The Framework I Use For Investing Emotionless and Peacefully
I don't time the market; the framework does it for me! Let me demonstrate how I use my framework for investing and its performance during 2020. It's a simple framework but powerful if used right!
Introduction 👋🏻
It is crucial to have a strategy before problems hit, precisely because no one can accurately predict the stock markets or the economy's future direction.
The investment strategy should let you sleep at night even when the market experiences volatility, knowing that your system will make the best use of the volatility.
I developed this framework with volatility in mind. Many investors consider volatility as a risk, but it's the opposite. It's your best friend in the market if used right.
“Volatility is the price worth paying for good returns”
When the stock market experiences natural volatility, investors jump out. Later, when things appear to be back on the upswing, the same investors buy back in. What they're doing, in essence, is selling low and buying high. This behavior doesn't make for a desirable long-term rate of return. And I don't blame them since humans act emotionally, so I made a framework to help me overcome this.
The Framework 🖥
Consider you’re starting your investment journey in January 2020 and have $1000. You created a basket of stocks/ETF’s, consisting of, let’s say [$ARKK, $ARKF, $ARKG, $ARKW, $ARKQ, $FNGU, $FNGO, $FNGS], a mixture of Ark and leveraged FANG+ ETF’s because you're young and ready to ride the wave!
$ARK_ -> Ark Investments ETF’s
$FNG_ -> FANG+ index ETF’s with 3x, 2x and 1x leverage respectively(Use leverage cautiosly, not recommended)
Using the framework, you’ll invest in multiples of $10 (1% of $1000. 1% is arbitrary, I will explain the reason below) monthly into each of these stocks/ETFs individually (Equally-weighted).
The multiple is determined by the volatility in the portfolio. To determine the portfolio's volatility, I use MTD(Month to Date) or each stock’s individual monthly percentage change and average it.
You might be confused 🤯; let me explain with an example.
It’s January 1st, 2020, and you’re pumped about investing. Let’s see how you would have performed using the framework!
Calculate each stock’s previous month's (Dec 2019) performance. You can use tradingview.com or yahoo finance to get the monthly percent change.
$ARKK -> -1% (-0.75% rounded off to -1%)
$ARKF -> 0%
$ARKG -> -4%
$ARKW -> +2%
$ARKQ -> +7%
$FNGU -> +23%
$FNGO -> +16%
$FNGS -> +8%
When you take the average(-1+0-4+2+7+23+16+8/number_of_stocks(8) = 51/8) you get 6% i.e., your portfolio moved by +6%.
In this case, since your investments have gone up, the minimum amount of $10 (1% of 1000) is invested in each stock.
Therefore, you’ve invested a total of $80 (minimum amount * no_of_stocks).
If you’re confused, please bear with me till the end. You’ll understand how it works when there’s a negative change in your portfolio.
It’s February 1st. Let’s see how your portfolio moved in January!
$ARKK -> +4%
$ARKF -> +5%
$ARKG -> -2%
$ARKW -> +10%
$ARKQ -> +4%
$FNGU -> +23%
$FNGO -> +16%
$FNGS -> +8%
The average is 9%, i.e., your portfolio moved by +9%. Just like the previous case, $10 is invested in each stock; or other words, you’ve invested $80 this month.
Total amount invested is now 80 (Jan) + 80 (Feb) = $160
It’s March 1st; let’s see how your portfolio moved in February!
$ARKK -> +2%
$ARKF -> -2%
$ARKG -> +5%
$ARKW -> 0%
$ARKQ -> -4%
$FNGU -> -6%
$FNGO -> -4%
$FNGS -> 0%
The average is -1%, i.e., your portfolio moved by -1%. When there’s a negative change, the ‘change’ becomes your multiple. Therefore, 1 (the change) * 10 (minimum amount) = $10 is invested into each stock, or in other words, you’ve invested $80 this month.
Total amount invested is now 80 (Jan) + 80 (Feb) + 80(March) = $240
It's April 1st; let’s see how your portfolio moved in March!
$ARKK -> -17%
$ARKF -> -17%
$ARKG -> -9%
$ARKW -> -16%
$ARKQ -> -10%
$FNGU -> -43%
$FNGO -> -24%
$FNGS -> -11%
The average is -18%, i.e., your portfolio moved by -18%. Covid crushed your portfolio, but fear not because we have a framework that embraces drops like these. When everyone is selling, we’re buying. Our buy has increased by 18x, i.e., we are exponentially averaging down on our stocks!
Here the multiplier is 18. Therefore, $180 (18*10) is invested into each stock, or in other words, you’ve invested $1440 this month.
What, $1440? I don't have that much money to invest. Exactly, in some cases, you won’t have enough money to invest as per the framework. I wanted to show you this with an example in case you thought 1% as the minimum amount is too low. For a portfolio of this volatility (because of the leveraged ETF’s), I would recommend at most 0.5% as the minimum amount. And to be on the safe side, you could further lower it.
For a traditional 60/40 portfolio consisting of bonds, 1% is sufficient because of the lower drawdowns. It’s on you to decide, depending upon the volatility of your portfolio. One of the best ways to measure it would be by calculating your portfolio drawdown during the most precarious bear markets like 2008 or 2000.
The Negatives of Using This Framework 👎🏻
During a big bull market, you would have more cash.
If you had started using this framework in April of 2020, you wouldn’t be making the most out of your cash as there were fewer drawdowns.
The Positives of Using This Framework 👍🏻
You would be sitting on cash to make the best out of the drawdowns.
Black Swans are just another opportunity for you.
You will start embracing the volatility.
Less emotional trading
Apparently, timing the market.
Conclusion 😎
Every framework has its ups and downs. Having cash on the sidelines to make the most out of a market decline gives me peace.
I believe this is a risk-averse framework that helps you to time the market and let you sleep peacefully!
The framework will help you to live by Buffett's famous quote, "Be fearful when others are greedy, and greedy when others are fearful.”
If you want to see the results of a backtest on this portfolio using the framework, comment below. If you liked the framework, like and share!
I would highly appreciate constructive criticism! 🤝
Thanks to @NathanWorden for the edits and valuable feedback! 🙌🏻
If you want to see how I use this on my personal portfolio and other lessons I have/am learning, subscribe and follow!