A Well-Balanced Wealth Management Investment Strategy

by: MyPlanIQ

Inflation and deflation are the two most important factors for a well-designed wealth management investment strategy. Inflation destroys the long term purchasing power while deflation reduces the effectiveness of the capitalism's basic profit machine. A well-designed long term strategy thus needs to have a well-balanced hedge in both economic cycles. Harry Browne's permanent portfolio is designed over various major asset classes to tackle this problem. A more actively managed strategy is Doug Roberts' Follow the Fed Strategy.

In this article, we will discuss this well-balanced strategy ValidFi maintains in some detail. This strategy is simply based on the Fed monetary policy to follow the Fed. Research shows that big caps behave better than small caps when money is tight, while small caps outperform big caps when money is easy. A similar relationship is also found between gold and Treasury bonds. Gold is doing better than Treasury bonds when the Fed's money policy is easy, and vice versa. Switching between large and small stocks, and between gold and Treasury bonds depends on the Fed's monetary policy.

To lower the risk still further, simple intermediate government notes are added to the portfolio. Thus, this strategy allocates assets equally among large/small stocks, gold/Treasury bonds and intermediate government notes.

1. Determine whether money is tight or easy

  • The indicator we use is T-bill -12 month value minus Inflation - 12 month value, as described in the Barrons' articles. If the former is larger than the latter, then Fed's money policy is tight.
  • The T-bill - 12m is the trailing 12 - month compound return using the last twelve monthly T - bill's values.
  • Similarly the Inflation -12m measures the trailing 12-month compound return using the last 12- month inflation values. Inflation is calculated as the change in CPI index between this month and last month divided by last month's CPI index.
  • We can also compare the above indicator value with the 64-day simple moving average value of the indicator. If the former is larger than the latter, then the Fed's tight, and vice versa.

2. Portfolios

The asset allocation of a conservative model portfolio would be simply allocating 1/3 each to large/small cap equity, gold/long term treasury and intermediate treasury notes.

  • If money is tight, the portfolio is composed of:
    • 33.33% in large stocks
    • 33.33% in Treasury bonds
    • 33.33% in intermediate treasury notes
  • If money is easy, the portfolio is made up of:
    • 33.33% in small stocks
    • 33.33% in gold
    • 33.33% in intermediate treasury notes

3. Switching frequency

The strategy adjusts portfolios every month according to the money status.

  • If short-term T-bill rate remains higher/lower than inflation, no adjustment is made to the portfolio because money remains tight/easy.
  • Similarly, if the indicator value stays above/below 0, or it's higher/lower than the 64-day simple moving average value of the indicator, no adjustment needs to be done to the portfolio.
  • However, if the money status changes, for example, money is tight right now while it was easy last time, investors must adjust the portfolio accordingly. In this case, portfolios should be switched to the other type so that investors can achieve higher returns while remaining lower risks.

We have found that using the 64-day simple moving average performs much better than simply basing on whether the indicator's value is positive or negative.

The following table compares the performance between the conservative portfolio and the permanent portfolio (PRPFX) from 1/1/1997 to 11/27/2009.

Last 1 Years Last 3 Years Last 5 Years Since 1/1/97 to 11/27/09
Roberts Portfolio Annualized Return 22.3% 7.4% 9.4% 9.9%
PRPFX Annualized Return 28.7% 7.3% 8.5% 8.46%
Roberts Portfolio Sharpe Ratio 1.7 0.5 0.68 0.77
PRPFX Sharpe Ratio 1.66 0.41 0.54 0.65

Doug Roberts' strategy is one of those well-balanced long term strategies adopted by wealth managers with the primary objective of preserving capital and purchasing power while achieving reasonable growth. At the moment, the strategy decides that "money is easy" (which is obviously true) and invests in both small cap and gold.

Disclosure: the author holds GLD.