Finally! The World of Investing Evolves
As President of the National Association of Online Investors (NAOI), I have taught thousands of individuals the basics of investing. Starting in 1997 with the founding of the NAOI I taught the use of Modern Portfolio Theory (MPT) to design portfolios. The MPT approach advocates using asset allocation to diversify away risk in order to match an investor's risk tolerance. Once designed MPT says to simply buy and hold the portfolio for the long term.
Because of its buy-and-hold strategy MPT portfolios are static investments in a dynamic market. As a result they simply don't work in today's volatile markets. They neither enable the holder to capture the positive returns potential that exists at all times somewhere in the market nor do they protect investors from the inevitable, periodic market crashes like the one we saw in 2008. During that time many investors lost up to 50% of their portfolio value. Yet, MPT is seen today by the financial industry as "settled science" and rarely if ever questioned. This needs to stop.
Markets Have Evolved - Investing Methods Have Not
The chart below shows the source of the problem. It presents the price of the DOW Industrial Average (a stock index) from 1950 to present day. It also shows that Modern Portfolio Theory (MPT) was introduced into the market in 1952. It is stunningly obvious that MPT was designed to work in markets that were far different than they are today. Since 1952 markets have evolved significantly. Today's trading volume is exponentially higher than it was 70+ years ago and volatility has increased proportionally. In addition, there are a plethora of new market forces and world catalysts that can move its price dramatically in short periods of time. Add to these factors the existence of many more investment types, the speed with which trades can be made and the advent of computerized trading and the world of investing today bears little resemblance to the one that existed in 1952. Yet we still use MPT to cope with it. And this is a problem.
Markets have evolved while investing methods have not. The financial services industry still gives us static, 1950's style MPT portfolios to deal with increasingly dynamic 21st Century markets. We should not be surprised that this theory produces portfolios that are totally inadequate for dealing with modern markets. This fact prompted me to search for a "next-generation" investing theory and and updated investment type that do work in today's markets.
Dynamic Investments - A Next Generation Investment Type
The NAOI and I began our search for an updated approach to investing in 2008. Following 4+ years of research, testing and development we found it in the form of Dynamic Investment Theory that you will read about on this site.
Dynamic Investment Theory (DIT) creates a Next-Generation investment type in the form of NAOI Dynamic Investments (DIs). DIs are unique. The world of investing has never seen an investment like this. It is the first comprehensive investment product that is sensitive to market movements and are capable of automatically changing the Exchange Traded Funds (ETFs) that they hold based on market trends. In this new world of investing trades are made based on scientific methods and empirical observation of objective data - not on subjective human judgments that are at the core of much that is wrong with investing today.
Dynamic Investments are built using a fundamentally different approach to investing than is used today. Whereas MPT portfolios have as their goal matching an investor's risk profile, DIs have as their goal capturing the positive returns potential that exists in the market at all times and in all economic conditions. They does so by periodically and automatically sampling market trends and buying only Exchange Traded Funds (ETFs) that are moving up in price while selling or avoiding those that are moving down. Thus DIs are the dynamic investments needed to cope with, and take full advantage of, dynamic markets. And because DIs have a universal goal that all investor's want to meet regardless of their risk tolerance, DIs are investment "products" for the masses with no customization needed.
As a result of having a common goal for all investors, DIs "productize" the world of investing. This is the Holy Grail of Investing that financial thought-leaders have been seeking for decades and haven't found. The NAOI has found it and so will people who read The Dynamic Investment Bible and/or take advantage of NAOI education classes and/or consulting services.
In addition, Dynamic Investments are the industry's first comprehensive / self-managing investment. Once designed, DIs go on autopilot, making trades periodically and automatically based on empirical observations as opposed to subjective human judgments. This breaks the unhealthy bonds of dependency that investors have today on financial advisors who are also salespeople. Individuals can simply select a Dynamic Investments from a menu of a company's product offerings and hold them for the long term. The DI will make trade decisions needed to take advantage of positive market movements and to protect investors from negative movements; all without human intervention. Investments that automatically make trades based on logical and proven scientific methods as opposed to fallible human subjective judgments will convince millions of average investors to enter the market with confidence.
A Comparison Table - MPT Portfolios vs. DIT Dynamic Investments
The following table shows just a few of the major differences between Dynamic Investments and traditional portfolios created using Modern Portfolio Theory (MPT) methods. DI's are not your father's investment type!
The Performance Difference: 2007-2016
The NAOI spent years testing various dynamic approaches to investing. And it came as no surprise to us in the end that the best performing approach was the simplest. Let's take a quick look at the performance of a very basic MPT portfolio as compared to the simplest possible NAOI "Core" Dynamic Investment from 2007 to mid-2016 when these word were written. The performance numbers shown below are the average annual return for the period along with its Sharpe Ratio. The Sharpe Ratio is a measure of the amount of return earned for each unit of risk taken - the higher the better.
A Basic MPT Portfolio. For the backtest period the NAOI tested the performance of a traditional, MPT asset-allocation portfolio with a 50% allocation of money to a total stock market ETF and 50% allocation to a total bond market ETF. Here is the performance:
- Average Annual Returns: +7.3%
- Sharpe Ratio: 0.53
The NAOI "Core" Dynamic Investment. This backtest used the simplest possible NAOI designed DI that holds at any one time either a stock-based ETF or a bond-based ETF, but never both, depending on market trends. The DI automatically sampled the market quarterly and bought (or held if already owned) only the ETF with the strongest uptrend at time of review.
- Average Annual Returns: +24.5%
- Sharpe Ratio: 1.13
The benefits of using dynamic investments to deal with a dynamic markets are obvious. The performance difference is night and day. As a side note, during the crash year of 2008 the NAOI Core DI earned +33% while most MPT portfolios lost up to 50% of their value! In addition, the NAOI has designed Dynamic Investments that averaged in excess of +32% annually during this backtest period.
Summary - The Dynamic Future of Investing
The simplicity and performance of NAOI Dynamic Investments tell us that this is the Next-Generation investment type that will replace static MPT portfolios in the future of investing.
Obviously individual investors will benefit from the use of DIs via their higher returns and lower risk. But financial organizations will benefit from the use of DIs as well. DIs will bring into the market millions of individuals who are currently on the sidelines in fear of another crash like they experienced in 2008.
The NAOI will teach the public about Dynamic Investments via The Dynamic Investment Bible and our education classes. This will create massive public demand. The Financial Services Industry will learn how to profit handsomely from this new public demand by taking advantage of NAOI consulting resources.