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Sunday, 2 August 2020

Implementing the "12% solution" trading system on a small ($10K) portfolio as an experiment

A few years ago I bought an eBook by David Alan Carter called "The 12% solution" (the Kindle edition only costs about five bucks, so its good value) and was interested in his method of tilting a simple asset allocation each month according to his calculated trading signals. Having bought the book I get a free monthly email at the end of each month telling me what asset allocation the method has decided is 'best'. The assumption being that you trade asap (the next trading day) to move your portfolio allocation to the new recommended mix.

I was going to start trading a test portfolio using these monthly trading recommendations a few years ago on my CitiIndex CFD tradining account, but discovered that not all the assets used in the 12% portfolio were available to trade. So I put the idea on the back burner.

When I received this month's email, showing that the '12% solution" portfolio 2020YTD performance is +18.1% and for 2019 was +12.4%, I decided I might try to test this methodology on a small scale using $10,000 of borrowed funds (from my St George 'portfolio loan' account, currently charging 4.98% pa interest, which is tax deductible as I use it for income producing investments) and trading on my newly opened IG share trading account. The IG account currently only has a balance of $468.85 and is invested in the Asian Tigers technology fund (code: ASIA). I'll use the $10,000 I've added to the IG account to make the recommended investments: 60% QQQ + 40% JNK.

Trading using the IG account costs $8 per Australian share trade (if 0-2 trades were made the previous month), and I saw a mention that US share trades on the IG platform cost $0 (not sure if that is correct - there are probably some other costs involved). With only $10,000 invested, an annual return of 12%, minus the 5% loan interest costs, would yield an expected net 7% return ($700 pa). Making an average of two trades per month (assuming I have to sell one holding and buy another most months), would cost up to $16 per month, or $192 pa. This would mean that I would mostly be making money for St George (interest) and IG (trade fees), and I might end up with a taxable profit of only $508 pa, which is hardly worth the effort and extra work when filing my annual tax returns.

So I might reduce trading frequency to every second month, which would halve the trading costs (Carter apparently tested different trading periods, such as bi-monthly or quarterly, and decided that the monthly trading cycle provided the best returns, but with a small account balance, frequent trades will have a larger drag on performance). What impact trading every second month will have on the portfolio performance is unknown. Trading every second month will obviously produce somewhat different results, but, as the trading signals are a 'point in time' calculation of the 'best' allocation to make, there is no reason why it should be much worse to hold that allocation for two months rather than just one month before rebalancing to the current recommendation.

We'll see how it goes. I might increase the amount invested (which will reduce the relative impact of the trading fees) if actual results go according to 'theory' for the next year or two.

In terms of how I've mapped the recommended ETFs in the "12% solution" portfolio to what is available to trade in the IG platform, I decided to use the following:


"12% solution" ETF list <> [ IG share trading platform ]

IWM - iShares Russell 2000 Index Fund <> [iShares Russell 2000 ETF]

MDY - SPDR S&P MidCap 400 Index Fund <> [SPDR S&P 200 Mid Cap Growth ETF]

QQQ - PowerShares Nasdaq-100 Index Fund <> [ProShares Ultra QQQ]

SPY - SPDR S&P 500 Index Fund <> [SPDR S&P 500 ETF Trust (All Sessions)]

JNK - SPDR Barclays High-Yield Corporate Bond Fund <> [SPDR Barclays High Yield Bond ETF]

TLT - iShares 20+ Year Long-Term Treasury Bond Fund <> [iShares 20+ Year Treasury Bond ETF]

CASH - cash or the SHY 1-3 Year Treasury Bond ETF <> Cash or [iShares 2-3 Year Treasury Bond ETF]

For many of the codes provided for the "12% solution" there were multiple similar investments listed for trading in the IG platform, so I've picked whichever one seems closest to the correct description and put that on a watch list in the IG platform so I can buy and sell the chosen units each month.

There will probably be some additional complications when I try to implement this portfolio within my IG account - for example the buy costs may not allow the exact percentage allocation recommended by purchased, so I may have a small residue sitting in 'cash' each month (earning 0% but costing me 5%pa in interest!)

The current unit buy prices are:

IWM  $ 147.61
MDY  $   57.08
QQQ  $ 169.68
SPY  $ 327.03
JNK  $ 106.10
TLT  $ 171.00
SHY  $   86.63

As soon as the $10,000 I've transferred from my St George Portfolio Loan account is available in my IG account I'll try placing buy orders for 35.36 units ($6,000) of 'QQQ' and 37.70 units ($4,000) of JNK.

As a benchmark I'll track my actual IG account balance each month vs. how an equal-value allocation to the seven listed securities performs. I'll also compare how my actual implementation performs compared to the performance reported for the 'ideal' implementation of the "12% solution" that is reported in the monthly email notifications.

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