Replies to post #38476 on A.I.M. Users Bulletin Board (AIMUSERS)

[OldAIMGuy]

Hi Allen, Re: Portfolio design and AIM......................

Those three things are what we think about when building the Equity Warehouse.

Time and time again I have to remind myself to pick the right things for the Warehouse. It's like a dating service. AIM has its own personality and it pays to find good partners for it.

As you've figured out, there are far more aggressive volatility capture methods than AIM. Mr. Lichello's model is much closer to Buy and Hold than Day Trading.

My stock selecting ideas in that one AIM-Users.com page are okay for one method of portfolio building. I also managed to build a portfolio of stocks that had good, slow growth and healthy dividends once upon a time. Using AIM to manage that one worked, too. However, the number of transactions was less.

As a general rule, AIM-High works pretty well with higher dividend payers that have low volatility. High growth stocks with little or no dividend are better managed with earlier versions of AIM with deeper pockets of cash for downturns.

It's interesting to watch your AIM mining operation as you go through these old posts!

[ls7550]

Three things are usually considered the basics of investment goals:
1) Price Appreciation over Time
2) Dividend Capture over Time
3) Profitable Volatility Capture over Time

Consider AIM-HI (80/20 initial stock/cash). Broadly the 20% of cash foregoes some opportunity gains - a lower return by being in cash than had those funds been invested in stocks (assuming that broadly stocks > cash over the longer term). Let's assume that cash earns 4% and stocks 8% then that 20% cash earns 4% less, which is 0.8% relative to the total portfolio value. i.e. some of the price appreciation gains are lost through holding cash.

AIM however trades stocks. 5% of stock value minimum trade size, 10% SAFE and assuming a average 80% stock = 4% of portfolio value traded, typically across a 30% hold zone (space between AIM buy and sell levels). 4% of portfolio value x 30% gap between buy and sell trades = 1.2% trading gain for each single pair of AIM buy and AIM sell trades.

A typical stock index AIM might see a average 0.33 buy trades/year (typically that's matched (or exceeded) by a higher number of AIM sell trades). i.e. the 1.2% trading gain in the previous paragraph scales to a average 1.2 x 0.33 = 0.4%/year. Which helps close down the 0.8% lost opportunity cost of holding cash as per the first paragraph above.

Instead of the 8% total return that 100% stocks provides, AIM-HI might provide 7.6% total return. 95% of the reward, for a average 80% allocation to stocks. If inflation averages 4% then 100% stocks yields 4% real, AIM-HI 3.6% real (AIM provides 90% of the all stock gain, 80% of the stock exposure).

Another factor is that cash often earns > dividends. If dividends average 4% but cash earns 5%, then with 80% stock dividends earning 4% and 20% cash earning 5% = 4.2%, 0.2% more than 100% stock dividends. Which closes down the gap between AIM-HI and 100% stock further still.

Instead of 8% total return from 100% stocks, AIM-HI might provide 7.8%. 97.5% of the all-stock reward, when holding a average 80% stock exposure. Or if inflation averages 4% then 100% stock 4% real versus 3.8% AIM-HI real reward = 95% of the all stock reward, for 80% of the risk.

In some cases AIM might encounter two consecutive buy trades in a row, and later (or preceding) encounter two sell trades in a row. Across those pairs one buy/sell pair had a 30% hold zone (trading range) and the other a 40% hold zone (trading range), i.e. higher combined trading gains. Which closes the gap yet further still between AIM-HI and 100% buy and hold.

AIM in effect reduces some of the price appreciation (cash drag), uplifts the income/dividend rewards (cash interest > dividend yield), and adds in a element of volatility capture (trading gains). Which is more diversified that relying upon price appreciation and income reward factors alone (as per 100% stock buy and hold).

Broadly whilst the difference between 100% stock and AIM-HI might be very little (comparable total gains), a big factor is that AIM steers you towards actually making those trades. You're more likely to achieve comparable rewards to 100% stocks in practice, but averaging 80% stock exposure. A common failing of investors is that they don't adjust their portfolios appropriately at the right times, by the right amounts, and often take/make counter-productive measures/actions that result in their portfolio lagging the index (tendency to sell low, buy high due to fear/greed). I've seen published figures of 3% lower average yearly rewards as a general approximation of such human-nature/emotional drive portfolio adjustments. So whilst a index might average 8% total gains and AIM-HI achieve similar in practice, some investors might in comparison achieve just 5% rewards. By the time hidden costs (withholding taxes that funds absorb directly out of the fund value), standard costs (brokers fees, fund managers fees etc) and taxes are all considered, average investor rewards might barely keep up with inflation - such that they might have been better served holding TIPS or iBonds. In contrast AIM users tend to achieve much closer to Index gains in practice.

AIM will advise you how much and when to trade and the standard AIM settings will broadly serve you well. Your job is reduced to deciding what funds/stocks to feed to AIM and to focus on elements you can manage such as tax and cost efficiencies.

A good alternative to AIM is to simply buy and hold 100% stocks using low cost tax efficient methods. In practice however few investors are truly 100% invested in stocks and will instead hold some bonds or bond equivalents (pensions etc), a home ... etc. Where some of those bonds are liquid then you can opt to lend to stocks periodically i.e. run a AIM-HI levelled so that the 80% initial stock allocation in $$$ terms is the same as the 100% stock $$$ amount.

$1,000,000 in stocks, $1,000,000 in bonds/bond equivalents i.e. perhaps a $10,000 inflation adjusted pension which when costed at 2%/year real = $500,000, plus another $500,000 in actual bonds, and you might create a AIM with a $1,250,000 allocation, $1,000,000 in stocks, $250,000 cash. Which might be considered as a 1.25 times leverage factor. Something similar to half of the actual bonds (half of the $500,000 amount) earning stock like gains instead of bond gains. That scaling might partially offset and possibly more the hidden costs, open costs and taxes associated with investing.

Personally I'm not adverse to using leveraged ETF's as part of that. If for instance I was holding $1,000,000 of stock exposure and AIM indicated that should be increased to $1,100,000, then rather than selling bonds (that might be locked into a fixed term), I might opt to sell $100,000 of stock to buy $100,000 of 2x leveraged ETF holdings. IME in this current low interest rate era its common for held bond yields to exceed the cost that leveraged ETF's pay to borrow - such that you can net gains from utilising leveraged ETF's. As and when interest rates rise however that might change.

Here in London the first day of winter was a couple of days ago now, and we've transitioned from one of the warmest Octobers to heavy rain, clocks going back and a distinct chill in the air. Would head off to a warmer climate excepting that I've become a full time family members taxi driver spanning 5am through to 3am. Fortunately fuel prices have dropped recently as visits to the petrol station are (too) frequent. Down from around US$ 8 per US gallon to around $7.50/gallon. [Just found this web site http://www.globalpetrolprices.com/gasoline_prices/ ]