Toward a New Model of Diversification

Fix ItThere are a handful of world class investors whom I will go out of my way to see, hear or read. One of these heavyweights is of course Oscar Rogers. I have not seen anything from him in a while, this link is from late October and I believe is his latest public commentary.

In that clip he gives an impassioned plea for them to fix it.

I think Oscar might be on the verge of throwing in the towel despite this article from the NY Times saying that diversification does still work and that investors should not give up on it.

The idea was simply that in a short term, panicked flight to safety yes everything goes down but the proper mix did go down less. The article never mentioned any sort of defensive strategy like the things I write about. It is no shock that an MSM article would omit such an idea but as mentioned in this week’s video hopefully you did something along these lines in the current bear market or have learned to for the next bear market.

I still believe in diversification. The notion of how to construct a diversified portfolio is evolving however by necessity and thanks to new investment products (not all new products are bad even if a lot of them are flawed). A few of my recent articles for TheStreet.com and a couple of posts on the blog have tried seek out different ways to structure portfolios to have much less risk and reward which of course means the need for a much higher savings rate.

The inspiration is that this decade will cause people to want to give up on the stock market. Well anyone wanting to give up still needs to save and get some sort of return on their savings even if a “normal” 70/30 allocation is not how they will do it.

One idea I’m trying to pull together for an article is along the lines of picking six or seven asset classes (including cash), picking one or two broad based funds for each one and from more of a bottom up tactical strategy entirely sell out of a fund (asset class) that goes below its 200 DMA, or any other defensive concept, and go back in when it goes above. While you are out you are out, not chasing into something else. I imagine this concept would have gone into cash asset class by asset class over the last however many months and now be 100% cash or close to it.

The asset classes might be:

  • Domestic Equities
  • Foreign Equities
  • Commodities
  • Domestic Bonds
  • Foreign Bonds
  • Inflation Protected
  • Absolute Return
  • Anything else you can think of

The reason not to use a target date fund or asset allocation fund is that most of the time diversification will work and breaking out the asset classes give a better chance to capture the zigs and zags as they occur.

For domestic equities, for example, this strategy could use the Russell 3000 Index Fund (IWV). It went below its 200 DMA last December. So the idea is to have sold when that happened and then just wait until it goes back above. Obviously it sill has not gone back above so that part of the allocation would be in cash. Obviously most of the different segments would have gone to cash a while ago.

This is obviously not that original on several levels but for someone on the verge of giving up there is not that much work. Pick one or two broad based, index-like funds for each segment, set up something to alert you when each holding breaches its 200 DMA and check your email. The funds used would ideally just be a proxy not an attempt to add value versus a proxy. IWV is the US market, something like iShares Aggregate Bond (AGG) is the bond market and so on.

One issue, and there are many, is that IWV is about 40% below its 200 DMA which is a lot of potential gain to give up. While that is a drawback the 200 DMA is headed lower and in another couple of months or so the slope down for it will steepen dramatically and so a crossover could occur long before a 40% rally, or not.

As a reminder this concept would be aimed at people that want to give up but know they can’t and I assume that if you take the time to read a stock market blog people that want to give up does not include you. So while there are flaws galore it is better than nothing.

About Roger Nusbaum 169 Articles

Roger Nusbaum is an Arizona-based financial advisor who builds and manages client portfolios using a mix of individual stocks and ETFs. Roger writes a popular blog, which focuses on risk management, foreign stocks, exchange traded funds, options etc.

Roger has been recognized by many in the investment management industry for his expertise in portfolio management. Roger has been regularly interviewed by the financial press, trade journals, and television news shows. He has also had numerous technical articles published and has been quoted in a number of professional trade journals, newspapers, and consumer finance magazines. He appears frequently on CNBC Asia as a market commentator.

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