AFP Defined Risk Status as of 9/1/2020

Defined Risk Assets are currently invested in STOCKS & BONDS.

U.S. STOCKS

Risk-On trigger date:

S&P500 close at trigger:

Current month S&P value:

S&P500 hedge-out target:

6/03

3,122  

3,500  as of 9/1

2,961  as of 9/1

INTERNATIONAL STOCKS

Risk-On trigger date:

EFA close at trigger:

Current month EFA value:

EFA hedge-out target:

8/12

64.07

64.98 as of 9/1

60.08 as of 9/1

*Values updated each month. Risk Off/On buttons updated when triggered.

AFP Defined Risk Strategy is designed to help limit large losses from short-term fear selling in the stock market.

It is a stop-loss process that is triggered when the stock market trades below its recent average range. (We sell stock positions on this trigger.) History shows us that most large losses occur when the stock market trades below its 200-day moving average. By selling stocks at these transition points, we seek to sit out until whatever is causing the market problems subsides.

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How Does It Work?

We apply this Defined Risk approach to a portion of stocks within diversified portfolios. If the market trades targeted amounts above or below its 200-day average, we buy or sell these stocks. We separate domestic and international stock trends, and apply different triggers to each. Once the market moves back into its 200-day moving average range, we re-establish our stock holdings. To reduce the quantity of trades, we apply a trading window % above and below specific price targets so that we are not buying and selling in/out repeatedly in short periods of time if the market is hovering near its 200-day moving average.

Risk On: The green highlighted areas illustrate the periods the AFP Defined Risk Strategy would have owned US stocks over the past 20-year period. The strategy would have owned stocks approximately 70% of all trading days.

Risk Off: The red highlighted areas illustrate when we would not have been exposed to equity market risks using the AFP Defined Risk Strategy during the last 20-years. The strategy would have not owned stocks approximately 30% of all trading days.

Why not stay invested all the time?

When the market endures large losses, it takes much higher returns to just get back to even.  Behavioral finance studies show that people have a larger emotional response to losing than they do winning.  A byproduct of this human instinct is that when investments lose value, we are tempted to take action, usually the action of selling. The more people sell, the more a selling frenzy can ensue. Research shows that more than 80% of the worst days in the market have occurred when the market is trading below its 200-day average. (Source: Portfolio visualizer data 1/1/85 through 4/20/20)

The impact of losses: What this shows us is that we need to make far higher positive returns to get back to 0% if we experience large negative returns. The greater the loss, the longer it takes to recover.

Trend Analysis provides another approach

In understanding that most of the worst days seem to occur when the market is trading below its 200-day trailing average AND avoiding losses is more important than just earning high returns, the concept of "win by not losing" is born. When we blend findings from behavioral economics and statistics, the goal becomes:

Own stocks (Risk On) when the market is trading consistently above its recent average, AND

Be on the sidelines (Risk Off) when the market trades below its recent averages.  

 

Missing the best and the worst days in the stock market has produced higher returns over the past 35 years than buy and hold strategies. Research provided by Ritholtz Wealth Management and data verification by Portfolio Visualizer 1985-2020.

Should this strategy be used as a complete portfolio solution?

In our opinion, no.  This defined risk strategy should be used in conjunction with a diversified asset allocation strategy.  There are many ways to diversify an investment portfolio against market risks.  This particular strategy is simply designed to create a short term "floor" on the portion of a portfolio that is invested in the broad stock market.  If one were to use this strategy exclusively, many of the long-term benefits of diversification would be lost.  Additionally, this strategy does not work well in a very volatile, but fundamentally sideways market cycle because of trading costs and execution issues associated with the specific timing of the trades in and out of risk assets.

How much does it cost?

Running this strategy is surprisingly inexpensive compared to most actively managed investments.  Because we can combine the low cost of indexing with a low number of expected trades each year, we find that the total cost to run this strategy is between 0.09% and 0.35% depending on which ETF or fund we use for domestic and international stock exposure.  There are some labor costs for us to monitor various triggers, but we absorb that as part of our standard account service costs or advisory fees.

Can this strategy work over the long term too?

Interestingly, the results of this approach over the long term are quite similar to what we have seen recently.  Typically, this defined risk strategy would have triggered a "risk-on" status about 70% of the time and "risk-off" about 30% of the time during the past decade. 

Be sure to ask your advisor to provide you with more information on how you can take advantage of the AFP Defined Risk Strategy.

All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful. 

A diversified portfolio does not assure a profit or protect against loss in a declining market.

Additional risks are associated with international investing, such as currency fluctuations, political and economic stability, and difference in accounting standards.

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