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What I Learned About Building a Match Winning Portfolio in 2020 - II

May 18, 2020

Rahul Shah, Editor, Profit Hunter

This is the second of my two part series on 'What I Learned About Building a Match Winning Portfolio in 2020'. You can read the first piece here.

The idea is pretty simple.

I am trying to find out whether you could have beaten the 14% returns of the Sensex between December 2014 and now, by just being a little contrarian.

Was there a way to beat the Sensex by using the exact same portfolio as the Sensex but moving in and out of the Sensex and not employing the passive 'Buy and Hold Strategy'?

There's good news. Yes, there is certainly a way to do this. In fact, I have come across two such ways. I discussed the first such method in the previous piece.

Here, I discuss the second such method...

Take a look at the chart again from last week. The second method or the second strategy is known as the 50:50 rebalancing.

Can a Smart Contrarian Beat the 'Buy & Hold' Approach to Investing?

The way the second method works is works is extremely simple.

We start with a simple 50:50 allocation between stocks and bonds (again assuming a 6.5% average return per year). Then, the allocation is periodically reviewed every three months.

If at the end of the three month period, the stock portion is equal to or higher than 55%, the portfolio is rebalanced back to 50:50.

On the other hand, if the stock portion has fallen to 45%, money is taken out of bonds and invested into the Sensex so that the portfolio is again split 50:50 between the two assets.

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And then, rinse and repeat the same process every quarter.

The performance of this portfolio may not have been as great as the one based on 75:25 valuation.

But it still outperformed the Sensex by a good margin, earning double the 14% returns earned by the Sensex.

I know what you might be thinking. Five years is too short a time period to test the effectiveness of a strategy. Besides, every market cycle has different characteristics.

Therefore, it's not necessary that a strategy which worked in one cycle will work equally well in the next one.

Your thoughts are certainly valid.

However, I believe these approaches are timeless.

That's because it takes care of the one thing that differentiates a successful investor from an unsuccessful one. The ability to BUY LOW and SELL HIGH.

Those who've spent time in the market know how easy this sounds in theory and how difficult it is to implement in practice. However, both these approaches have in-built rules that help you do just that.

Therefore, as the first strategy shows, as the markets keep going up, they become expensive and therefore, you sell at high levels and move into cash.

And then when markets become cheap again, you move out of cash and get into stocks to the tune of 75%.

Ditto for the second strategy. As markets go up and your stock exposure becomes 55%, you sell some and go back to 50:50. Thus, you SELL HIGH.

And then when markets go down and your stock exposure goes below 45%, you buy more stocks and take the ratio back to 50:50. Thus, you BUY LOW.

It is shocking how majority of the people don't follow this simple approach and end up doing exactly the opposite despite numerous warnings.

However, this near mechanical approach of both your portfolios ensure that you don't commit the same mistake.

Thus, if you expect the markets to have a significant correction every few years and if you think you would be able to implement the two approaches without getting carried away by what the rest of the investing community is doing, I think you have a great chance of beating the Sensex across any market cycle.

The magnitude of the outperformance may differ depending on the magnitude of the correction and how long a bull market lasts.

But at the end of it, you are certain to come out ahead.

By the way, I have not even considered the possibility of having a portfolio of stocks with a much better risk-return profile than the Sensex.

If you are able to identify a group of such stocks on a consistent basis, your overall returns can look even better.

This is precisely what I have achieved in my Microcap Millionaires service. Using a valuation based approach and using a portfolio of stocks that promise better returns than the Sensex, I have been able to beat the markets by almost 3x.

Yes, that right. The service has returned 145% since inception in February 2014 against the 55% returns of the Sensex during the same period.

That's the power of this approach which believes that Sensex will have a major correction every few years and you can prepare for it by reducing exposure once the markets turn expensive.

The fact that we chose stocks with better overall upside than the Sensex also helped matters.

Good Investing,

Rahul Shah
Rahul Shah
Editor, Profit Hunter
Equitymaster Agora Research Private Limited (Research Analyst)

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