Why my portfolio is up YTD — Stocks & Gold Strategy

Why is my portfolio still profitable despite the COVID-19 market crash? After covering the rules that I follow in this COVID-19 bear market that you widely shared here is a study showing what would have happened if you invested in Equities and Gold over the past 30 years. This is a simulation of high returns at pretty much any point during that time.

Keep reading:

• If you want to sleep well at night, don’t like volatility of stocks and aiming for consistent returns of your portfolio with limited downside risk
• If you wonder whether it’s possible to generate High Returns no matter at which point you enter the stock market
• If you are invested in Stocks but want to diversify risk
• If you want to invest your savings over the Medium to Long Term
• If you want a portfolio that is Easy to Implement
• If you want an investment that is Cost Effective

1. Warren Buffet’s “Rule №1: Never lose money”

Compound interest is when you earn money, or interest, on the interest you’ve already made on an initial investment. If you lose money the opportunity is lost. Einstein famously said compound interest is the 8th wonder of the world.

There is lots of ways to quickly lose money — online casino, penny stocks, leverage e.g. spread betting or CFDs, single name stocks during a bear market — look at airlines or Macy’s (remember asset allocation not stock picking drives 90% of your returns!) or even entire high risk sectors (especially when leveraged!). Yes, an Oil ETF has fallen overnight by 99% in March.

It’s going to be painful and it will take you a long time to recover the money back. Remember when you lose 25% it takes 34% gain to get back to your starting point. In a recession making actively making money (not speculating) in order to invest it and generate #passiveincome is even more difficult.

In this market some investors opt for ETFs but exactly how likely will S&P or Dow Jones ETF generate positive return over the medium term?

2. Portfolio 100% in Stock ETFs — Why you can lose money

“Rule №1: Never lose money. Rule №2: Never forget rule №1.”

Now, look at the above chart and read the analysis below:

How does it work?

• I assume that you want to fund a project in 5 years and I look at the last 30 years as guidance.
• I also assume you don’t have time to gradually deploy and want to get returns in 5 years
• OK, so let’s look at the following scenario — you may have invested at any point during the past 30 years (at the beginning of any quarter) and held the exposure for 5 years (any income is reinvested)
• Each blue bar is the annualised cumulative return over the 5 year period at the point of exit* (when you sell the exposure) of the S&P 500 Index
• Look at the chart above. As an example: if the investor sold his exposure in June 2003 (i.e. 5 year after intial investment) he would have generated an annual return of c. 6%.
• By investing 100 in June 1998 would have got back 133 after accounting for the total return (100*1.06⁵) in 2003

You can see a fundamental problem investing in stocks without hedge — almost the entire decade from 1997 until 2007 was ‘lost’ apart 2001–2003 period!

3. Two ways of Making Money and Staying Safe

Assuming you are/ aim to invest in stocks. There are two way of going about it in this market:

3.1 High Returns through Active Investing

A number of investors I know want high returns hence opt not to diversify from Stocks. They remain cash-rich (cash is king!). There are strategies you can deploy such as the COVID-19 bear market to lock S&P 500 returns no matter how the S&P will behave this year. The condition is having some cash on the side to invest should the stock market dive further

3.2 Hedging the Downside

If you want to deploy most of your money to work without having significant cash on the side you’d typically hedge your Equity exposure by invest in some form of Fixed Income products e.g. Treasuries or Gold

THE TRADITIONAL WAY

Treasuries’ yields are at historical lows

How do I hedge the downside? Traditionally you would diversify with a Fixed Income investment e.g. Treasuries. However, opportunity cost is a problem. Real rates (yields after accounting for inflation) are in fact negative. If you have e.g. 5 year investment objective and your bond portfolio is not matched (e.g. you hold longer duration treasuries to better hedge downside risk) you can also make losses.

Without going into the Maths the Ballpark Rule is that for a 20 year bond paying back the principal at maturity a 1% increase of interest rates brings your bond price down by 20%. You could make a case that nominal yields can go negative and you can make profits the same way but the risk is asymmetric to the downside (look at the below graph). Some even argue it’s flat-out foolish to hold bonds in this environment

4. The shiny alternative — the case for Gold

How does it work?

• I assumed that an investor invested at any point during the past 30 years (at the beginning of any quarter) and held the exposure for 5 years (any income is reinvested)
• Each blue bar (Stock exposure diversified with Gold) or point on the red curve (Stocks diversified with Treasuries) is the annualised cumulative return over the 5 year period at the point of exit*
• Again, please look at the chart above. As an example if the investor sold his exposure in July 2013 (i.e. 5 year after intial investment) he would have generated an annual return of c. 9%.
• By investing 100 in July 2008 the investment would have returned over 150 in total(100*1.09⁵).
• It wouldn’t have mattered if the investor put 50% in Bonds or Gold since both red and blue charts cross at that point in time (same outcome)
• You can easily visualise when Gold vs. Treasuries were more advantageous

Here are two other simulations- 40% Gold and 20% Gold allocations

Can Gold act as diversifier?

Although Treasuries enjoyed a substantial rally in the last decades since the yields were going down Gold is capable of delivering a similar diversification role. The general recommendation that you hear in media is to have some marginal exposure to Gold as part of a wider portfolio (5%-7%)

As a reminder, this analysis is a simplified one and only assumes one diversifier for comparison. However, analysing the data over the past 30 years the diversification away from stocks should be at least 20%

• Even a 80% Stock and 20% Bonds or Gold allocation would have been painful if exiting around 2002–2005 and 2009 whereas,
• 60% Stocks 40% Bonds or Gold allocation there is only a brief moment when exiting is disadvantageous. Outside of this isolated case it’s historically been a profitable mix consistently generating high returns

5. The ideal allocation

The ideal mix depends on your risk tolerance and return requirements. While we’ve been more obsessed by downside risk in this article returns are arguably as important. Below graph is also quite interesting. In our analysis there were 120 (30 years x 4 quarters) possible entry points when you could have invested for 5 years. Using a 60% Stocks 40% Gold allocation investing at any time would have generated you at least 6% annually over 5 years in 75% of cases.

*No rebalancing is modelled in this analysis

6. A word of caution

Note that Gold acts as long term diversifier. It can (and has during the 2008 Global Financial Crisis) moved in line with Equities over the short term due to technical reasons. This happens with a sudden shock when investors initially liquidate their ‘winners’ to cover margins on loss making positions. Gold has subsequently rallied with central bank stimulus announcements. The same happened mid-March 2020 with a fall in prices followed by a rally.

HOW TO INVEST — CHECKLIST

How do I buy Equity, Bond or Gold ETFs?

Research the appropriate ETF based on your needs

• Large US Equity ETFs by size are listed here. Some are covering the S&P 500 Index covered in this article.
• How to invest in gold?While you may consider physical gold your starting point to look for Gold ETF candidates is also on the ETFdb website.
• In case you’re curious about Fixed Income ETFs you can have an overview of the largest Government Bond ETFs here

Investigate Liquidity, Fees, Commissions and Taxes

• Check the size of the fund and liquidity — it is usually preferable to stick to the larger vehicles that are more liquid
• Low fees are the most cost-effective feature of an ETF — make sure you select a low fee vehicle
• How is the purchase or sale of an ETF going to affect your tax return? While U.S. based ETFs have many tax advantages, a foreign ETF may not be so tax-friendly and therefore not cost-effective. Tax implications vary from region to region
• Verify any commissions and fees charged by your broker

DISCLAIMER — the views expressed here are my own personal views. The above is a simplistic generic scenario analysis. The information provided is general in nature only and does not constitute personal financial advice. You should consider the appropriateness of the information having regard to your objectives, financial situation and needs, and seek professional advice where appropriate. This website is not affiliated with any of the investment firms for which products are described here. These are meant to be illustrative investments. Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this newsletter (article), will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio.