My Macro-style Trend Investing Strategy

When it comes to investing, I love clear rules and simplicity. I don't mind being different from the conventional wisdom. I also have a good grasp on market history, I understand what goes up will come down, and I'm comfortable with losses because of my extremely high savings rate and long time line.

Reading lots about market history across the entire globe and going back to the 18th century has significantly influenced my investment philosophy. I don't believe in using just one strategy for my entire portfolio. I also welcome leverage to amplify positive price movements.

Being several years away from 30, my investment timeline is at least 60 years based on current life expectancy. I don't care what happens this year or five years from now because it's largely irrelevant in the big picture.

Global buy-and-hold could work well for me, like it generally does for anyone with the discipline to stick with it. But, in my quest for being different and willingness to experiment with my own money, I've decided to invest my own portfolio in a very different strategy.

It's important to emphasize that this is not an endorsement of doing something other than buy-and-hold, nor a criticism of buy-and-hold. Pursuing something different means conviction of its benefits, sound knowledge of the strategy, and strict adherence to the rules. Whether you buy-and-hold, or dividend invest, or anything else, rules are important.

Investing is not a game where you dabble in and out of strategies as it suits. It's a commitment to your future well-being with continual development as you learn.

Macro-style Trend Investing

Macro:  very large in scale, scope, or capability; of or relating to macroeconomics
Trend:  the general course or prevailing tendency; drift
Invest:  to put (money) to use, by purchase or expenditure, in something offering potential profitable returns

Macro-style trend investing is what it sounds like: purchasing investments which are large in scale and drifting upwards.

With this strategy I generally don't invest in individual stocks, I don't necessarily buy what is the cheapest, and I follow very specific, but broad rules to determine what I can purchase, when I can purchase, and when I must sell. I also pay attention to tax triggers and trading costs.

Background & Criticisms of Trend Investing

Trend investing is actually a small corner of the retail investing world. When I mention it, people often look confused. It is wildly different from the more popular strategies out there: Boglehead indexing, Buffett-Graham value investing, the gold bugs, Lynch's investing in what you know, and the good old dividend crowd.

These other strategies are much easier to wrap your head around and are very talked about in the investing world. They are all based on popular paradigms and prove difficult to dispute because of herd mentality.

Pure trend on the other hand seems faddy and reckless. Using moving averages, ignoring current valuations, technical charting (gasp!). Some of the most popular jabs in the investing world include poking fun at "chartists".

But the fact is technical analysis has a long history and there are many very wealthy technical investors. I don't necessarily mean highly complex strategies, but basic trend combined with fastidious discipline. Jesse Livermore was a famous early-1900s trend investor who made, lost, made, and lost fortunes worth billions in today's money. Martin Zweig was a more recent example of proficient pure technical investing. Today there are a few technical investors who are billionaires: David Harding, Cliff Asness, Paul Tudor Jones, and John W. Henry (the Red Sox owner) come to mind.

Many of the original trend investors tended to be loners, working in small offices and being intensely private about their approaches to investing. For them, freedom from "noise" was an important element of their success. Successful technical investing requires extreme discipline. Some of the newer big trend investors have become more public because of the "celebritism" surrounding the money management business.

While there are many popular versions of trend investing, many of the criticisms involve day-trading, or similar short term trading. I believe these strategies are poorly thought out; the taxes and trading costs are likely to eat you alive even if your theoretical performance should be good. But that doesn't mean you should throw out the baby with the bathwater and ignore all versions of trend investing.

In macro-style trend investing positions are bought and held for months, if not years. Generally new contributions can be used to buy into existing positions rather than looking for a new signal on a new product. Trend investing is just a set of rules which tell when an asset is acceptable, and when it must be sold.

Risk management is another important aspect of trend investing. Limiting position sizes, continually assessing risk in each position, and using stops are all important.

Converting Academic Research Into An Investment Strategy

The strategy that I developed is unique to me. But that doesn't mean it's purely my own creation. The strategy is based off of work and research done by Antonacci, Jegadeesh, Titman, Faber, Fama, Asness, Covel and other academics or industry professionals.

The difficult part of momentum and trend research is converting that basis of knowledge into actionable strategies which should provide pervasive and reliable returns. That's where the development of my own investment approach comes into play.

The challenging part is using these academic principles without having the powerful back-testing tools available to large institutions. Also, many of the products I use have only been around for 10 years at most. In a broader sense, Antonacci in particular has done a great job of demonstrating the power of momentum going back to 1974. Other academics have now gone back hundreds of years, even using old bond market data.

In truth, I don't believe there is a perfect investment strategy that exists. Back-testing, while important, can always be tweaked and prodded to find anomalies. However, using the principles, I believe there exists a potential for great performance.

There's also some wisdom in running more than one strategy. I personally divide my portfolio into two smaller portfolios. It keeps a clean separation and reduces the temptation to peel money away from the strategy that performed the poorest in the more recent past.

My 10 Rules: Macro-style Trend Investing

1. Invest in lower cost broad country, region, or asset class index ETFs as appropriate, large cap stocks can be used if they are representative of the asset class and the index ETF is not liquid;
2. Except for bonds, U.S., EAFE, or Emerging index funds no new position can be more than 20% or less than 10% of the portfolio;
3. New purchases must be trading above a predefined moving average or breakout, longer timelines are better at eliminating noise;
4. Avoid new purchases of broad indices with extremely high Shiller-CAPE ratios even when they're in an uptrend;
5. Each position must be sold when it trades below the predefined moving average;
6. Use stop-loss orders where you can to avoid doubting sell signals;
7. Each position should be held until sell signal, except when partially sold to manage risk;
8. Hold no more than six positions in the total portfolio to keep costs down and the portfolio easy to manage;
9. Consider using leverage with a wide safety margin, if available at a low cost;
10. When no eligible positions exist, hold short-term government bonds, tax-efficient bonds, or cash.

What the Portfolio Looks Like

The end result of this strategy is you would generally hold somewhere between two and six broad positions in the portfolio. Sometimes the portfolio will be in all cash or bonds.

You would enter a position when it hits a new high based on one timeframe and potentially add to that position if it hits a new high on a longer timeframe. The inverse happens when selling.

While draw-downs will occur, their overall effect on the portfolio will be limited due to the sell signals. Price breakouts, moving averages, and position risk management can offer a nice amount of protection from large and extended drawdowns. While whip-saws occur in approximately one-half of all trades made, on the big moves the new entry price will be lower than the price the position was sold at.

It's impossible to perfectly time the markets, but using the Rules it's possible to sell before getting hit with long bear markets and buy only months after the markets turned around. In my view that's a pretty reasonable compromise.

Comments & Questions

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Transitioning to an ETF Retirement Portfolio

Growth Portfolios built with ETFs look a bit different from income-oriented Retirement Portfolios. Since we invest keeping growth in mind throughout our working lives, as intended in the Growth Portfolio's design, how do we make the transition to a Retirement Portfolio?

You want to think about this transition well ahead of time to be tax smart and prepare yourself financially and emotionally for retirement.

To avoid getting whacked with taxes, you should avoid selling any investments in your Cash/Margin accounts. Try to fund your desired portfolio with new savings and existing dividend/distribution income.

Target Savings Towards the Portfolio You Want

The first step is to assess your own assets currently and pick the Retirement Portfolio that you want to go with. Don't forget that your assets do not just include your portfolio. You should also consider your home, small business, shares in other businesses, or any other investments you may have. Many people sell some (or all) of these assets in retirement and they are often sold with tax advantages built in.

If you plan to significantly downsize your home and sell your small business, you might find yourself paying little to no taxes on these transactions. The realized value might be enough to fund the required components of your target Retirement Portfolio.

Generally, when shifting your portfolio, you will need to buy 10% each of short term bonds and preferred shares. You may also need to buy corporate bonds and REITs. This can add up to 40% of your total, and still growing portfolio, which is a substantial amount of money.

If you're not going to free up assets in other areas, you will have to fund these components from your current savings as you approach retirement. Also use your distribution income from current investments. Depending on your savings rate, you will need 5 to 10 years of saving before retirement to purchase to these missing components.

First Steps to Take

I would start with the Cash Cushion, which typically should be held in your Cash/Margin Account. (Remember to open two joint Cash/Margin accounts if needed for tax efficiency.)

Direct all savings to short-term bonds until the Cash Cushion is worth 10% of your total portfolio value. The cushion will come in handy in any bad situation as you approach retirement and the interest income is quite low so it won't substantially impact your tax bill.

After the Cash Cushion is built up, you should take a step back and look at your entire account picture. You want to make sure you are tax-optimized for retirement as tax savings will reduce your drawdowns and increase your success rate.

Account Type Considerations

You will have a TFSA, probably RRSPs as well, and a non-registered (Cash/Margin) investment account. In retirement you want to make sure Canadian dividend income will be realized in your Cash/Margin accounts and interest income in your RRSPs.

Remember you can shift your ETFs within registered accounts without affecting your taxes. Just don't make any account withdrawals!

The next step is building your preferred share allocation. Preferred shares should be held in your Cash/Margin accounts as they generate tax-friendly Canadian dividend income.

After this, it is likely you will need to start selling some assets within your TFSA & RRSP accounts. For example, if your Canadian stock ETF is in your RRSP, sell a chunk of it within the account each year. Use your new savings to buy Canadian dividend ETFs in your Cash/Margin accounts. Within the RRSP, buy your 10% corporate bond allocation instead as it generates interest income.

I believe the best place for REIT allocations is in your TFSA accounts. REIT income is a mixed bag of income types which are all taxed differently and come in different proportions from year to year. Approaching retirement, use your new TFSA contributions to buy your desired REIT allocation.

Final Touches

When retiring, you should make your final account shifts to achieve your final desired allocation and make sure the right ETFs are in the right places for tax efficiency.

This means you will be doing some buying and selling within your registered accounts. Use my tax guide to get an idea of proper allocations.

  • All bonds (except the Cash Cushion) should be in RRSP accounts.
  • Canadian dividend paying ETFs should be in Cash/Margin, or TFSA if you don't have a Cash/Margin account.
  • Foreign stock ETFs can be in your TFSA or RRSP first. If you need to have them in Cash/Margin accounts consider swap-based ETFs.
  • If you have a larger RRSP filled with U.S. corporate bonds and your U.S. stock allocation, be smart and switch to a U.S. dollar RRSP and hold comparable U.S.-listed ETFs to save on withholding taxes.

Summary

Planning ahead and giving yourself plenty of time to make the right moves will make things a lot easier in retirement. For an average couple in retirement with full TFSAs, healthy RRSPs, and Cash/Margin accounts generating Canadian dividend income, your income taxes should be super low (around 10%).

Investment assets of $1 million generating $40,000 a year split between two people, plus CPP/OAS income, should add up to a total tax bill of less than $5,000 in BC, AB, SK, or ON. That's less than a 10% tax rate when averaged over all income. It can be even $0 with certain account setups.

OAS is really a form of negative tax as it's a government benefit which you don't directly contribute to. Although it's a taxable benefit, often your after-tax OAS income will exceed the taxes on your CPP and investment income. What a fantastic country to grow old in!

If you own a small business, work with your CPA and a good financial adviser to plan your shift to retirement allocations well in advance. Proper planning can save you tens of thousands in taxes.

Comments & Questions

All comments are moderated before being posted for public viewing. Please don't send in multiple comments if yours doesn't appear right away. It can take up to 24 hours before comments are posted.

Comments containing links or "trolling" will not be posted. Comments with profane language or those which reveal personal information will be edited by moderator.