What is Quantelligent Investing?
Basic "Bull" Premise:
The U.S. market goes up over time
We're strong believers in the long-term viability and growth of the U.S. economy. Over the past 90 years the S&P 500 has grown on average about 10% per year -- which is not to say there haven't been bad years or recessions, but that the market has always eventually recovered and subsequently reached new highs. This is our investable expectation for the near future.
Where to Invest:
U.S. based broad market index funds
Indexes are a great way to represent the overall health of the U.S. market, and you can invest your money into funds that track the indexes rather than buying shares of individual companies, essentially allowing you to invest in the overall U.S. market.
Index investing is essentially a continuous "bet on the winners" because, as market conditions change, losing companies that fall out of the index are replaced by new winners.
The most popular U.S. based indexes are:
While some financial institutions have mutual funds that track the indexes, there are many exchange traded funds (ETFs) you can invest in, regardless of which broker you're using.
Strategy:
Never sell at a loss.
Sometimes referred to as a "Hell or high water" approach, we believe so much that the U.S. market will eventually recover that we will never, ever sell at a loss. If you truly believe as we do, then any money you invest into U.S. broad market index funds can be held until your position reaches profitability, otherwise known as "high water", and it's not a question of "if" it's just a question of "when".
And if the U.S. market ever doesn't recover -- then that probably means all Hell has broken loose and we have bigger problems.
OPTIMIZATIONS
Optimization #1:
"Buy Low" with Dollar Cost Averaging
Rather than investing your money into the market all at once, you can spread out your investment into equal installments of a fixed percentage over time so you can take advantage of price dips and lower your position's average entry price, effectively resulting in a "buy low" entry without having to time the market.
This is known as Dollar Cost Averaging.
Won't beat a pefectly-timed entry at a relative market bottom, but if you have perfect timing then you probably don't need this type of strategy.
Optimization #2:
"Sell High" with Value Averaging
Similar to "buy low" on price dips, you can achieve a kind of "sell high" by setting Value Averaging sell targets at a percentage margin above break-even (or high water) to capture profits and compound the gains into additional buys, thus perpetuating the strategy and resulting in compound growth.
Also doesn't beat a perfectly-timed exit at a relative market peak, but -- again -- if you have perfect timing then you probably don't need this.
Optimization #3:
Reset and restart frequently
To reduce the probability of your account being over-exposed to a drastic market downturn, due to most of your account being invested in the market when it happens, you can set an overall growth "reset" target where, when reached, you exit your position(s) entirely and begin the process over again from the start.
Not only does this give you an opportunity to withdraw some of your earnings between cycles without messing up your targets, but also compounds whatever gains you don't withdraw into the next cycle with new percentage targets based on a larger starting amount, thus enabling compound growth.
Optimization #4:
Utilize a "cash hedge"
Drastic market drops will inevitably occur, and Dollar Cost Averaging into the drop only lasts for as long as you have cash to spend. When a drastic or extended downturn occurs your account can run out of cash and get "stuck" waiting for recovery. For this optimization we recommend holding some cash "in reserve" (also known as a "cash hedge") only to be deployed for additional buys if/when your account experiences a significant drop in value.
Doing so not only reduces your exposure to the drop initially, thus diminishing the overall impact the market drop will have on your account, but also gives you the ability to take advantage of much lower market prices for more effective averaging down so you can start capturing profits again earlier upon recovery.
Optimization #5:
Amplify with Leveraged ETFs
Leverage amplifies the volatility of the underlying index which creates opportunities for more effective averaging down due to lower lows, and the ability to capture more profits due to higher highs, which also makes using smaller percentage amounts more effective when implementing this strategy.
The nice thing about Leveraged ETFs is that the leveraging happens inside the fund, not in your account. This means that you do not need to have a margin-enabled account, and your account can never go negative -- the worst that could happen is the fund could go bust and you lose your entire investment.
CAVEATS
Caveat #1:
Leveraged ETFs are risky
Because they amplify the volatility of the underlying index, a Leveraged ETF will typically have a very high beta, also known as "risk score", and therefore are considered very high risk investments. If the index drops 3% in a day, the 3x Leveraged ETF will drop 9%, etc. Leveraged ETFs are rebalanced daily and are susceptible to what's known as "volatility decay", which describes the characteristic of taking longer to recover back to previous highs after an extended downturn.
Mitigation #1: Reduce exposure
Using an incremental investing strategy such as this one modulates your risk exposure by not investing all at once, and exiting frequently when targets are hit. This results in a lowered average beta for your account and therefore reduced risk exposure.Mitigation #2: Cash hedge
Utilizing the "cash hedge" mentioned above also helps you more effectively average down to overcome volatility decay.
Caveat #2:
Waiting for "high water"
Depending on the market and the aggressiveness of your impelementation, during an extended downturn you could be waiting for a very long time for the price to recover to a profitable level above your average entry to be able to start capturing gains and trading again. Sometimes this can take months or even years.
Mitigation #1: Customize aggressiveness
You can reduce the impact of downturns and reduce the length of time in which you're "stuck" waiting for recovery by using more conservative parameters. This is a double-edged sword, however, as doing so will also affect your overall average returns. Parameter values can be tuned by back-testing various scenarios to determine what behavior would be suitable to your personal preferences for aggressiveness and risk.Mitigation #2: Additional investment
If you're stuck in a downturn and have already deployed your "cash hedge", you can always add more cash. This will enable further averaging down thereby reducing your recovery targets and therefore wait time as well.
Caveat #3:
Higher taxes
An incremental investing strategy such as this one results in nearly all positions being held short term, especially since one of our optimizations is to exit frequently. If you're not doing this in a tax-sheltered account this will result in higher and more frequent taxes than if you merely did a single long term buy-and-hold where you'd only pay long-term capital gains tax when you exit your investment at the end. With incremental investing, however, you're going to have tax implications every time you exit.
Mitigation #1: Individual Retirement Account
Use a tax shelter Individual Retirement Account! 'Nuff said.Mitigation #2: Marginalize the impact through higher returns
If we assume, for simple numbers, that the difference between short-term and long-term capital gains tax is 10%, that would mean that the short-term strategy would need to perform at least 10% better than the long-term comparable. And that's not 10% additional return, but 10% of the return.This means that if your long-term investment produces a return of 15%, your short-term alternative would only need to produce an additional 1.5% return, for a total return of 16.5% to compensate. So if your strategy can exceed that level of return, you're good to go.
Mitigation #3: Set money aside
As you're capturing profits you could set some aside to help cover your tax bill when it comes, rather than reinvesting everything back into the program.
Caveat #4:
Idle cash
When you start, and after each reset, your entire account will be sitting as cash as you starting building a new position. Generally this is looked upon as a bad thing because cash diminishes in value over time due to inflation. However, having cash on-hand is a necessary ingredient for Dollar Cost Averaging and maintaining a "cash hedge".
Mitigation #1: Earn interest on idle cash
Many brokers will pay interest on idle cash, so you can shop around for brokers that pay higher interest.Mitigation #2: Reallocate
You can move your money into higher-yield instrument that would pay a better return than the idle cash interest, but it needs to be liquid / readily accessible for new DCA buys. If you're sticking to a regimented DCA schedule, you should be able to plan when to make cash available before it's needed.
Caveat #5:
This is harder than set-and-forget portfolio investing
Incremental investing requires active management of your position(s) to place new trades, update targets, and manage assets. This definitely is not a "set and forget" portfolio-based strategy -- which is also part of the reason why nobody else is running a program like this: it's hard to implement.
And there are no magic numbers! Unlike other "fad strategies", you have to determine your own parameters to capitalize on the unique volatility of each ETF and match your personal risk tolerance.
Mitigation #1: Automation
Automate it with code! We have, and it works gloriously.Mitigation #2: Back-testing
You can perform your own back-testing by downloading historical CSV data and using a spreadsheet program, such as this one. There are also some back-testing providers out there with some very elegant tools. Alternatively, if you know how to code you can write your own back-testing software.Mitigation #3: LymanWealth
LymanWealth has already done all of this for you! With our automated trading platform we have performed millions of permutations, highlighted several ETFs that work well with this strategy, and fine-tuned the parameters for 3 levels of aggressiveness so you can build a personally-customized portfolio suited to your risk tolerance.You can view our models here.
