Guest Author - Guido Deboeck

Have you ever run into a friend who tells you about a fantastic investment strategy --or better tactic-- that is incredibly easy and works so well for her (him)? Where you ever at a party where, as the night goes on people, already tired of talking about all the irrelevant social and political happenings, start bragging about their investment successes?

The other night I was dragged into one of those conversations where a friend claimed significant success with an option strategy he had applied on a systematic basis: you just write some options and you collect enough to pay for an entire year of (her) college, he said. How often have I listened to the same and wondered: “if making money on options is that simple, why are not more people making money with options”? Fact is that trading in options, futures and/or commodities successfully requires a great deal more skills and discipline than passive or active trading of stocks or ETFs. The risks involved are often ignored: writing options is not without substantial risks!

As the conversation went on, I learned that my friend’s option strategy was only “the tail” end of his strategy, in other words “there was a dog”! How much did the tail end wag the dog? How much did his option strategy influence his overall result? The answer to that question remained unspoken. When I pressed to discuss “the dog” and not the tail – in other words did his entire investment strategy outperform the markets on a systematic and sustained basis – the conversation quickly diverted to another topic.

Sound investment strategy focuses in the first place on the overall return relative to what the markets do in a particular time period. Good practice is getting an overall rate of return that year after year beats the major indices. Better, yet ambitious investors try to do better than the best professionals. If you can obtain results that put you in the top 5 or 1 percentile of professional managers (comparing apples with apples) you have what I would consider a constitutional right to be proud (don’t brag about it because staying in that class is hard work). Any additional tactics that go beyond that are great, but if the basics are not met, they should be considered as “distractions”, not value added essentials.

Earlier this year I wrote about a simple passive portfolio management strategy with asset allocation between three ETFs. You recall that we allocated 1/3 of a portfolio to ishares Russel 2000 (symbol IWO), 1/3 to ishares Trust Coohen & Steers (symbol ICF) and 1/3 to ishares Msci EAFE (symbol EFA). Coming closer to the end of November with only one more month to go before the end of the year, it is time to revisit that portfolio.

Year-to-date this portfolio of just three ETFs is up 21.2%. Since the S&P 500 is up 12.5%, the Nasdaq, 11.6% and the Dow 14.9% (as of the time of this writing 11/22/07), we find that our simple passive strategy produced a value added of 8.7% vs the S&P, 9.6% vs the NASDAQ and 6.3% vs the Dow or an average of 8.2% value added over major market indices.

That’s a dog whose tail is wagging!