Quick – if an investment or portfolio loses 50% of its value, what percent return must you achieve just to reach parity (break even)? The answer is: 100% return. If you start with $100 and lose $50, you need a 100% return on the $50 you have left to get back to where you started. And so it works with the stock market, your IRA or your 401(k). Here is a more complete table:

For number geeks, here is the formula: (1/(1-% Loss))-1

Some real life examples:

·         A “balanced” portfolio of 60% US stocks (IWB) and 40% US bonds (AGG) has lost 21.8% of its value over the past year. Investors holding the portfolio need a 28% return to reach parity.

·         The S&P 500 has lost 44.3% over the past year. The index must rise 80% to reach parity.

·         The NASDAQ index, an indicator of technology stocks has lost 71% of its value since peaking at 5132.52 on March 10, 2000. Investors who bought at the peak need a 240% return to reach parity.

·         The Japanese stock market (Nikkei 225) index has lost 77% of its value since peaking at 38,915.87 on December 29, 1989. Investors who bought at the peak need a 339% return to reach parity.

The point is that investors can little afford to follow popular strategies that result in huge portfolio drawdowns. Yet proponents of popular investment strategies like the Lazy Portfolios are proud of the fact that their buy-and-hold portfolios are “…beating the benchmark S&P 500 by anywhere from three to 18 percentage points.” Their logic is something like this: “The 8 Lazy Portfolios have lost “only” 21.86% to 39.80% in the past year – they all beat the S&P 500 Index!”

Applying simple “investment math” shows that it will take returns between 28%-66% for those portfolios just to break even. With math like that, you might as well go to a casino.

In my earlier experiences as a modeler, I sometimes found it an emotional challenge to follow my SISTM (Sage Investment Strategies Timing Model) without question. Sometimes the model would tell me to do one thing while my emotions tugged at me to do something else which might have seemed more logical at the time. Whenever I allowed my emotions to get the best of me and did not follow one of the signals, the SISTM almost always proved to be right.

Over time I gained complete confidence in my SISTM and disciplined myself to follow its signals. That confidence and self-discipline kept me out of trouble in 2008. I’m 60 years old and can’t afford to lose a big chunk of my portfolio as I did during the 2000-2003 bear market before becoming a modeler. I designed my SISTM to strike a good balance between nominal and risk-adjusted returns. I measure standard deviation, Sharpe Ratio and peak-to-trough drawdown of each portfolio and compare these measures with those of key benchmarks (the S&P 500 Index and a 60% US stocks/40% bonds portfolio) as well as a buy-and-hold portfolio

Looking back at 2008, one of the most the most difficult and tumultuous periods in financial markets in the last 80 years, I’m very pleased with the performance of my SISTM. From 2007 onward, I invested 100% of my own, my wife’s and my mother’s money using the “buy” and “sell” signals that my SISTM generated. The results which I update weekly on my website speak for themselves

The point is that whatever your investment strategy, to be successful you must follow the strategy mechanically and unemotionally regardless of what the markets or others do.

What challenges have you experienced with following your investment strategy?