Many investors like to be invested in the leading sector and specialty funds and exchange-traded funds, but the hair-raising volatility of these funds can make it difficult for investors to stick with their investment strategy. Although the goal of all equity investors is to sell their investments for more than they paid for them, many investors end up selling their funds or ETFs when they start to drop, only to buy back after they’ve rallied. This is clearly not a recipe for success.
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NoLoad Fund*X’s approach to speculative fund investing has generated good performance for decades. We’ve learned that if we are going to invest in more aggressive funds, we have to be disciplined. Here are some of the guidelines that help us stick to our strategy and come out ahead:
1. Set Aside a Portion of Your Portfolio
Including limited exposure to more speculative funds has improved our long-term results in NoLoad Fund*X, so I suggest carving out just a portion of your portfolio for more aggressive funds. This part of your portfolio should aim to maximize returns and it should be a component where you can tolerate greater volatility.
In our moderate growth portfolios, we limit speculative funds to 30% and, of that, we generally limit 10% to the most concentrated sector funds and ETFs (listed in our Class 1). Current buy recommendations include Rydex S&P Midcap 400 (RFG) and SPDR S&P Biotech (XBI). Particularly aggressive investors may venture more of their portfolio to these speculative funds. It’s not unusual for us to take 1% to 2% positions in a number of sectors.
2. Diversify Your Exposure
Sector and specialty funds and ETFs can be volatile so take smaller positions in these funds. Instead of concentrating your exposure in a single sector, take small positions in a number of funds from several highly ranked sectors. Rather than buying a fund that tracks one developing economy, we may opt to buy a fund or ETF that invests in several emerging market countries or regions.
3. Don’t be Afraid to Take Losses or Leave Potential Gains on the Table
It’s difficult to sell funds that have lost you money, and it’s often just as difficult to sell funds that made good gains. But don’t hold on to funds that have performed badly in the hopes that they will come back. In our Upgrading strategy, we sell funds and ETFs when our rankings indicate that there is a better place for us to put our money.
4. Expect Volatility and Stick to Your Discipline
Large moves are a normal part of investing in stock funds and ETFs, but the normal volatility of aggressive funds and ETFs can make it difficult to stay the course–even for experienced investors. When speculative funds are in favor, outsized gains tend to tempt investors to increase their allocation to the hottest sectors and specialty funds, but these funds may fall more than 10% in a matter of weeks. iShares Silver Trust (SLV), for example, lost 20% in May alone.
We continue to hold SLV (as of June 2011) because it’s highly ranked in our system and we accept that we won’t know if SLV will turn out to be a winning or losing trade until it is ultimately replaced by something better. We do, however, know that SLV is volatile, and that’s why we chose to limit the size of our position.
5. Fight the Urge to “Double Down” or Go “All In”
It’s always tempting to jump into the most speculative sectors when they are hot. It can also be tempting to double down when positions fall hoping they pop back up. Resist these casino-like techniques. We suggest that you adjust your allocation to aggressive funds based on your risk tolerance, not based on how well or how poorly a position is doing.
Among more aggressive funds, we may occasionally skip over a fund that’s had a massive gain just before our buy signal, or we may opt to take a smaller position. But once we have established a full position, we will not exceed that position size.
6. Revisit Your Allocation Over Time
Being disciplined does not mean that you don’t revisit your decisions as your circumstances change. As you accumulate wealth, it makes sense to revisit your allocation between equities and fixed-income and rebalance to meet your current circumstances.