Investment strategy 11: Simple ETF Momentum Strategy Using Stocks and Gold

The principles behind this strategy are as follows:

  1. Stocks give higher returns than bonds or other asset classes over the very long run.
  2. If we invest in stocks all over the world and not in one region alone, we are likely to have better returns.
  3. Although gold is thought to have long-term returns of close to zero, one should remember this includes the era when we used a gold standard. If you look at gold returns from 1972 to 2012, they have given an annual compounded return of 8%, which is a very good return. Gold acts as a hedge against inflation and has real value in today’s world of excess money printing.
  4. Momentum works.

The strategy is as follows:

1. The asset classes we are going to use are:

2. We can invest in each of these asset classes in an easy way using ETFs as shown above.
3. Calculate the last one year’s return for each of these ETFs. This can be done using data from morningstar.com( performance).
4. Choose the top 2  or  3  ETFs with the highest return over the past year.
5. Buy equal amounts of them.
6. Hold them for 1 year.
7. Repeat steps 2-6 again.

The historical returns using such a strategy from 1973-2012 are as follows:

  • Top 1-15.38%
  • Top 2- 17.61%
  • Top 3-17.89%
  • Top 4-15.42%
  • Top 5-13.81%
  • Equal weighted-12.67%

The average annualised 10 year returns over the same period are as follows:

  • Top 1: 17.26%
  • Top 2:19.50%
  • Top 3: 18.82%
  • Top 4: 16.17%
  • Top 5: 14.55%
  • Equal weighted: 13.33%

If we use the data from the indices on which the above ETFs are based, from 2004-2012( because we have data for some of the indices only from 2003), the annualised return for the top 3 ETFs is 12%. The annualised return using the original data for the same period is 12.15%.

We can see that this strategy outperforms the equal weighted strategy. The returns of the equal weighted strategy are not too bad either compared to traditional asset allocation strategies. Either of these strategies is better than simply investing in US stocks, But we should be ready for short-term volatility and underperformance but the long-term results are very good( almost Warren Buffetesque like).

If you want to invest using this strategy today, the 1 year returns are as follows:( taken from morningstar.com)

  • US large cap:35.88%
  • US small cap:46.20%
  • EAFE:  31.51%
  • Emerging: 6.04%
  • Ex-US small cap: 23.91%
  • Gold :  -23.43%

So the Top 3 asset classes are: US small cap, US large cap, EAFE. You might feel concerned in investing in stuff, that has gone up in price, but if you can stick it out for the long-term, i.e 10 years or more, you are likely to outperform.

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