A Look at the Model Shadow Stock Portfolio’s True Risk

by James B. Cloonan

The stock market has come roaring back and now is at pre-recession levels. However, the economy does not appear to be back—particularly employment.

It is hoped that the second-worst market drop in a century is over and we will have some normal markets for awhile. So far this year, the Model Shadow Stock Portfolio is up 10.6%, compared to 6.6% for the S&P 500 index as measured by the Vanguard 500 Index fund (VFINX). The results for 2012 and other periods can be seen in Figure 1 and Table 3.

Comparing Risk Levels

While the Model Shadow Stock Portfolio was hit harder percentage-wise during the downturn than the overall market (as can be seen in the cumulative return chart in Figure 1), it took much less time to recover. Looking at the yellow line, which is the Vanguard 500 Index fund, and the purple line, which is the Model Shadow Stock Portfolio, what would you say about the comparative risk? I am referring to risk in the real sense of the word—the chance of loss. The Vanguard 500 Index fund fell less than the Model Shadow Stock Portfolio from its high, but has taken almost twice as long to recover. It has the lowest standard deviation, but does it have the lowest risk?

A major factor determining true risk lies in the processes of the investor. If an investor was long term and disciplined with a horizon of four to six years, there was little risk with any of the portfolios. If, on the other hand, the investor panicked and sold near the bottom, or had invested money needed in less than four years, then there was probably a loss. The best time to examine your risk tolerance and your asset allocation is just after a market crash. If you net sold during the downturn, then you need to adjust your exposure in the future.

Despite the domestic and foreign problems that are out there, I continue to feel the market wants to go up. My long-term philosophy, however, has been to be mostly neutral with long-term allocations. I have been willing to be more aggressive when the market was below its long-term highs because it has always come back. I get more conservative when the market is setting new highs even though what is going up tends to keep going up—until, of course, it doesn’t.

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James B. Cloonan is founder and chairman of AAII.


Discussion

Ted Nicholas from California posted about 1 year ago:

It would be interesting to see Mr. Cloonan compare the model Shadow Stock Portfolio performance with the Stock Superstars performance and any comments he would have on how the two strategies compare/differ, particularly in minimizing risk.


David Neblock from Illinois posted about 1 year ago:

yes please


Jessica Lahr from Virginia posted about 1 year ago:

Exactly!!! I just sent an email in yesterday about this very issue. My finances are not robust enough for two portfolios using both the Model Shadow Stock Portfolio AND the SSR approach. I need to decide; the Model Shadow Stock Portfolio, based on the above outcomes and from my research yesterday, seems to out shine the SSR, unless I'm overlooking something....(which could very well be the case!!)
Thank you


Kent Barrois from Washington posted about 1 year ago:

I too would really appreciate an article discussing the relative merits of the Shadow Stock Portfolio and the SSR portfolio. I see almost nothing in common between the two portfolios. Certainly the market cap size of the Shadow Stock Portfolio selections are tiny compared to the SSR portfolio stocks. I have thought about selecting perhaps fifteen of the Shadow stock listings and forming a micro cap Group to form a Group 5 within the SSR format.
Following the guidelines you give, it would take about fifty stocks to do both portfolios. Should one be perhaps emphasized over the other based upon the age of the investor, the amount of risk the investor is willing to take, etc? I know it is an individual decision, but your comments would be indeed welcomed.


Mike Andrie from Indiana posted about 1 year ago:

I have a question on why the Model portfolio appears to have done really well in the last 10 years relative to the previous 10 years (1993-2003). During the previous 10 years, the rate if return appears to be similar to the reference portfolio. Is this due to a change in the way the Model portfolio was determined?


Lonnie Gibson from West Virginia posted about 1 year ago:

I would like to invest in the shadow stock portfolio. Should I invest now since the market has had a steep run or should I wait for a pull-back? I know I should invest equal dollar amounts in each stock. Should I invest all of the money at one time or make the investment over a certain period of time? Your comments would be very much appreciated.


Charles Rotblut from Illinois posted about 1 year ago:

Hi Lonnie,

There are two ways you can go about this.

If you buy all the stocks in the portfolio right now, you will approximate the performance of the portfolio going forward. Your returns won't be exactly the same, however, because of the fluctuations in the prices since each stock was initially added. This applies to any model portfolio you follow, regardless if it is one of ours or a portfolio from a different organization.

The second strategy would be to buy only those stocks currently listed as being "qualified" and keeping the remainder the amount you plan to allocate in cash. You would then add to your portfolio as other portfolio holdings are listed as "qualified" or new stocks are added. Qualified means the stocks currently meet the buy rules for the strategy. The advantage of this strategy, and the reason I suggest it, is because limits your purchases to only those stocks currently trading a very low valuations.

As far as allocation, we suggest investing equal dollar amounts in each stock.

I hope this helps,
Charles
AAII


Ted Nicholas from California posted about 1 year ago:

I compared the performance (in % terms) from 2002-2013 YTD of the:
1. Shadow portfolio
2. Stock Superstars
3. Wilshire 5000
I simply added (or subtracted) the percentage gain (or loss) starting with the 2002 figure through the 2013 YTD. The results are:
1. Shadow portfolio = 290%
2. Stock Superstars = 104.1 %
3. Wilshire 5000 = 68.6%
Unfortunately, I don't know how to calculate the 3 yr. risk index and standard deviation for the 3 portfolios during the 2002-2013 YTD period that would allow comparison of those 3 portfolios.
Interestingly, my simple arithmetic calculations differed from those published for the Superstars (mine was 104.% vs. 111.1%) and Wilshire 5000 (mine was 68.6% vs 57%). I did not include the 1 week figure published for each but that would not begin to account for the differences.
The Shadow Stock had 2 losing years (2007 and 2008) totaling 52.6%. The Superstars had 2 losing years (2005 and 2008) totaling 43.8%. The Wilshire 5K had 3 losing years (2002, 2008, and 2011) totaling 61%. To the novice investor the Shadow portfolio is looking better and better by any measure.
It would certainly be nice if Mr. Cloonan could calculate the 3 yr risk index and 3 yr std. deviation for the Shadow portfolio over the time frame above and publish it as a comment in this section. :-)


James Leever from Michigan posted about 1 year ago:

I'm 79 figure I have 15-20 years left,(in apparent excellent health), just put all my IRA into the Shadow Stock Portfolio, kept 4 years cash available for distributions, and my Roth is in the SSR. My theory is that as long as I have 4 years cash available, I can ride out market downturns without having to sell stock, until the markets stabilize. Based on the charts available there was no 4 year period in which the MSSP lost money. Even when it lost 50% in 2008 it bounced back the next year and then went on to trounce the Vanguard 500 and the Vanguard Small Cap Index. I realize past history is no guarantee, but charts are the only thing to go on. I really should have pulled a Peter Lynch and bought Ford stock when it was at its lowest, but I chickened out.


Steven Saarela from Minnesota posted about 1 year ago:

It would be beneficial when looking at the Model Shadow Stock Portfolio to have a column showing the price each stock was purchased at and a column showing the percent of return or loss since. Thanks


John Horman from Illinois posted about 1 year ago:

I have money in super stock, Would it get better return in shadow potfolio--enough to pay for the exchange?


Prem Jindal from Pennsylvania posted about 1 year ago:

Recently, i read that liquidity plays a big role in return performance (Prof.Ibbotson of YALE UNIVERSITY) and less liquid stocks show better performance in addition microstocks and valuation measures (low P/B ratios). Probably, be the very good performance shadow stocks may partially be due to that. Also Professor Ibbotson showed in one of his papers that standard deviation( a measure of riskiness of stocks) was lower for less liqidity stocks. This flies contrary to your thesis that low P/B ratio microstocks are more riskness. Fundamentally thinking stocks with very low valuations either low P/B or P/E or P/S are less risky. It appears that most of the shadow stocks in the portfolio are are not only low P/B but also very illiquid.
Will youy please make any comment.Also, i want to personally thank for finding AAII and also your mall book (Maximum Return/ Minimum Risk. I am 72 years old, I joined AAII last year and wished beciome member when you founded AAII more than 25 years ago.


Prem Jindal from Pennsylvania posted about 1 year ago:

Recently, i read that liquidity plays a big role in return performance (Prof.Ibbotson of YALE UNIVERSITY) and less liquid stocks show better performance in addition microstocks and valuation measures (low P/B ratios). Probably, be the very good performance shadow stocks may partially be due to that. Also Professor Ibbotson showed in one of his papers that standard deviation( a measure of riskiness of stocks) was lower for less liqidity stocks. This flies contrary to your thesis that low P/B ratio microstocks are more riskness. Fundamentally thinking stocks with very low valuations either low P/B or P/E or P/S are less risky. It appears that most of the shadow stocks in the portfolio are are not only low P/B but also very illiquid.
Will youy please make any comment.Also, i want to personally thank for finding AAII and also your mall book (Maximum Return/ Minimum Risk. I am 72 years old, I joined AAII last year and wished beciome member when you founded AAII more than 25 years ago.


Harry Cloonan from Arizona posted about 1 year ago:

Re: Mike Andrie
Most of the reason the portfolio looks to have performend better in the last 10 years is that Figure 1 is linear and the strong rise is due to compounding. A log graph would be closer to a straight line. The little difference that does exist is due almost entirely to 2003 being in the second 10 years. James Cloonan


Victor from California posted about 1 year ago:

Why pay for SSR, when Shadow has a better performance and is included in AAII membership?


dan sheehan from Ohio posted 11 months ago:

What happened to aosl today,a drop of more than 15%???


James Leever from Michigan posted 11 months ago:

You're absolutely right. But I started with SSR years ago and finaly woke up to the fact I was missing something by not using the Shadow Stock Portfolio, so I invested the balance of my retirement account. Both are doing well and it adds a balance to the account.
James Leever, Michigan


Charles Rotblut from Illinois posted 11 months ago:

Hi Dan,

It was likely a reaction to AOSL's earnings. A copy of the earnings release can be found at:
http://finance.yahoo.com/news/alpha-omega-semiconductor-reports-results-201500583.html

Because the Shadow Stocks have lower volume, they can experience greater degrees of price volatility.

-Charles Rotblut


Giridhar from North Carolina posted 11 months ago:

James,

Is this portfolio appropriate for Non IRA account, if one is considering long term view like 10 years?


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