A.I.M. Users Bulletin Board

[OldAIMGuy]

Hi Jake, Re: Assessing Market Risk directly vs indirectly....................

AIM does a magnificent job of moderating market risk by selling into market strength (tempering irrational exuberance) and buying into weakness (shopping for bargains) when applied to broad market indexes. Clive's work shows this well with AIM's performance being quite close to Buy and Hold's over multiple investor lifetimes. AIM manages this with far better Return on Capital at Risk (ROCAR).

Further, Clive's work takes into account regular withdrawals for "Living Expenses (SWR)." This is something that Mr. Lichello's examples never attempted to do. For those of us who are still employed, this isn't probably what we're doing, however. For those of us who no longer have a source of earned income (retired), Clive's work adds a heavy dose of reality to an AIMer's goals.

Another aspect that Clive's work presents is the unavoidable aspect of governmental debasing of currency over time. Referred to as "inflation" doesn't change its meaning or nature. A quote from a famous AIM user, (Me!) serves as the underlying root of this problem:

Never, ever, has there been a government that, given enough time, didn't debase its own currency."
- Thomas Meldrum Veale

Something I've meant to examine in Clive's work is the annual rebalancing of an AIM Portfolio back to the Equity/Cash ratio suggested by the AIM-Index Portfolio. Where does the divergence occur? Is it driven by currency debasement alone? Is it a combination of debasement and withdrawal rate for living (SWR)? Or is it mostly driven by withdrawal for living (SWR)? I think the answer is that it varies over time in relationship to inflation. High inflation rates would drive the need for the Equity/Cash ratio to be modified during those years and the SWR would be the driving force in other times. It would be interesting to know what the average annual Equity/Cash realignment has been over the test period. In other words, how well did AIM do all on its own compared to the AIM-Index Portfolio?

Using the AIM-Index Portfolio as a risk measure for suggesting starting and ongoing cash levels in a real time investment could be compared directly to the v-Wave and the MRI (formerly Idiot Wave) for the data since January of 1982. That's the earliest we have for these data streams. If there was a 'problem' with Mr. Lichello's original AIM, it was the One Size Fits All cash reserve (actually three different One Size Fits All guesses).Further, AIM's Equity/Cash ratio of an ongoing investment was not sensitive to the performance of the Equity side vs the performance of the Cash side. During times of higher cash yields, AIM's reserves of cash appear to contribute nicely to overall performance. However, that's offset by whatever the inflation rate is during that same period. This negates or washes out this apparent yield advantage. AIM can be a good judge of Market Risk. AIM Cash's value is only realized when it's put to use rebuilding investment inventories. Having an non-AIM based opinion of market risk for verification of AIM's assessment can add significant comfort to an investor's mind. Plotting the three measures
1) AIM-Index Portfolio Cash
2) MRI Cash
and
3) v-Wave Cash
side by side could be telling in confirmation and accuracy for the last 40+ years.

AIM's Equity side can only perform as well as the underlying investment during times of no AIM designated trades. AIM only has the chance to out-perform the underlying investment by inventory adjustment (buys and sells) over time. The Portfolio's total performance is the combination of the Equity side performance and the Cash side performance. If the Cash side underperforms the Equity side then it acts as a performance dilutant (upward sloping market performance). If the Cash side is outperforming the Equity side, it acts as a buffer as long as it lasts (downward sloping market performance).

I think Clive's work has enhanced the understanding of AIM's long term performance as compared to Buy and Hold. Buy and Hold isn't what a retired person will do if the Withdrawal rate (SWR) is necessary for living expenses. So, his work is far closer to reality than simple Buy/Hold comparison. Our Equity Warehouses are a combination of businesses - Warehouse Inventory Management and Savings & Loan. Like any business, it has fixed costs that should be recognized (such as living expenses) which Clive represents well with his SWR. Our Warehouses operate in the Real World, so are sensitive to disruptive influences such as Inflation (currency debasement). Luckily, the warehouse's inventory can offset some or all of the inflation over time through growth.

Going back to a book report I wrote some decades ago helps to flesh out our Warehouse activities:
https://web.archive.org/web/20120830055138id_/http://www.aim-users.com/books.htm#b6

Best regards,
OAG Tom