A.I.M. Users Bulletin Board

[ls7550]

Neko

If you'd invested 100% into a total stock market index between 1972 and 2009 (inclusive) then you'd have encountered a total (including dividends) annualised gain of 9.73% or 5.05% real (after inflation). The standard deviation was 18.78% which is an indicator of how much the returns bounced around over time and is often considered as representing risk.

In contrast had you instead fully invested in 5 year treasury (which might be considered as a form of 'cash' like investment) then the annualised was 7.89% (3.28% real) with a 6.83% standard deviation.

An equal blend of the two, yearly rebalanced back to 50:50 weightings yielded 9.31% annualised gain (4.64% real) with a 10.21% standard deviation.

The point to note is how 100% all in stocks yielded only 0.42% more each year than having invested only half in stocks, half in 'cash'. Whilst the risk was nearly half (18.78 std. dev versus 10.21 std. dev).

If, instead of maintaining a fixed 50% allocation to each of stocks and cash, you perhaps periodically moved 10% from cash into stocks when stock prices were relatively low, and then sold that stock at a later date when stock prices were relatively high, such that perhaps a 30% difference in price between buying and selling, then a 30% gain x 10% of funds exposed to that gain = 3% of total fund value benefit. Such 30% ranges occur relatively frequently, for example most stocks prices typically have something like a 40% range between their year low and year high price levels.

You don't have to follow this precise buy and then sell sequence and might instead perhaps sell 10% first at a relatively high price and then later buy back 10% at a relatively lower price. Or you might even encounter a couple of buys before later encountering a couple of sells.

A simple low cost index tracker is a reasonable investment alone as it distances you from single stock risk. Blending the index tracker with some cash further reduces risk, but can still achieve reasonable gains overall. Adding in a bit of additional trading - increasing exposure when prices are relatively low, reducing as prices are relatively high, can further enhance rewards. This latter 'trading' part however is probably the most difficult to implement correctly and is where AIM steps up to advise us both when to trade and how much stock to add or reduce at each such trade.