Adam O’Dell | Friday, September 13, 2013 >>
I remember a few useful points from the college psychology classes I took years ago. Some tend to surface during heated debates with my fiancée, but that’s a story for another day.
One of these gems goes like this:
“If all you have is a hammer, everything looks like a nail.”
It’s one example of the many cognitive biases – or “mental glitches,” as I think of them – that tend to turn well-meaning people into poor decision-makers. Here, you make the mental error when you try to solve a problem using only the tool you have in your possession (a lazy choice), even if other tools would be better suited for the job (the right choice).
And this is precisely the mistake many can’t-teach-an-old-dog-new-tricks investors are making today.
You see, between 1980 and 2000 the stock market essentially went one direction – up!
Against a backdrop of the Efficient Market Hypothesis – which theorized that all investors are rational, everything is priced in, and there’s no way to beat the market – retail investors were told to buy index funds… to maintain a simple 60/40 mix of stocks and bonds… and of course, to just buy and hold.
The idea was simple: If you can’t beat the market, join it. And since the economy was growing strongly during those two decades, investing in only stocks and bonds was an easy and profitable plan of action.
Of course, that all changed at the turn of the century. Since 2000, U.S. stock markets have crashed twice, dropping more than 30% each time. The Dow is up just 40% in the last 13 years, compared to the 433% it gained in the prior 13 years.
Now, I am not saying there was no money to be made in the markets over the last 13 years. Indeed, there was… and lots of it!
But my point is that if you only used a hammer for the last 13 years, you likely got pounded.
Today’s markets require a more diverse and advanced tool chest.
You should still invest in stocks and bonds. But today’s successful investors are also branching out, investing in the commodity and currency markets with alternative investment strategies.
So, what exactly are alternative investment strategies?
To start, it’s easier to say what they’re not. They’re not limited to stocks and bonds. They’re not limited to long (bullish) positions. And they’re not limited to long, set-it-and-forget-it timeframes.
Also, there are many flavors of alternative strategies.
You’ve got long/short equity, where you buy strong stocks and short weak ones.
There are event-driven strategies that seek to profit from price changes immediately after a catalyst event.
And there are managed-futures portfolios that are typically systematic, trend-following strategies, trading a basket of 30 or more futures markets.
I could write for days on the merits of each of these. But let me cut to the chase, because I’m sure by now you’re interested in hearing the WIIFY – the “What’s In It For YOU!”
Simply put: higher returns, lower risk.
And here’s the proof…
Let’s get oriented…
The blue dots represent traditional investment assets and strategies, while the red dots are the alternatives. The vertical axis shows annual percent returns, where higher is better, while the horizontal axis plots annual standard deviation, a measure of risk, where left is less risk and right is more risk.
So the top-left corner is where you want to be: high returns, low risk.
As you can see, alternatives come out the clear winner. Five out of six alternative strategies show returns that are higher than all but one of the traditional strategies. Likewise, the six alternative strategies show less volatility and risk than all but one of the traditional strategies.
That’s proof enough for me that alternatives were the way to go over the time period covered in the chart (1997 – present). But that’s all in the rearview mirror now. The real question, looking ahead, is this: Will alternative strategies outperform traditional strategies over the next 13 years?
I say, emphatically: YES!
And here’s why…
A buy-and-hold portfolio of traditional assets requires strong economic growth. I just don’t think we’ll muster growth anywhere close to what we enjoyed in the ’80s and ’90s.
Meanwhile, alternative strategies excel as long as price trends persist. Price trends persist when markets are out of equilibrium… and establishing a well-balanced equilibrium in today’s “new normal,” Fed-manipulated and completely irrational environment is a practical impossibility in my view.
So I say: “Long live alternative investment strategies!”
If you’re with me… if you’re interested in an alternative approach to booking double- and triple-digit percentage gains in a matter of months, not years… you have the opportunity to join me and more than 1,000 subscribers with my top-tier investment service, Cycle 9 Alert.
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