Someone asked me today how I felt about the stock market, as it was on its way to falling more than any single day since the initial COVID panic. I shrugged and said “I’m a long-term investor, so I like when the market goes up.” I won’t be making any changes in reaction to today’s news, and in general I do not make investment decisions based off of market news. I rely on scheduled rebalancing between portfolio assets to take advantage of this kind of volatility.1
I thought more about the question and I realized that another part of why I was unconcerned about the market is that I know a leveraged, ultra-diversified portfolio outperforms the market during downturns like this. For example, the S&P 500 is down by 8.25% so far this year, and the Model Hedge Fund Portfolio has outperformed it by over 3%.2
| Portfolio | Year-to-Date Return | 2024-to-Date Return |
|---|---|---|
| S&P 500 | -8.25% | 14.46% |
| Model Hedge Fund Portfolio | -4.95% | 16.85% |
Any portfolio that includes bonds will do better than the S&P 500 during drawdowns, and a leveraged-diversified portfolio like this has a high bond allocation so you would expect it to do well. However, a leveraged-diversified portfolio is able to both outperform during bear markets and match the market performance during bull markets. When you combine the 25% returns of the S&P 500 last year with the 8% loss so far this year you end up with 14.46% returns. Over the same time period the Model Hedge Fund Portfolio has returned 16.85%. These small gains build on each other to give more than double the total return over longer periods.
Whatever investment plan you are implementing, don’t let disruptions like we are currently seeing keep you up at night. Stay the course and remember that you are being compensated for taking on this volatility.
- See Volatility Harvesting: Why Does Diversifying
and Rebalancing Create Portfolio Growth? or Volatility Harvesting: From Theory to Practice for some of the math on why scheduled rebalancing between stocks and bonds gives higher returns in years with steep drawdowns compared to years without them. ↩︎ - I keep referencing the Model Hedge Fund Portfolio but there is nothing particularly special about this portfolio. I originally used it to give a simple example of how using additional asset classes beyond stocks and bonds gives a statistical advantage when you add leverage to the mix. I specifically chose hedge fund categories that have market data going back to 1998, but a modern version of this portfolio would have several improvements. It would contain additional categories like managed futures and relative value arbitrage, as well as additional asset classes and modified allocation percentages. In a future post I will give a few examples of what a modern version looks like, and the performance is even better than the numbers we are looking at here. ↩︎
-A clear, simple strategy. Great work! Thanks for sharing the insight Monte! I enjoy the focus of your newsletters.
Thanks Dave. I’ll keep them coming!