Investment strategy 9: Defensive Investor Tactical Asset Allocation

This strategy is inspired by Benjamin Graham’s Investment Strategy for the Defensive Investor.

Benjamin Graham wrote in ‘ The Intelligent Investor’- the best book on investing ever written: The investor should divide his funds between high grade common stocks and high grade bonds. He should keep a minimum of 25% in stocks and a minimum of 25% in bonds at all times. The basic split is 50% in stocks and 50% in bonds. If stocks have gone down a lot , you can increase stocks to 75% and if you thinks stocks have gone too high then decrease stocks to 25%

The defensive investor tactical asset allocation strategy is as follows:

  1. The basic split is 60% in stocks and 40% in bonds at the start of an year. If you start investing in the middle of a year, then use the same split (60% stocks, 40% bonds)
  2. The stock component is divided into three groups: US(20%), Developed International(20%) and Emerging( 20%)
  3. The bond component comprises of 5 year US treasuries.
  4. After one year, if each of stock groups( i.e. US, developed international and emerging) all have positive returns, then keep the same split( 20% US, 20% International, 20% Emerging,  40% 5 year treasuries)
  5. If a particular stock group has a negative return for a year, the for each year of negative return, increase by 4% and decrease the amount of treasuries by the same amount.
  6. If that stock group subsequently has a positive return, then decrease the allocation by 4% each year till you get back to 20% for each group.
  7. You don’t decrease the percentage of stocks in each group to less than 20%, even if you think the market is high.

Some ETFs you can use for the different asset classes are:

  • Vanguard Total Stock Market ETF
  • Vanguard Emerging Markets ETF
  • Vanguard EAFE ETF
  • ishares 3-7 years Treasury Bond ETF.

The returns from following such a strategy are as follows:

  • Annualised return 1972-2012: 11.68%, worst year 2008: -20%
  • Worst 10 year annualised return is 6.94% for the year ending 2008.

If you invested 1/3 in each of the stock ETFs, your annualised return from 1972-2012: 11.75%, worst year 2008: -43.81%

This is a very good strategy for defensive investors. You participate in all the major stock markets of the world and you take advantage of Mr. Market as well.

The detailed returns and how the strategy is implemented is shown in this spreadsheet.