In Search Of Kind Of Close
Barry Ritholtz had a great post on Friday titled Why You Should Stick With Buy And Hold. If you buy and hold on no matter what, save for rebalancing and changing your asset allocation based on life events, and you have an adequate savings rate then you have a very good chance of having what you need for retirement or at least getting very close to what you need. The average annual return from the stock market varies depending on the time studied but the 8-10% that most studies cite should be sufficient but in addition to an adequate savings rate you need to avoid any truly self destructive behavior like selling after a large decline and watching the rally from the sidelines. Two of those three (savings rate and not succumbing to emotion) are within your control which is very encouraging and obviously market performance is not in your control.
Barry offers the following quote from an email sent to him;
“I followed you out of equities in 2008, but I thought you were crazy in March 2009 for going back in. It’s been three (or four or five) years, and I am still all cash and paralyzed. Help!”
Anyone who has been reading this blog for any length of time might remember what a huge bet I think getting all out is and for two reasons, once cited in the quote which is when/how do you get back in and getting completely out at some given time may simply be wrong. I don't think too many people would be happy going 100% cash in front of what turned out to be 6% decline not to mention capital gains consequences for certain accounts.
If you want to take some defensive action in the face of an increased likelihood of a large decline it is crucial to realize you cannot trade the event perfectly. I of course believe in this but spend no time trying to be exactly right. My goal as always is to avoid the full brunt of any large declines.
Including a fund like the Pacer Trend Pilot Large Cap ETF (PTLC) in your portfolio is an easy way to avoid the full brunt. It goes to 50% cash when the S&P 500 Total Return closes below its 200 DMA for five days and then goes 100% cash when the slope of the 200 DMA has been negative for five days, both happened at the same time on this go around.
Today, in the face of a 2% decline for the S&P 500 PTLC was up a couple of pennies. If a bear market has actually started and we go on to a 20% or 40% or some other big number decline then I would expect PTLC to be pretty much unchanged as for now, it is a cash proxy that will re-equitize once the S&P 500 retakes its 200 DMA.
So while it is doing what I would hope it would do for clients (it is a client holding), it is not perfect, no fund is and PTLC has a couple of drawbacks. The biggest one, I believe, is that if the market goes to some extreme oversold level, like 10-15% below its 200 DMA, then PTLC wouldn't capture the snap back for still being in cash.
Something like PTLC, and there others that do similar things, when included in a diversified portfolio can help avoid the full brunt of a large decline which I think supports Barry's post that you should probably just hold on no matter what.
Keeping it simple, a mix of a total market (cap weighted), a dividend oriented fund for a little yield and something like PTLC will at times outperform, will at times lag but I think would have a very good chance of smoothing out the ride during volatile times and maybe make it a little easier to avoid succumbing to emotion.
There is of course more work in picking funds but even overlap may not be so terrible. Where many ETFs are free to trade and have very low expense ratios, it is not the end of the world to allocate a slice to a specialized fund that overlaps another holding, paying the $6 commission, if it can do what you expect it to do.
It is crucial to understand a mix like that may never be the best portfolio but it doesn't have to be. No one needs the best (whatever that means) as long as they are kind of close, have an adequate savings rate and avoid panicking.