I've long been fiddling around with various mechanical methods of adjusting an almost passive index investing stragety to improve the risk/reward ratio. This is sometimes known as Tactical Asset Allocation (TAA). I thought I'd put up some charts of my efforts.
The lines in the charts are for four portfolios: Cash, with the returns calculated using the average instant access interest rates borrowed from the rather excellent Swanlopark; The FTSE 100 with dividends reinvested; A 60/40 FTSE 100/cash split rebalanced each year; Another FTSE 100/cash split which is rebalanced annually using my asset allocation function which is fed with the FTSE 100 real earnings over the period in question.
The first chart shows the portfolios with a single lump sum invested in 1993:
As I'd expect, the cash is safe and predictable but has the weakest returns; FTSE 100 is the most volatile with the greatest returns most of the time; the fixed 60/40 split is somewhere in the middle. The interesting thing is that by taking note of the value of the stock market the red line has better returns that the fixed split, but with broadly similar volatility.
I think this is very suitable for a 'conservative' portfolio and it's exactly how my wife's pension is invested. The most important thing is the small drawdowns, which is how most retail investors measure risk, i.e. how much has it fallen from some previous value. In the above chart the FTSE loses almost 40% in its biggest drawdown, the 60/40 split loses 18% (2000-2003) and the TAA portfolio loses 15% (2008-2009).
The next chart shows the returns when the investment was added in 2000, i.e. a bad time to invest in stocks:
As you can see, cash was a much better place to be than stocks if you were putting away a lump sum in 2000, however theh TAA portfolio has recently taken the lead and looks much healthier than the other stock holding portfolios.
The next chart shows the benifits of dollar cost averaging, where you invest new money over time. This means you buy more when stocks are cheap and less when they are expensive:
Although…
