Investment Strategy Overview

Before I outline my investment strategy, I will share a little information about myself. This will help you understand my risk profile and why I invest the way I do.

I am retired and live off my investment income. I have no other income streams. I spend roughly 4% of my capital per year. When you factor in taxes and inflation, I need to earn roughly 8% on my capital each year to keep my capital steady in inflation adjusted terms (assuming 2% inflation).

Volatility negatively impacts how much of my capital I can safely withdraw each year. This is because I would be withdrawing capital during drawdowns, leaving less capital to recover losses. As well, when you have a fixed amount of capital to finance your life, it is extremely stressful to suffer large drawdowns. In doing so, you run the risk of panicking and making rash decisions, like selling out at market lows. For these reasons, I need to manage my investments to avoid large drawdowns. I consider anything greater than 20% to be a large drawdown. Ideally, I would like to keep drawdowns to around 10%.

My investments can be divided into two strategies: (1) a balanced long-only portfolio of ETFs that I adjust infrequently (“Core Portfolio”); and (2) discretionary trades that I make using margin (“Discretionary Strategy”).

Core Portfolio

The table below outlines the holdings of my Core Portfolio:

Core Portfolio
Asset Class ETF Min Target Max
Global Equities (Trend Following) ROMO 20% 20% 20%
Gold GLD 0% 15% 20%
30Y US Treasuries TLT 0% 15% 80%
Biotech BBH 0% 10% 20%
Consumer Staples KXI 0% 10% 20%
Utilities XLU 0% 10% 20%
Global Equities VT 0% 10% 80%
Short AUD/JPY FXY/CROC 0% 10% 20%

I have selected asset classes that have low to negative correlation to global equities. Of course, correlations are not static and change frequently (and often go to 1 during times of stress), but this is probably as good a group of uncorrelated assets as you can get using publicly traded ETFs.

The correlation matrix below shows the correlation between these ETFs over the past 3 years using monthly returns (using Portfolio Visualizer):

When managing the Core Portfolio, I generally stick to the target allocations unless I feel that an asset class is trading at an exceptional discount or premium, in which case I will adjust the allocation within the minimum and maximum boundary. The only ETF that I never adjust is ROMO. This is an actively managed ETF that rebalances its holdings between equities and bonds based on historical momentum. It would not make sense to adjust ROMO’s allocation since I would be going against its own rebalancing.

So how has the Core Portfolio done historically using the target allocations? Unfortunately, ROMO, CROC and KXI have little history, so we cannot back test this for more than a couple of years. However, if we use VT as a proxy for ROMO, substitute XLP for KXI and used cash for CROC, we get the following performance (using Portfolio Visualizer):

It would have performed reasonably well during the past decade. Key for me is that the CAGR is roughly equal to the maximum drawdown. It trailed VT (global equities), but the maximum drawdown was less than half of that of VT. Of course, it would be possible to add leverage to the Core Portfolio to increase returns, but I do not do that.

Obviously, there is zero guarantee that the Core Portfolio will perform anywhere near as well over the next decade or that its volatility and drawdowns will remain low, but I believe that it would be difficult to design a simple portfolio of ETFs with a greater chance of achieving stable, future returns. To create a portfolio with better prospective risk adjusted returns would require the inclusion of other hedge fund type strategies such as long/short or mean reversion.

Discretionary Strategy

My goal with my discretionary trading is to add to the returns generated by the Core Portfolio, without significantly adding risk. This means that I usually trade securities that are uncorrelated to the Core Portfolio or I am careful to use stop losses if I am adding correlated risk.

Because I have a baseline return from my Core Portfolio, I do not feel pressured to make discretionary trades. I can afford to be selective, which I feel improves my win rate and performance. I will sometimes go weeks without making a trade.

It may be the case that my Discretionary Strategy outperforms my Core Portfolio, in which case it may be asked why not just rely on the Discretionary Strategy? I believe that relying on the Discretionary Strategy alone would hurt my performance because I would be under pressure to trade and generate returns. Psychology is a huge part of trading and I am mindful of this. Also, I cannot be sure that my discretionary trading will be profitable over the long term.

I make trading decisions using charts, sentiment, macro views and gut feel. It is not a quantitative system. I will continue to do it for as long as it adds to my nominal returns without meaningfully increasing risk and drawdowns. So far, so good. If at some point I realize that it does not, I will stop.