This post also appeared on AlphaArchitect.com
So you’re a trend-follower. Great.
But here is a question:
What do you invest in when your rules suggest “risk off?”
Many investors suggest low duration cash or t-bills. Seems reasonable.
But is it optimal?
Perhaps we should invest in longer duration risk-off assets like 10-yr bonds? We investigate these questions and come to the conclusion that keeping it simple is probably the best solution — dump “risk-off” assets into truly low risk assets like cash or t-bills.
This post was also featured at Fortune Financial Advisors
Written by Lawrence Hamtil and Daniel Sotiroff with help from Alpha Architect’s Jack Vogel and Severian Asset’s Sam Lee
In the first installment in this series, we discussed how, contrary to conventional wisdom, the most profitable industries historically have tended to be not the companies most closely associated with technological innovation, but rather those that are least subject to disruption. In other words, industries such as tobacco and beer have tended have higher risk-adjusted returns than more glamorous industries such as software and financials.
Ratios and normalized metrics are used regularly in the hard sciences, particularly when it comes to comparing scenarios and outcomes. The efficiency of a vehicle, for instance, is typically measured in miles per gallon, or the distance traveled per unit of energy. A Toyota Prius at about 50 MPG is without a doubt substantially more efficient compared to say a top fuel dragster.
The financial world has its equivalent of miles per gallon: the Sharpe Ratio, which combines both return and volatility into a single metric
Several years ago when I made my first real attempts at managing my own assets the idea of a fixed asset allocation strategy made a lot of sense. Diversify by allocating broadly to a wide range of foreign and domestic securities using fixed income to control volatility. Rebalance regularly, limit transactions as much as possible, and always mind fees. When you run strategies such as these through a back-test the results come out to be fairly decent over many different time periods and market cycles. There is nothing wrong with these strategies, and the vast majority of individual retail investors out there are most likely well served through such investment policies. The difficulty is often finding a strategy that aligns with one’s personal preferences and tolerance for volatility.
The Richest Man In Babylon was originally a collection of parables penned by George Clason in 1926 that focused on the judicious handling of money. Ninety years later these stories are still very applicable to our modern financial lives, with many of the lessons having been repeated numerous times in various forums. For all the time spent analyzing portfolio strategies and understanding asset class behavior there are some foundational concepts that must be in place to ensure personal financial success. Sound advice seldom, if ever, changes.