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Improving Your Returns with True Diversification
People keep asking me about how they can improve their profits in the stock market. And I keep telling them it’s simple. It really is.
Here are 3 steps you can take:
1. Only buy the best ETFs – ones that are already going up
2. Avoid high fees
3. Keep a risk-balanced portfolio.
That’s it. If you can do this, you can make money in the stock market. The rules for successful start market trading aren’t hard. But despite that, the stock market still creams the average 401k investor.
A formal study from the stuffy Journal of Pension Benefits documents the horrible performance of most investors:
“The elephant in the room that no one seems to want to discuss is that individual investors as a whole do a poor job managing their own investments…It is, by and large, a recipe for disaster…It has long been known that individual investors don’t typically fare well in their efforts at do-it-yourself investing. This notion has been validated by numerous studies, including one by Dalbar, Inc., which revealed the staggering margin by which the average individual investor trails the returns of the broader market.”
Wow! Nobody wants to talk about it, it’s that bad.
When the stock market only makes 8% per year, giving away 6% eats up almost all of the possible returns. In fact, it’s possible you’ll get a better return from Social Security than you will from the stock market.
Fortunately, there is help.
Improving Your Returns with True Diversification
Trend Following 101 is big on picking investments that are already going up. This covers step 1. Still, there is more to making money than just blindly hopping on the trends.
If you want to really make money, you need to take active control of your investing.
The best way to improve the performance of any trading strategy is to balance the risk taken on each trades. Diversification works wonders for increasing returns. But it only works when you actually diversify!
Most people do not get similar exposure to the risk of their investments. They dramatically over-invest in some of their portfolio, and under-invest in others. It’s like only watering ½ of your garden but expecting it all to grow.
To get great returns, you need to give each and every investment a fighting chance to make money for your portfolio. Each investment needs to be able to provide meaningful returns for you to make real money.
Many people split their portfolio 50-50 or 60-40 between stocks and bonds. This doesn’t work. It ends up being only slightly better than burning $100 bills in a fire.
Why? Stocks are 3-4 times more volatile than bonds. All of the returns and risk are due to what happens to the stocks in the portfolio. The only way bonds will have equal impact on the portfolio is for the allocation to be 75% bonds, 25% stocks – or even higher!
Balancing the portfolio is one technique we use to squeeze great returns out of our ETF system - even though it only trades once per month. We balance the dollar amount allocated to each of the monthly ETF selections by the risk taken by each ETF.
The EZ ETF system does this for you. It automatically takes into account how much risk each ETF has, and then adjusts the amount of shares to trade for you.
So you know you get equal exposure to each of your investments. This has come in extremely helpful this month for the EZ ETF system. This month allocated extra dollars to real estate and preferred stocks, which have outperformed the S&P 500.
As a result, the EZ ETF system is up about .5%, while the S&P 500 is down nearly a full percent. Instead of underperforming the stock market by 6% a year, the EZ ETF system outperforms the stock market by nearly 8% per year.
The EZ ETF system finds the best way to allocate your funds automatically in our risk calculator. The EZ ETF system tells you exactly how many shares of each ETF to buy.
Still, risk balancing works great for really pushing returns upwards for our system. You can use it in your own trading too!
If you want to know the steps - and are a real math geek - here you go:
- Find ATR: Find the Average True Range (ATR) for each of your Stocks/ETFs
- Find Volatility: Divide the ATR by the Price of the Stock/ETF
- Invert Volatility: Take 1/(Step 2) for every stock
- Find Total Volatility: Total up Step 3 for your entire portfolio
- Find Percent Allocation: Divide Step 3 by the total given Step 4
Step 5 will give you the percentage of your account you should allocate to that investment.
You can see the steps are pretty complex, but you don’t have to know this at all. All you have to do is put your account value into the box and press the button, and the EZ ETF system gives you the number of shares to buy.
If you want more information on how to use risk balancing to increase the returns of any portfolio, just contact me. I’ll send you a spreadsheet and a complete write up on how to do it for your portfolio.
Your Friend in the Trend,