Expert Opinions:

  • Warren Buffett thinks investing in S&P 500 over 30 years is a good idea to be completely hands off.
  • Michael Burry of “The Big Short” warned the boom in index funds and ETFs is a dangerous bubble. Not sure if Michael Burry is right, but the US equity market is getting crushed this year. S&P 500 Will probably see an additional 20+% drop in 2023.
    • Burry said the passive-investing trend is hurting small-value stocks and shareholder activism.
    • Passive investing has removed price discovery from the equity markets.
    • So much money going into index funds leads to unsustainable valuations. In other words, price setting without fundamental security analysis means those stocks are overvalued on price and risk.
  • Ray Dalio thinks stock market will probably see an additional 20+% drop in 2023.
  • Wall Street legend Peter Lynch said passive investors are missing out on market-beating returns.

Can I use these expert opinions to my advantage?

  • Do I know with data what general economic cycle we are in (Growth, Recession, or transitioning to growth/recession)?
  • Can I use the economic cycles to adjust my investing strategy?
  • Will these adjustments result in better returns?

Why:

I want to be able to retire quicker. I only want advice from people with lots of skin in the game and a long successful track record (someone like Buffett). Being aware of Loss Aversion Bias (losing hurst more than winning), I don’t want to lose 25-50% of my total portfolio value during downturns/recessions.

How:

Medium term investing strategy (3-5 years) and pivot depending on medium term market conditions. Medium term takes advantage of Michael Burry’s concerns. It invests in small and large caps during growth periods, and sells most index funds during plateau periods. Medium term investing is better than hands off investing because it will provide better returns and has a feedback loop. That feedback loop will help adapt/adjust methodology.

What:

Uses only Vanguard etfs. Uses my modified DCA strategy to buy more during downturns and less during upturns. When the equity market is over-leveraged, ladder selling most of your growth portfolio and pivoting to defensive etfs. When in Growth stage pivot to US small and large cap growth etfs.

What this strategy doesn’t do:

  • This plan/strategy will not protect you against Black Swan events. The only thing that can protect you against Black Monday or unpredictable (and perhaps catastrophic) events is betting against the market on a regular basis. I considered double and triple leveraged short etfs that bet against S&P 500. The problem is that you can lose a lot of money holding these etfs waiting for a black swan or recession event. I thought the equity market was overvalued since 2018. We had a Grey Swan event in 2020 (aka pandemic), and a recession in 2022-2023. That’s 2 years of negative returns to pandemic and 4 years of negative returns until recession. It’s too long to be holding put/short positions.
  • It doesn’t invest in international stocks. Vanguard has large cap VSGX and small cap VSS international funds. I will keep an eye on these, but they haven’t performed very well when compared to their US counterparts ESGV and VBR/VBK

What this strategy does do:

  • You don’t have to become an active investor. Meaning, you don’t have to dedicate tons of time reading and doing financial analysis on stocks. On the other hand, it does require a bit more time invested understanding economic cycles. You have to recognize White/Grey Swans, and economic downturns on the medium term horizon.
  • Feedback loop. Track monthly performance. Re-evaluate and adapt every few years.
  • Be flexible: In practical terms, an investor should always be ready to sell if an investment thesis is broken. The way a bull case fails to deliver can take many forms and should be based on the original thesis. Let my losers become a small part of my portfolio by not adding to them (doing less of what doesn’t work). And I let my winners compound into a large part of my portfolio without interruption and add to them (doing more of what works).
  • Will lose considerably less money during correction/bear/recession/depression economic environments. During bear markets or recessions the S&P 500 will lose 25-50% of its value as the market corrects from overvalued to fair value. (i.e. 2008-2011, or 2020-2023)
  • Will make better average annual returns than S&P 500 during growth years (i.e. 2012-2018). During growth stages the majority of your portfolio will be in small and large growth cap etfs (VBK/VONG). S&P 500: The average annualized return since adopting 500 stocks into the index in 1957 through Dec. 31, 2021, is 11.88%, Adjusted for inflation, the historical average annual return is only around 8.5% (using CPI)
  • Will make less returns during transitionary years (i.e. 2000, 2007, 2019). These are the years that you’re transitioning from aggressive to defensive portfolios. From Small Cap etfs to defensive etfs (Utilities, Gold, Energy). Not all recessions are the same so only shift to oil/energy if the recession has strong inflation characteristics (i.e. current stagflation recession versus real estate crash of 2008).

Risks:

  • Black Swan events. Unpredictable and perhaps catastrophic events. Small caps will lose a higher percentage than big caps during catastrophic events.
    • How do I make this investment resilient and then anti fragile? How can I better tolerate volatility?
      • Keep cash. Feels great to buy during recessions. Also, buy dips during growth periods. Feels great to have cash when the market is going down.
      • Use modified DCA.
      • Let my losers become a small part of my portfolio by not adding to them (doing less of what doesn’t work). And I let my winners compound into a large part of my portfolio without interruption and add to them (doing more of what works). Feed the etfs that do better than other etfs.
      • Be flexible: In practical terms, an investor should always be ready to sell if an investment thesis is broken. The way a bull case fails to deliver can take many forms and should be based on the original thesis.

What do these stages look like:

  • Growth – 45% Small cap growth VBK, 45% Large cap growth VONG, 10-15% in Cash for investments.
    • When coming out of recession (think 2011 or 2025): 80% VBK, 20% VTEB
    • When growth is in high gear (aka Buffett indicator hits 1st overvalued standard deviation) (think 2015 or 2028/2029): Ladder sell half of VBK (up to 40% of total portfolio), sell half of VTEB (10% of total portfolio), then use cash for modified DCA buying VONG.
  • Growth to Defensive Portfolio
    • Buffett Indicator severely overvalued (two standard deviations out or more than 145%): Sell all VBK, Ladder sell most of VONG (Place VONG limit sell at 20% loss, just in case). Keep 10% of portfolio total in VONG. The VONG position is to take advantage of the dumb money during transition periods. Sell VTEB if interest rates are low and fed is expected to raise them. Don’t sell VTEB if interest rates will stay low. Only Buy/Sell VTEB in non-retirement accounts.
    • With cash proceeds, buy VPU (up to 40% of total portfolio).
  • Recession – 50% in cash, 40% Utilities (VPU), 10% in VONG.
    • When Buffet Indicator is fair to undervalued, use modified DCA to buy VBK (up to 80% of total portfolio). Keep 20% in cash.

Alternatives:

  • Why not invest in Berkshire B stock or Vanguard total market index fund(VTI)? S&P 500 index had done better than VTI and Berkshire in the past 10-20 years, and then you’re investing in a lot of companies you don’t want to invest in: Tobacco, Kraft, Oil, McDonalds, Coca Cola, See’s Candy. Do you trust Buffett’s successors to be as good as Buffett? Buffett has also said that if he had less money to manage he’d invest in small and micro caps. He’s stated he could make 30-50% annual returns at that level.
  • How about the Golden Butterfly Portfolio? Excellent defensive portfolio, but lags behind during growth years.
  • Instead of a portfolio that does all in all market conditions, you need one that adjusts to the specific conditions.

Going from consciously incompetent to consciously competent in investing. Regular people will probably never want to dedicate the time and energy that it takes to become unconsciously competent in investing (these are competitive investors, and probably professionals).