Introducing a Universal Portfolio
By Leland B. Hevner
President, National Association of Online Investors (NAOI)
This is the fifth in a Series of articles that show how the NAOI is changing the way investing works today in order to provide individuals with portfolios that produce higher returns with lower risk and absolute protection from stock market crashes.
As the premier provider of objective investing education to the investing public we are a major influencer of how thousands of individuals invest and which financial organizations they choose to work with. The information provided in this Series and in this article is a sampling of what we are teaching to our students.
What Is a “Universal Portfolio”?
Just imagine. What if an investment portfolio existed that worked for all investors without the need for customization? What if this portfolio produced returns significantly higher than those held by most investors today, with lower risk and absolute protection from market crashes? What if this portfolio automatically signaled trades without the need for subjective judgments of market analysts and investing advisors? And what if this portfolio was so simple to use that people could implement and manage it on their own using an online broker? If such a portfolio existed the world of investing would change at a fundamental level, and for the better.
Well, the fact is that this portfolio does exist. Developed by the NAOI based on a multi-year research and development project, it is called the NAOI Universal Portfolio. Via our education courses and published books we are now teaching students how it works and how to use it. The purpose of this article is share with you the same information.
An Overview of Previous Articles in this Series
This is Article 5 in a Series of articles presented on Nasdaq's website showing how the NAOI is evolving the world of investing to better cope with modern markets. The reasons why change is urgently needed are discussed in Article 1. The change needed comes in the form of Dynamic Investment Theory (DIT) as discussed Article 2. DIT creates a new investment type called Dynamic Investments (DIs) that are discussed in Article 3. And Article 4 discusses Dynamic Portfolios that are also discussed in this article. You can access a list of these articles on one page at this link.
A Review of NAOI Dynamic Portfolios
As mentioned above, in Article 4 of this Series I introduced NAOI Dynamic Portfolios (DPorts). DPorts hold both an MPT-based, buy-and-hold Segment and a DIT-based, buy-and-sell Segment as illustrated in the diagram shown below.
The DIT Segment contains one Dynamic Investment (DI), an innovative investment type created by the NAOI that is capable of changing the ETF they hold based on a periodic sampling of market trends. They are described in detail in Article 3. The inclusion of a DI building block in an MPT portfolio makes it market-sensitive and capable of producing higher returns with lower risk than the “static” portfolios that most people hold today. Here are the components of an NAOI Dynamic Portfolio:
A virtually unlimited number of DPorts can be created by defining the variables in this configuration. Via extensive testing, the NAOI has found a set of values for each variable that produce the optimal balance between risk and reward needed to create the NAOI Universal Portfolio.
Defining the NAOI Universal Portfolio
The list below discusses each of the DPort variables along with the values we set for each in order to create the NAOI Universal Portfolio.
- The DIT Segment Allocation % – This is the percentage of investment money assigned to the portfolio’s Dynamic Investment Theory (DIT), buy-and-sell Segment. We gave it a 50% allocation.
- The Dynamic Investment Used – The DIT Segment holds one Dynamic Investment. For the Universal Portfolio we used the DI discussed in detail in Article 3. It simply rotates between a Total Stock Market ETF and a Bond Market ETF based on a quarterly sampling of the price trend of each. It purchases, or retains if already held, only the one ETF that is moving up most strongly in price at the time of the quarterly review.
- The MPT Segment Allocation % – This is the percentage of investment money allocated to the MPT Segment of the portfolio. It buys-and-holds two ETFs with a quarterly rebalancing to maintain their original allocations. We gave this Segment a 50% allocation of investment money.
- The MPT Segment ETFs and their Allocations – In the MPT Segment we placed two ETFs: a Total Stock Market ETF with a 25% allocation and a Bond Market ETF with a 25% allocation which, combined, equal the 50% allocation of total investment money to the MPT Segment.
The final configuration of the NAOI Universal Portfolio is shown below: Note that the specific ETFs we used are shared with our students and the financial organizations we work with.
You can see that this is a comprehensive and self-managing portfolio product. It not only specifies the ETFs to work with but also how they are to be managed on an ongoing basis. And trades are signaled based on objective observations of market data, not on subjective human judgments. As a result, this portfolio can be bought and held by an investor who takes action only when the Dynamic Investment signals that a trade is needed. This is the “default” portfolio that we recommend to NAOI students.
Two States of the Universal Portfolio
The NAOI Universal Portfolio can be accurately described as “market-biased.” It switches between two configurations depending on which ETF, and thus which asset-class, the Dynamic Investment selects at a quarterly review. The two configurations are shown below:
When Stocks are trending up:
When Bonds are trending up:
The ability of the portfolio to automatically change its market-bias to overweight the asset-class that is trending up most strongly is a major reason why it is able to produce returns that MPT portfolios can’t match and with lower risk. This performance difference is illustrated below.
The NAOI Universal Portfolio Performance, 2008-2019
The following table shows the performance of the NAOI Universal Portfolio for the period from the start of 2008 to the end of 2019 as compared to the performance of a generic MPT portfolio for same the timeframe. This is a period that included both a massive stock market crash and an unprecedented stock Bull Market as shown at the left of the table.
You can see that the NAOI Universal Portfolio, by being dynamic and market-sensitive, crushed the returns of the static MPT portfolio. And it did so with far lower risk as indicated by the higher Sharpe Ratio.
How the World of Investing Has Just Changed
The introduction of the NAOI Universal Portfolio (NUP) is a game-changer in the world of investing. Here are just a few of the most impactful changes.
- A Standardized Portfolio Product. By the NUP having the universal goal of maximizing returns while minimizing risks in all economic conditions, it works for all individuals regardless of their risk tolerance. Thus, financial advisors can recommend it to all of their clients as either a complete portfolio or as the Core component of a Core-and-Explore Portfolio.
- The Use of Four Diversification Elements – A critical element of effective portfolios is that they be diversified. The NUP has a massive advantage in this area over MPT portfolios. MTP uses two diversification elements – Company and Asset – both of which reduce risk but also reduce returns. All DIT-based portfolio, including the NUP, use four diversification element – Company, Asset, Time (by the DI periodically changing the ETF it holds) and Methodology (by having both a buy-and-sell Segment and a buy-and-hold Segment). Time and Methodology diversification both reduce risk and enhance returns! Adding two diversification elements to a portfolio is an evolutionary change to how investing works today.
- The Elimination of a Major Risk Element. The NUP signals trades based on empirical observations of market data, not on subjective human judgments. This eliminates a massive human-risk element that is the source of much that is wrong with the way investing works today. Also, by eliminating subjective judgments, the NAOI has transformed the investing process from and “art’ to a “science” and finally made it easily “teachable” to the public.
- A New Portfolio Performance Benchmark. The NAOI teaches our students to use the performance of the NUP as a benchmark to measure the effectiveness of any MPT-based portfolio that they are offered by an advisor. If the MPT portfolio does not provide better performance than the simple NUP (+18% per year as shown in the above example), investors need to ask why they should accept an MPT portfolio with lower performance (+7.4% per year as shown in the above example).
- The Productization of Investing. The NUP is an intelligent, plug-and-play portfolio product; periodically signaling trades in response to market price trend changes. The introduction of this portfolio is the beginning of the productization of investing which opens the doors to a far simpler and more profitable world of investing – for both buyers and sellers.
- Lowering the Stress Level of Investing. Holders of the NUP can simply tune-out the daily barrage of financial news, market forecasts and “expert” recommendations that bombard them on a daily basis and subject them to high levels of stress. Holders of the NUP can rest easy knowing that their portfolio is constantly monitoring the market and signaling the trades needed to profitably react to economic and world events that can affect market prices.
These are just a few of the fundamental changes that the NAOI Universal Portfolio brings to the world of investing. Focus groups of NAOI students who are currently holding the NUP tell us that this is the portfolio type that will enable them to finally enter the market with confidence and without fear.
There Will Be Skeptics
Of course there are skeptics that tell the NAOI that this new investing approach cannot possibly work. It is just too simple and the performance is impossibly high. The NAOI has dedicated an entire Section of our book “An Introduction to NAOI Dynamic Investments and Market-Sensitive Portfolios” (found in the NAOI Store) to rebutting this skepticism. We have yet to hear a valid reason why the use of Dynamic Investments, Dynamic Portfolios and the NAOI Universal Portfolio should not be taught to the investing public as a superior alternative to, or supplement for, MPT-based portfolios and methods.
Summary: Why Are We Teaching this New Approach?
The mission of the NAOI is to empower individual investors. Dynamic Investments and Dynamic Portfolios do just that. Students who have learned this new approach no longer simply accept the MPT portfolios recommended to them by advisors without question, as most people do today. They can evaluate any portfolio they are offered by comparing it to the NAOI Universal Portfolio’s simplicity, returns, risk and fees. Then it is up to the advisor to convince them that their recommended MPT portfolio is better. We give our students the questions to ask and also show them how to rebut any answers that simply aren’t correct.
Financial advisors and organizations need to be aware that if they refuse to offer Dynamic Investment based products, NAOI students and others who learn about this new approach will be able to implement and manage them on their own, using an online broker and NAOI support resources if they wish.
Next Up:
In the next article of this Series I show why investment advisors and financial organizations should welcome the introduction of Dynamic Investments with open arms and how, by offering them, they can increase revenues, capture market share and gain a massive competitive advantage over those that prefer to remain stuck in the past.
Disclaimer: The information provided here is investor education, not investing advice. More information is found at www.naoi.org.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.