This winning strategy can make you more money in the stock market with less risk

This Honor Roll includes just those monitored investment newsletters whose model portfolios have produced above-average performance in both up and down markets. To identify which those are, I segregated newsletters’ track records over the past 16 years into what was produced in both bull- and bear markets. Only newsletters with above-median performance in each made the Honor Roll. (A fuller description of how I constructed the Honor Roll is available here.)

Consider two hypothetical portfolios, one that each year is divided equally among the model portfolios of that year’s Honor Roll newsletters, and the second among the model portfolios of non-Honor-Roll newsletters. Since 2006, the first portfolio was 27% less volatile, or risky, than the second.

Nevertheless, this lower-volatile portfolio performed 1.0 annualized percentage points better over the past 17 years. Needless to say, it’s a winning combination to make more money with less risk.

Average can be better than average

It shouldn’t come as a surprise that lower-risk newsletters do better over time. That’s because of an arithmetic quirk of compounding: To recover from a given percentage loss, it takes a greater percentage gain to get back to breakeven. So it’s possible to come out ahead simply by reducing your losses.

To illustrate, consider the U.S. stock market, which has produced a 7.7% annualized return since 1793 according to a database constructed by Edward McQuarrie, an emeritus professor at California’s Santa Clara University. Imagine a hypothetical investment that each year performed exactly half as well or poorly as stocks. That is, if the stock market produced a 10% return in a given year, this hypothetical asset would have gained 5%. If the market lost 10% in a given year, this hypothetical asset would have lost 5%.

You might think this second asset would have produced an annualized return since 1793 that was exactly half that of the actual stock market. But in fact it did better: Gaining 4.2% annualized, versus the 3.8% annualized it would have produced had it gained half that of the market itself. This extra 0.4 percentage point per year is what you would have earned simply by keeping risk low.

This is one of the secrets behind Warren Buffett’s phenomenal long-term performance, according to a study that appeared in the Financial Analysts Journal in 2018 entitled “Buffett’s Alpha.” The three authors, each from AQR Capital Management and sporting a strong academic pedigree, found that Buffett has beaten the market not because of “luck or magic” but by “leveraging cheap, safe, quality stocks.” In other words, rather than favoring high-risk speculative stocks that could win big but also lose big, Buffett favors highly conservative situations. He then leverages up his super-safe portfolio so that its risk more or less matches that of the market as a whole.

Woody Allen is credited with the infamous quotation that “90% of life is just showing up.” The investment equivalent is that 90% of long-term success is staying in the game — invested, in other words. While investors are inevitably drawn to the excitement of high-risk strategies, they often throw in the towel when that risk translates into intolerable losses. You’ll likely do better over the long term by a lower-risk strategy that you can live with through thick and thin.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected]

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