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URL:  http://boards.fool.com/jefflondon-i-am-in-some-ways-pretty-much-with-you-26110678.aspx

Subject:  Re: Optimizing Blends with Sharpe/(GSD^x) Date:  11/18/2007  12:10 PM
Author:  MoeBruin Number:  204029 of 252118

JeffLondon,

I am in some ways pretty much with you here. If I am young and looking long term who cares what the volatility as long as you get the highest maximum CAGR. I can tell you personally I have taken hits on my portfolio that make most people shudder and to be honest it isn't that bad. The pain of those hits has been far less painful to me then where my portfolio is now. Of course if you get older and/or closer to actually needing the money then you have to watch out for a hit coming when you need the money.

That said here is why Zee and Elan are for the most part correct in my opinion. Having successfully used these screens for many years I can tell you one thing for sure the future predictive power of these screens is much less then you can imagine. Most of the great screens I started with myself and most people on this board won't touch today with one or two exceptions.

What people have discovered is that the volatility around a screen is a much better predictor then the CAGR but again I personally don't consider even that as perfect a predictor as most people. That is in part why Elan has stated your expectation have to be at beating the market not getting the past return on these screens. Otherwise you are bound be disappointed with your returns and will tend to pick screens that minimize not maximize your returns especially if the market collapses. This again is said from knowing the past experience of many people who have invested in MI.

So when you try to maximize for CAGR you are fooling yourself with these screens. You are maximizing on a mirage.

It is for these reasons that the strategy I use is two fold.

1) I invest in simple screens that have been around for ever and have worked for a very long time like a the RS26. 26 week return has been something that has been known to work for decades and has been backtested with VL data since the 60s.

2) I use a blend geared toward volatility.

One final note I can tell you is that Elan is basically the pioneer of actually using a blend in his portfolio. He has always blended in part for volatility although it may not have been totally intentional in the early years. He always blended for variety which did give him a volatility edge in the early years.

I can also tell you that that nobody I know on this board including myself (must say I don't know what Zee gets but I wouldn't bet against him) has had overall higher returns throughout the years.

There were some very famous poster on this board who ran portfolios trying to just maximize CAGRs. One did it to the nth degree possible (cherry picking) any possible backtested screen you could find. The other just kept switching each year to what he thought high fliers were for the coming year (without the blending tool we have today to help). The first of these portfolios over a fairly long period of time lost money and way underperformed the market. The other portfolio over a number years also did not beat the market.

Moe
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