Creating a Portfolio with Low Risk 7/15/12

Trading is a mental challenge. Often it is easier managing money when you do not look at your account frequently. Unfortunately that can also have you lose excessively in a bad year. My goal is not to have a losing year, and while we are positive this year, it feels like I am being taken through the wringer and nothing good is happening.

I just finished reading a book called 7Twelve. It is about portfolio management and the author advocated a portfolio divided into twelve segments – wide diversification with about 50% in bonds when you are 50. The percentage of each of the segments is not equal, as there are lesser categories for bond funds. The segments included:

Large-cap stock           6%       Emerg non-US stock    6%       Bond                20%    

Mid-cap stock              6%       Real Estate stock          6%       TIP                  20%

Small-cap stock            6%       Natural Resources        6%       Intl Bond          6%

Dev non-US stock        6%       Commodity                  6%       Cash                6%

By allocating similar to this and rebalancing once per year, he showed an average return of  7.7% per year over the 2000 – 2009 time frame, I recall. Unfortunately in 2008 there was a 24% drop even with such a diverse allocation. A 24% drop is completely unacceptable to me and there lies my problem with diversification and letting things ride for a whole year and re-balancing once a year.

Instead if I let each segment run using my timing systems, the only major risk that would remain would be for a terrorist incident overnight. I could lose a large percentage before the markets would even open after such an attack. If I hedged the stock trades with put options, I would reduce the risk; but also reduce the reward. I would need to also do a dynamic hedge and trade the downside to make up for the cost of the hedge. I listened to a sales guy on TV yesterday promoting their wealth management system and he seemed so confident. That is ultimately just a lie. The process of trading or investing has risk and reward entangled together. You can act as confident as you want; but the future is not known, and best thing you can do is follow a system and stick to it through thick and thin. Just make sure it is a decent system. 

This time I am not attaching any charts; just a scene from Roger waters' concert "The Wall" -- it was fabulous...

" Money

It’s a crime

Share it fairly

But don’t take a slice of my pie

Money

So they say

Is the root of all evil today

But if you ask for a raise

It’s no surprise they are giving none away”    Roger Waters