The Most Amazing Thing I've Ever Learned About Finance

The Most Amazing Thing I've Ever Learned About Finance
By Porter Stansberry, founder, Stansberry Research

This should be the most important Digest I have ever written. What I'm going to tell you about below could make you more money, over time, than any other advice you'll ever receive from me or anyone else.

But that will only happen if you're willing to read carefully and genuinely think about the concepts I'm writing about. Remember, there's no such thing as teaching, there's only learning. That's especially true about what you'll find in today's Digest.

So... do me a favor. Don't read today's Digest unless you're willing to take my recommendations or write me a note about why you're choosing not to. I'm serious. If you're not willing to do that, then don't bother reading any further.

If you're still reading, then I want you to promise that you'll send a letter to feedback@stansberryresearch.com explaining why you're not going to follow this advice...

What if I told you that there's a way to instantly turn terrible investors into good investors? What if I told you that there's a way to turn good investors into great investors overnight? What if I told you that this has nothing to do with what stocks you buy? What if I told you that this has nothing to do with trailing stops?

This idea is the single most amazing thing I've ever learned about finance.

It's also the hottest area of financial research among academics and top quantitative hedge-fund managers right now.

Most people would never share this idea with anyone because it's incredibly valuable. It's a secret that transforms losing investment portfolios into winners. It has nothing to do with what stocks you buy. And it has nothing to do with what stocks you sell... or when you sell them.

I'm only going to tell you about this if you promise you'll explain yourself if you choose not to use this incredible tool. I want to see you explain why you like losing money and why, no matter how hard I work to help you improve your investing, you aren't going to take even the first step in the right direction. I want to know why.

So quit reading if you're not willing to write me a note to explain yourself. Say it out loud: "I promise to send Porter a note explaining why I'm so hard-headed that I've come to enjoy losing money."

I'm talking about using risk-adjusted position sizing. Let me explain what that is and why it works so well to improve actual investor results.

For many years, I've seen in our portfolios that almost all of our best-performing investments are low-risk. That means these were investments in big, dominant, slower-growing businesses with good balance sheets and brands.

These stocks have a few standout quantitative traits aside from these qualitative basics that can help you identify them in advance. First, they pay good dividends and have a long history of growing those payouts over time. And second (and this is far less understood by most investors), their share prices aren't volatile. Their stock prices tend to move around a lot less than the market as a whole. That's because they have a stable cohort of investors who own the company – investors who are unlikely to sell.

Academics measure this advantage by comparing the daily volatility of a company's share price with the volatility of the S&P 500 Index, which is made up of the 500 largest publicly traded companies in America. (This is called "beta.") Stocks with a volatility equal to the S&P 500's average are awarded a volatility score of 1.

That is, the volatility of these stocks is perfectly correlated with the market as a whole. Stocks that move around more have higher betas. So a company that is 50% more volatile than the S&P 500 would have a beta of 1.5. A company that is two times more volatile than the S&P 500 would have a beta of 2, and so on.

Don't let the math or the Greek letter (beta) intimidate you. There's nothing hard to understand about the idea that high-quality, dividend-paying businesses, which are more likely to do well over the long term, are more likely to have dedicated investors who aren't constantly trading in and out of stocks. As a result, the share prices of these businesses will tend to move around a bit less – or even a lot less – than that of the average large company in America.

Sure, you can sometimes find a few – a precious few – big winners, like Steve Sjuggerud's original recommendation of Seabridge Gold (SA). But over roughly the last 20 years, the overwhelming majority of our best recommendations have always been low-risk (and low-volatility) stocks. If you look at the list of our current "Top 10" – the top 10 best-performing recommendations that are currently in one of our model portfolios – you'll find that only one has a volatility rating that's materially above the average volatility of the S&P 500.

Most of these stocks have betas that are much lower than that of the market as a whole. McDonald's (MCD), for example, has a beta that is roughly half the market's average. Likewise, Automatic Data Processing (ADP), Altria (MO), and Hershey (HSY) are extremely low-volatility stocks. This is numerical proof of the steady nature of their businesses and the "wise hands" that own the shares. These are the folks you want to invest alongside.

While I've known about this concept for a long time (see our "magic" stock research), I didn't have firm proof that applying these ideas to actual investor accounts would make a substantial difference in performance. But now I do.

At our 2015 Stansberry Conference in Las Vegas, TradeStops founder Dr. Richard Smith revealed a fascinating study he had just completed using actual investor accounts. The study was done on 40 real-life investor accounts, some of which contained total assets in the millions of dollars. Richard explained...

We put together a group of 40 real-life portfolios – real buy and sell data from real investors. I asked my team to back-test all of our different stop-loss and position-sizing strategies against these real portfolios to see which of our tools made the biggest difference in performance... And I was amazed to see that there was one tool that improved investment performance more than anything else: volatility-based position sizing. If you only ever pay attention to one thing that I have to say, this is it – use volatility-based position sizing.

What exactly is volatility-based position sizing? It's using the volatility of a stock to determine how much of it you should own relative to your portfolio. The goal is to have the same amount of risk in every stock you own. To accomplish that, Richard (who went to Cal-Berkeley and has a PhD in math) built an algorithm that determines the total volatility of your portfolio and then tells you how many shares to buy of a given stock so that your portfolio is "risk weighted," with each position carrying the exact same amount of risk.

It sounds complicated, but it's simple: The formula just makes sure you don't buy too much of a risky stock, and helps you buy more of the high-quality, safe stocks that we recommend. It allows you to buy the kind of "story" stocks that investors are always attracted to, while making sure you don't risk too much in those kinds of ideas.

To back-test the strategy, Richard took the 40 investor portfolios and figured out how much of each stock these investors would have bought if they had built risk-weighted portfolios instead of using their actual allocations. Just making this one change – just changing the amounts of shares they bought – almost doubled the average returns of the portfolios he studied.

Richard didn't change the stocks they bought. He didn't change when they bought or when they sold. He only changed the relative amounts of each investment. And just making that one change saw the average return go from 6.7% to 12%. No other form of portfolio management – not even smart trailing stops – made as big of an impact.

Why did focusing on volatility work so well? Because volatility (as measured by beta) is a great indicator of risk. Colleges still teach that in the financial markets, risk equals reward. That might even be true in a lab setting. But it's not true at all with real live human beings. Most investors who set out to practice "buy and hold" investing end up doing "buy and fold." That is, they end up selling at precisely the wrong time... when fear in the market is peaking.

Richard has created a new tool for his best clients at TradeStops – a volatility-measuring and risk-allocation function. You simply link your existing portfolio with his website, hit a button, and learn how risky your current portfolio really is. Hit another button and Richard's software will show you how to balance that risk evenly across all of your existing positions – telling you exactly how many shares of each stock you should own.

I firmly believe there is nothing else you can do more easily and more safely to vastly improve your actual investment performance. It might be impossible for you to get rid of all of your bad investment habits. But using Richard's risk-balancing technology can at least show you exactly how much risk you're taking... and you can manage those risks far more effectively.

Doing so is worth huge multiples of the cost of using Richard's system... This new risk-measurement and balancing tool is only available to his TradeStops Premium subscribers. It joins a huge suite of services that Richard offers individual investors, giving them the same kind of risk-management tools that professional investors enjoy, including specialized, volatility-based trailing stops. In my mind, there is no logical reason to not use these tools... unless you want to continue making poor returns and suffering terrible losses.

If I told you I could double your investment returns... even turn losing portfolios into winning portfolios... just by altering the position size of the stocks you select, you probably wouldn't believe me. But that's exactly what Richard's volatility-based position-sizing tool did.

Here's one example, No. 438. (The investor account names were hidden and each account was assigned a reference number.) This investor had $434,000 in his account. Over the period of the study, he lost 23.1% of his savings – just more than $100,000. That's a massive, horrific loss.

But using Richard's volatility tool to change the position sizes of his actual investments, his portfolio would have produced a total return of $59,494 (a gain of 13.7%). Note: This simulation did not change the stocks purchased or the timing of the buys and sells. It merely changed the position sizes by equalizing the amount of risk in each position.

Here's a simple question: Are you going to begin calculating your position sizes by knowing the beta of your entire portfolio and adding new positions only by equalizing the risk of each new stock?

If the answer is yes, the only way I know to get the tools you need is to sign up with TradeStops Premium. Richard will make it as easy as hitting one button to know how many shares to buy, for any stock, to equalize the risk with your other positions. And he can show you the same thing across your entire portfolio so that you can rebalance to get started. Click here to try TradeStops Premium with a 60-day, 100% risk-free guarantee.

If you're not going to do this, my best advice is to stop investing on your own and cancel this newsletter. You can probably double your average returns if you'll start equalizing the risk of your investments. It's that simple. It's that easy. If you're not going to do this, I want you to take the time to try and explain why not. "I can't afford it" is not an acceptable answer. If you can't afford advice that's this valuable, you shouldn't be investing. Send your excuse to me at feedback@stansberryresearch.com.

By the way, fair disclosure: I own a small amount of Richard's company via my interests in Stansberry Research. We made an investment in TradeStops a few years ago. The amount of money in question is trivial to my net worth – far less than 1%. We didn't invest in the company because we thought we would get rich selling software to investors. (We haven't.)

We made the investment because Richard was a longtime subscriber. He was one of our first Alliance members. We knew he had a shared passion – to help people improve their investment results. We wanted the ability to help Richard build those tools so that our subscribers would benefit. And that's what's happening.

Regards,

Porter Stansberry