How do the three portfolio models differ (moderate, growth, aggressive)?
As described in the paragraphs that follow, the best way to manage risk and improve performance is via the allocation decision between growth assets and conservative assets. All three portfolio models use the exact same mix between growth and conservative assets. The difference is what we can “plug into” each side of the equation. The model is built to track/monitor the S&P 500. Therefore the “safest” way to run the model is to plug the S&P 500 ETF (SPY) into the growth side 100% of the time. Therefore, the moderate portfolio model, by rule, must maintain a higher exposure to SPY than both the growth and aggressive portfolio models.
Assume, hypothetically, the average allocation recommended by the model during the last three years of the dot-com boom (1997-2000) was 90% growth and 10% conservative mix. If we plugged in SPY during that three year period, we would have done well. However, if we plugged in technology stocks, or the QQQ ETF, we would have done much better. In simple terms, the growth and aggressive models are allowed to plug in more QQQ and less SPY into the growth side of the portfolio. More often than not, adding a more attractive ETF, such as QQQ, adds value, but sometimes it hurts performance. Thus, the moderate growth portfolio (the most conservative one) always plugs in a high percentage of SPY (or something very similar like VTI or SCHB) into the growth side of the allocation.
Asset Allocation: Focus On Investment Buckets
Numerous studies tell us roughly 90% of variances in portfolio performance can be attributed to allocation choices between major asset classes, such as stocks and bonds. Roughly 10% of the value added is dependent upon individual stock or bond selection. Therefore, the best way to add value is to focus on our allocation to asset classes, sectors, regions of the globe, countries, etc. According to Ibbotson Associates, research has estimated that asset allocation accounts for 91.5 percent of the variation between returns on different portfolios. ETFs are efficient investment vehicles that allow us to focus on “investment buckets”. The allocation between buckets is what matters most, not individual stock or security selection.
Anecdotally, you did not need to pick a winning technology stock during the dot-com boom to make money; technology ETFs and indexes did quite well. Conversely, after the dot-com bust, stock selection would not have helped much since almost all technology stocks got hammered.
While the market model is based on sound economic and investment principles, there is no guarantee any of the objectives will be met in the future. The terms odds and probabilities also speak to uncertain outcomes. Risks are covered in more detail in the CCM Client Agreement and LPOA.