|
The Risks of Investing (in SweetSpot
and Otherwise)
The major risk we face as SweetSpot
investors is "market risk." If the broad stock market is declining, we can hope to decline by less or maybe even profit a
little, but we are unlikely to do well in absolute terms. We won't be all that happy about beating the market by 10 points
if the market is down 20 points. That means we lost money, never a good thing...
We can be confident that SweetSpot
will do well in the long run, both in absolute terms and relative to the market. The short run, however, is anybody's guess.
Therefore, investors should only invest money they won't need for 3-5 years, and longer is better. But if you're weighing
the risk of SweetSpot investing against the supposedly lower risk of other approaches, including an index fund that tracks
the overall market, consider this:
Commonly used risk measures tell us that the SweetSpot approach exposes us to less
risk than the market. An investment's "standard deviation" is a measure of past ups and downs. SweetSpot's is slightly lower
than the market's (that's good). But this measure has a flaw: it penalizes an investment for both upswings and downswings.
SweetSpot fares much better when we measure risk after filtering out the upswings that investors find desirable. Back-testing
showed that we can expect to suffer through half as many double-digit price drops as the market while enjoying almost twice
as many double-digit upswings. Less pain, more gain...
There is also a measure called the "Sharpe ratio" that attempts
to reduce risk to a number. Here a higher number is better, and SweetSpot's is 0.89 to the market's 0.53.
That's nice, but for most investors
the true test of risk is: "Will I lose money?"
It helps to know that the chances
of losing money are far greater when an asset is overvalued, which we know SweetSpot investments are not. Still, back-testing
showed that we should expect to suffer an occasional losing trade. Every now and then, maybe we'll see a chart that looks
like this:
After Japan and the Pacific Basin were bought as SweetSpot picks in December
2000, their performance resembled this chart. Yet both positions were profitable by the time they were sold in January 2004,
while the market showed a loss during the same period. Now consider that SweetSpot's reported performance is based on the
date a trade is first entered. Only when the price goes down from there can we improve upon that performance (by adding shares
at the lower "Actual Sweet Spot" price).
Maybe we should be rooting for a weak start every time, as long as we're
confident that we'll recover by the time we sell. We can't be certain of that, but note that in eight full years of real-time
trading, SweetSpot has never lost money. Given its favorable risk/reward profile, its broad diversification across market
sectors, and its hands-off nature, the SweetSpot Investment Strategy looks like it might be suitable for an investor's entire
stock portfolio.*
|
