Wise Advice -- Risk parity

Hello friends,

I would like to share an excerpt from a newsletter I subscribe to, Stansberry Digest. Today's edition contains an explanation of how understanding risk parity can improve your investment portfolio returns, lower its volatility, and help you grow your wealth over time. And sleep better at night.

Porter Stansberry:

"I've written about 'risk parity' investing before, but I doubt most subscribers believe me when I tell them what an incredibly powerful strategy this can be.

And what I'd bet almost no one believes is that this strategy can take losing portfolios and turn them into big winners without changing anything else about your investments.

In other words, by only changing the relative sizes of your investments, you can radically increase your likelihood of producing profitable results.

Hard to believe, isn't it?

Well, the world's biggest and most advanced quant hedge funds (firms like Bridgewater and AQR, that emphasize numerical models for identifying investments rather than human reasoning) have used these techniques since the late 1990s to dramatically increase the performance of their portfolios, while decreasing volatility.

So... please... let me show you exactly how you can radically improve your results as an investor without changing anything about what stocks you buy or when you buy them.

Here's the secret:

You decide how many shares to buy and how much capital to allocate to each position in your portfolio by measuring the volatility of each stock. You use volatility as a proxy for risk. And you make sure that each position has the same amount of capital at risk.

Huh? The same amount of capital at risk?

Yes. Let me walk you through it.

Let's say you have a $100,000 portfolio.

If you're smart, you're holding at least a dozen positions. If you put the same amount of capital in each position, that's $8,333 in each investment. And let's pretend that each position has the same amount of risk. That means the average daily change in value of these stocks is probably around 1%. So on average, you're risking $83 each day, on each position. A bad day sees your portfolio fall by $1,000.

But, of course, most portfolios don't contain positions of equal risk.

If one of your investments is a conservative blue chip, like chocolate maker Hershey (HSY), its volatility might be only half of the average. To have the same amount of capital at risk in this position, you'd have to double the allocation, to $16,666.

Or on the flipside, you might have a biotech stock that's twice as volatile as average. To have the same amount of capital at risk, you'd have to reduce your position size by 50%.

In our studies of actual newsletter subscribers' portfolios, we've found that there's no better or more powerful way to increase results than by simply using risk to define position sizes.

The world's top quant hedge funds have found similar results in their studies.

Virtually every portfolio we've ever studied (out of hundreds) was improved by this technique – usually substantially. It even turned losing portfolios into winners. So if you've never had great results with your overall portfolio, this is the strategy I believe will help you the most. This will improve your results more than any other technique we've ever studied.

I know... it seems too simple to work.

It's hard to believe that you can radically improve your investment results by simply changing the amount of capital you put into each stock. But I know it really does work. In fact, it works better than any other technique we've ever studied.

It works because it allows you to buy far more divergent types of investments (like biotechs and gold stocks) without overwhelming your portfolio with volatility. And it forces you to concentrate your investments in the best businesses, which typically have low volatility."

{I measure the volatility quotient (VQ) of my portfolios with TradeStops, an incredibly complete set of portfolio management tools. It's the only way I know how to, actually.}

Bye for now!