Timing is everything when it comes to retirement investing, but most people do it wrong. Let’s explore a research-backed trend-following strategy for retirement investing that has helped many avoid big losses and participate when the market goes up.

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The Classic 60/40 Portfolio: A Cautionary Tale

Many new clients believe in the classic 60/40 portfolio, which consists of 60% stocks and 40% bonds. This traditional strategy can be effective, but it’s not foolproof. For instance, in 2022, a portfolio with 40% US stocks, 20% international stocks, and 40% 7-10-year treasury bonds was down about 16%. Both stocks and bonds declined significantly, a big drop for a moderate investment strategy. If you’re withdrawing income from your portfolio, such declines can be even more detrimental.

The Dilemma of High Returns and Low Risk

Everyone desires high returns with low risk, but investments like the S&P 500, which offer high returns, also come with high risks. Losses of 20% are not uncommon, and drops of 30-40% can occur. The challenge is to earn high returns while limiting risk.

The Myth of Market Timing

Perfectly timing the market is nearly impossible. Relying on gut feelings or hunches, like moving everything to cash based on a relative’s advice, is a recipe for disaster. However, there is a solution rooted in academic research: a trend following strategy for retirement investing. This strategy helps investors participate in market upswings while avoiding large drawdowns.

Understanding the Trend Following Strategy for Retirement Investing

A trend-following strategy for retirement investing is simple and can be implemented using low-cost index funds. There are two key rules:

  1. Absolute Performance: Compare an asset class against another asset class. When an asset class performs worse than cash, move to cash. For example, in 2008, US stocks performed worse than cash, so you’d move to cash. In 2009, when US stocks performed better than cash, you’d reinvest in the S&P 500.
  2. Trending Performance: Compare an asset class to itself using a moving average. When an asset class trends downward, move to cash. In 2008, US stocks trended downward, so you’d move to cash. In 2009, when they trended upward, you’d reinvest in US stocks.

Historical Performance of Trend Following Strategy for Retirement Investing

Alpha Architect tested these rules from 1976 to 2014 on various asset classes: S&P 500, international stocks, 10-year US Treasury Bonds, real estate, and commodities. Let’s compare the performance of buy-and-hold vs. a trend-following strategy for retirement investing:

  • S&P 500: Trend following provided nearly identical annual returns (11.71%) as buy-and-hold (11.74%) but with half the drawdown risk.
  • US Treasuries: Trend-following yielded slightly better returns with significantly lower drawdown risk.
  • International Stocks: Similar outperformance and reduced drawdown risk with trend following.
  • Commodities and Real Estate: Trend-following massively outperformed buy-and-hold, especially during inflationary periods like 2022.

Implementing a Trend-Following Strategy for Retirement Investing

The best part is that a trend-following strategy for retirement investing can be executed using low-cost ETFs, without the need for expensive investment products. However, there are important considerations:

  1. Tax Implications: Trend following involves frequent trading, which can lead to significant realized gains in brokerage accounts, eating into after-tax returns. It’s best suited for retirement accounts.
  2. Tracking Error: This strategy won’t mimic traditional benchmarks. There can be long periods of underperformance, making it difficult for some investors to stick with it.

Strategic Allocation

Not everyone should allocate their entire portfolio to a trend-following strategy for retirement investing. A balanced approach might involve allocating a portion, say 10%, to trend following, while the rest remains in a buy-and-hold strategy. This provides diversification and protection during large market declines.

Conclusion

A trend-following strategy for retirement investing offers a data-backed approach to enhance retirement investing. While it may not be suitable for everyone, understanding and considering this strategy can provide significant benefits. Always consult with a financial advisor to determine the best strategy for your specific retirement income needs.

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This does not constitute an investment recommendation. Investing involves risk. Past performance is no guarantee of future results. Consult your financial advisor for what is appropriate for you. Disclosures: https://onedegreeadvisors.com/solutions/#disclosures

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