Building a portfolio strategy that has performed well over the past 10-15 years using ETFs (Exchange Trade Funds) is a simple matter, there is a ton of information widely available that shows performance numbers for a short section of stock market history. But does this strategy perform over the long haul, does it perform over a significant period of history or does it just happen to work for a little while? In this article we backtest a simple strategy over more than 60 years of historical data to see how one of the simplest strategies has performed during that period. Our strategy is testing a portfolio composed of a mix of US and world equities,
Our core portfolio will be composed of 40% US Mid Cap Value Stocks, 40% US Small Cap Growth Stocks, and 20% Total World Stocks. When any one of these categories is below the 175 day moving average we will invest in Intermediate Term US Bonds. Investing in a bond fund instead of equities will allow us to limit our risk.
During the period from November 1954 to today, US Large Cap stocks have provided 9.16% average yearly return, our portfolio without timing has given 10.51% returns if you rebalance it yearly. However our portfolio has also had 57.4% drawdown and only a 0.72 Sharpe Ratio over that period.
Adding in portfolio timing to this portfolio is an active strategy that's goal is to avoid draw downs by de-investing in funds as they fall below moving averages, and re-invest when the fund goes back above the moving average. Our strategy is to apply the 175 day (~8 month) moving average to this portfolio, and only invest in funds that are above this moving average. We will be able to see if this strategy is profitable over the long term, or if this management style only works over smaller sections of history.
Results: 11.26% CAGR, 1.11 Sharpe, 6.86% daily volatility, 29.36% maximum daily drawdown.
Below we see the strategy is invested ~70% of the time, while ~30% of the time the strategy invests in the bond fund.
Below is a chart that shows time in trades vs. return. If your account is a taxed account, this is a major concern to make sure trades are held at least 1 year. Below shows 1 year is the minimum length of time any trade making more than 15% occurs, although there are several trades in the 10-15% range that last for shorter periods of time.
Over more than 60 years of backtesting adding a timing aspect to a portfolio results in superior results with less drawdown and a greater risk/return ratio. The drawdown over a long period of time was reduced from 57.4% to 29.36%, while increasing the annual percent gain from 10.51% to 11.26%. A simple portfolio strategy of investing in funds when they are above a moving average, and switching to a bond fund when they are below a moving average worked over a long period of time to reduce strategy drawdown and increase portfolio returns.
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This product uses the FRED® API but is not endorsed or certified by the Federal Reserve Bank of St. Louis.