New portfolios – one risk added, one risk removed

[ikoskela]

Regarding the shift from individual stocks to asset class-based index funds, one risk has been added and one risk has been removed.

One risk that has been added is that, by using leveraged index funds, you are overweight the highly capitalized stocks that are dominating these indexes. Do the built in leveraged hedges compensate for this overweightedness? Backtesting may not fully capture this phenomena so I’m not sure. For instance, today, indexes are down, led by their overweight leaders (MSFT, AMZN, etc) but the old Aggressive portfolio is unaffected with TMUS and VZ are carrying the load, up 6.25% and 1%, respectively.

One risk that has been removed substantially is survivorship bias. As discussed last month, strategies backtested using individual stocks suffers from having picked from a pool of survivors so naturally the performance will look better than if the delisted stocks had been included in the pool. Trading asset classes reduces this risk since asset classes generally don’t suffer from the survival vs delisting issue — the pool is consistent. (I learned this from AllocateSmartly.)

I’m currently splitting my portfolio 50/50 between the old Aggressive Risk portfolio, that mixes individual stocks and leveraged funds (using 2x GLD via DGL), with an unleveraged index-based portfolio.

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