Rules-Based

Investment Models

 

We believe in using a process for investing.  This process can include using rules-based investment models (RBIM).

Using RBIM eliminates emotional trading because it establishes pre-determined parameters for what to invest, when to buy, sell, or continue holding the investment.

When evaluating an investment, analyzing total return isn’t the only metric you should use.  It is important to also look at risk.  Two measures of risk are volatility and drawdown.

 

  • What if a large drawdown happens just before retirement?

 

  • Will you be able to regain your investment?

 

  • What if it happens while you are taking withdrawals from your account?

 

  • Can your account sustain the withdrawals during the down market?

 

While no investment is guaranteed to be profitable and past performance is no guarantee of future performance, managing risk can help prevent losses.

Volatility

is a statistical measure of the dispersion of returns for a given security or market index.  The higher the volatility, the riskier the security.

 

Drawdown

is the peak-to-trough decline during a specific record period of an investment.

 

More about Rules-Based Models

How are the models created?

The models are created using a set of rules for investing.  We then back-test the rules using data for a full market cycle or longer to verify the results of the rules.

What is back-testing?

Back-testing is applying the rules of the model to historical data to determine if the results will be favorable in all market conditions.  Back-testing is not actual investing.  By testing the results, we can determine how the model could react in future market conditions.  However, we are not predicting the future.  Past performance is no indication of future results.  Gains are not guaranteed; losses are possible.

Who makes the trading decisions?

The trading decisions are made by the investor following the rules of the model.  Trades are not made on a whim, meaning the investor doesn’t decide when to make the purchases or sells or to deviate from the rules of the model.  The rules are followed no matter the current market conditions.  If an investment drops after a rebalance, the model will continue to hold the investment until the next rebalance.

When do the models rebalance?

The stock models rebalance weekly.  The ETF models rebalance on a monthly basis.  But remember, a model may select the same investment currently held.  Back-testing has shown that rebalancing more often than once a month for ETFs can make the models too sensitive to market noise.  Rebalancing longer, for example, quarterly, causes the model to hold a losing position for a longer time frame.

Why should I use rules-based investing?

Studies have proven that investors get emotional when investing.  Various conditions such as herding, loss aversion, and being scared of repeating past mistakes can prevent investors from making the right choices when investing.  By following a set of pre-determined rules investors are more likely to reach their investment goals.

Do I have to use the models?

No.  As a client of Drawbridge Wealth, you have access to model investing but it isn’t a requirement.  As an investment advisor, I will review your tolerance for risk, goals, time frame for investing, and more to determine the best strategy for you.