.S. stocks and 50% Real Estate when the 2008 crisis started. Yikes!
Of course you wouldn't have been in those for too long. But it can still be painful. And we don't want you getting crazy.
That's why I like to combine Momentum with another strategy, like the Everything strategy.
You would avoid the possible pain from Momentum alone, while being able to 'lean' towards a direction showing momentum.
All with simple rules to follow.
You now know the four strategies I use. Individually they have their own risks and benefits.
But when you combine them, they can work really well together.
I'm going to show you how this might look.
As with everything else in this article, this is not specific investment advice. I'm providing this as educational material only.
For these examples I'm assuming a portfolio of $300,000 in a tax-deferred account (IRA, Roth, SEP, etc.).
Here's an idea of how I might mix the strategies:
You could make the Everything (blue) portion very conservative, say a 50/50 mix of stocks and bonds (via ETFs using Betterment).
Here's how the portfolio could change depending on what the individual strategies are doing:
Of course this mixing of rules-based strategies can still be hard to manage in the real world.
That's why some (most?) people should have a fiduciary adviser doing this for them. To act as a circuit breaker for when an investor (you?) gets a little crazy when the markets are volatile.
The beauty of this mix is that you're not constantly hedging away your returns while waiting for that next big correction. But you still have a plan to get safer if the environment changes.
You just follow the rules. It doesn't matter how you feel. Or it shouldn't if you want to be a good investor.
I hope this article was helpful.
Understanding how different strategies work can give you more confidence to invest. And having a plan of action should help you sleep at night.
Every strategy has it's pros and cons. These strategies are not for everyone. But investing SHOULD be a part of everyone's retirement plan.
Just be sure to keep things as simple as possible.
If you have questions or comments, please leave them below.
Thanks for reading!
Tommy is the founder of Wealthific. He's passionate about helping middle class Americans master their money and finances. When not helping people build wealth, Tommy can be found playing soccer, traveling and cheering on the Tar Heels. ⚽️🧳🐏😀
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