Three Different Ways to Follow the Model Shadow Stock Portfolio

by James B. Cloonan

Three Different Ways To Follow The Model Shadow Stock Portfolio Splash image

It has been a very strong year for the Model Shadow Stock Portfolio. The portfolio is up 32.8% year-to-date compared to the S&P 500 index, which is up 15.3% as measured by the Vanguard 500 Index fund (VFINX).

These results as well as results over longer periods can be seen in Figure 1 and Table 3.

Most U.S. indexes are now above their highs prior to the Great Recession. There has been quite a bull market run, but for most indexes it has been mostly recovery of previous losses. Most pundits keep talking about a correction and get excited every time there are a few down days, but the trend keeps edging up—at least so far.

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James B. Cloonan is founder and chairman of AAII.


Discussion

Craig Campbell from California posted 9 months ago:

I am trying to get better understanding of model stock portfolio and how to commence building it. why do you not include initial entry price or a buy below price in your table? your comment about how long it would take to build a portfolio buying only new entries would make one think that I could also buy those additions that are still trading at the entry price, in order to build faster.


Priya Balakrishnan from Texas posted 9 months ago:

Agree with Craig, there should be more details on entry points for new members who are starting to build their portfolio. Since the changes are made quarterly, any entry and exit prices would be useful.


Raymond Gundersen from California posted 9 months ago:

I agree with Craig & Priiya - without the entry price or at least the percentage increase/decrease to date, the figures in the table are almost meaningless. I would encourage everyone to take a look at picks like AOSL, MIND, and WLFC and compare their performance with the S&P 500 on Yahoo Finance. Some of the picks listed are questionable!


Charles Rotblut from Illinois posted 9 months ago:

Craig and Priya,

The buy and sell rules for the portfolio focus on valuation, market capitalization size and profitability, not price action. If a stock's price rises from the purchase price, but the stock otherwise meets the buy criteria for the portfolio, it is considered to be "qualified" for purchase.

This said, we do maintained a detailed list of the portfolio's transactions for those members who are interested in seeing them.

-Charles Rotblut


Craig Butler from Oregon posted 9 months ago:

Craig (Campbell): the way I bought into the portfolio 3 years ago is similar to the way Charles suggests. I took positions in all the stocks listed as qualifying, and avoided taking any positions in those listed as on probation or near any kind of limit (value or size). I also bought a few of the remaining ones that either seemed to me to be unusually good values (p/e or book value ratios) or in industries I understood to be growing. So I think I bought 8 the first quarter, and as more stocks qualified or funds became available I bought 1 or 2 more each quarter after that and now own about 20. I have also bought one or two that qualified but weren't bought by the portfolio and they also worked out well. I've never been able to own exactly the entire portfolio but it hasn't mattered. The results have been truly excellent.
Good luck


Anjan Ghose from California posted 9 months ago:

Charles,

How about creating an ETF that clones the Shadow Stock portfolio, or even a fund? I will be happy to purchase its initial shares.


Billy Greer from Mississippi posted 9 months ago:

I would like to hear from someone who basically follows all the rules, but adjusts the portfolio monthly or weekly.


James McGehee from North Carolina posted 9 months ago:

Billy-I basically follow all the rules of the Shadow Stock, the only thing I do that is not in the "rules" is that I weight the holdings equally on purchase (30 stocks, enter as 3.33% of portfolio) and if any position grows to 4.33% I sell it back down to 3.33% and use funds raised to buy smallest holding back up to 3.33% max. Make sense? Interestingly my YTD return is very close to what AAII shows as their YTD return on the portfolio.


Blair Picard from Missouri posted 9 months ago:

The problem with the shadow portfolio and others(pietroski is the perfect example) is that enough of aaii's subscribers are following these portfolios and their buy/sells are market impacting enough so as to make the performance numbers meaningless. The recent recommendation of ISH for purchase in the shadow portfolio or any of the pietroski buy or sell recommendations will prove this out. If you bought ISH anywhere within 15% of its price when it was recommended, my hat is off to you. But look at the chart. Buy/sell slippage is huge and while I am a big fan of the shadow portfolio, etc, I consider the published return numbers to be unrealistic and unreplicable in the real world.


Andy Crane from Florida posted 9 months ago:

I follow all the rules of the Shadow Stock Portfolio.
I started two years ago with 10 stocks from the existing portfolio and only buy and sell when the portfolio does, and my little portfolio is up 54%. I am one of those little of the little investors so you folks may have different ideas or ways to do it then I do.


Chadwick Gibbons from New York posted 9 months ago:

The rates of return are suspect. For instance,
ISH was added to the portfolio 6/6/13 when it was about 18. I received a Email advising it had been added several weeks later when the stock was around 21+. The stated rates of return are suspect if the reader receives
receives buy/sell information sometime after
the trade has occurred in the portfolio.


James Fitko from Louisiana posted 9 months ago:

Blair,

You are right about the market impact. Just like TV celebrity stock pickers, if you buy what they recommend, it is usually too late as the price has already risen. One way around this is to do your own research. I already owned ISH, chosen by looking at Stock Investor Pro, before the announcement. So I did well after the announcement. (I have no financial interest in SI Pro, I'm just an AAII member).


Blair Picard from Missouri posted 9 months ago:

Mr. Crane's remarks illustrate my point. While we all should be pleased with that 54% return he describes, if you look at the table above these remarks, the shadow portfolio is apparently up about 69.25%, ie 3.15 in last half of 2011, 33.3 in 2012 and 32.8 in first half of 2013, during the same time period. So did Mr. Crane do a poor job of buying his stocks, a poor job of choosing which ones to buy or is the the slippage I described impacting his return. The point is not did the shadow portfolio go up in the last 24 months, but could one following the portfolio in the real world achieve the 69.25% return, or have to settle for 54%. Whether one's portfolio is big or little, like mine, a 15% difference is real money.


James Mcgehee from North Carolina posted 9 months ago:

There is no question that it will be hard to replicate the published performance of the Shadow Stock portfolio exactly due to "pop" that new additions receive as followers of the strategy take positions, but if you believe that the research points to a longer fundamental uptrend for the Shadow Stock holdings you should still do well. Even though the AAII followers undoubtedly drive up these stocks short-term, I have to believe that we have relatively little long-term impact on the valuation of these companies, that comes from long-term positive performance of the companies businesses and the accumulation of the stock by other investors over time.


Floyd Gaines from California posted 9 months ago:

Floyd Gaines San Jose, Ca.

I bought My first portfolio Aug of 2012, Put in $1000.00 in each stock and equally added to these stocks as I aquired money. I followed AAII's rules. I checked the extra 10 stock for what I thought might be better than my first 20. I made very few switces. my return is over 30%. That's good enough!


E Birnbaum from Pennsylvania posted 9 months ago:

It seems obvious that if a stock price jumps between the time it initially qualifies for purchase and the time the AAII member sees the recommendation, that while it may still qualify, the upside may be significantly impacted regardless of the reason for the jump in price. Ultimately, the member has to decide if the reduced upside potential is still worth it.

Also, I found the Shadow Portfolio detailed history table that Charles made available (via a link) to be both interesting and useful. Is that link available on the website? It would be nice to have that link shown as one of the options under the Shadow Portfolio menu, or otherwise easily found.


Dave Steffes from Minnesota posted 9 months ago:

Mr.Fitko has the answer. Use the AAII rules, do your own research, and buy before they are added to the Shadow Stock Portfolio.


Lihong Quan from New York posted 9 months ago:

Dave,I agree with you. As a new part-time investor, I need time to learn the rules before I can do the research. My trouble is that I have full-time job already, and I usually do not have enough time to do my own research. Respectfully.


Andy Crane from Florida posted 9 months ago:

Gee Blair you make me feel bad about my little 54% return. I thought that was pretty good with only ten stocks when the Shadow Stock Portfolio holds around 30 stocks. Did I pick mine wrong? Heck if I know but any time I can get a 54% return does it matter, not to me it don't. I do appreciate your comments, I just try not to get too technical when I buy/sell stocks.


Steven Stark from Idaho posted 9 months ago:

I loaded the rules into Fidelity stock screener and I check it regularly.
It doesn't take long once you save the parameters in the stock screener.


Jim Peabody from Vermont posted 9 months ago:

Am not an experienced investor so the following question may be naive. But, why the rule: "No financial stocks or limited partnerships will be purchased"?


Alan Bloom from Pennsylvania posted 9 months ago:

Some of these questions are good ones. Where do you answer the questions. Alan


TWC from posted 9 months ago:

New Member here. Are covered calls permitted in methodology?


Charles Rotblut from Illinois posted 9 months ago:

TWC - Since these are micro-cap stocks, options contracts are typically not available.

E Birnbaum - A link to the detailed transactions page can be found on the transactions page.

-Charles


Charles Rotblut from Illinois posted 9 months ago:

Jim - Here is the response from Jim Cloonan regarding your question:

"There is nothing wrong with financial stocks or partnerships. The problem is that the process used for selecting stocks in the portfolio doesn't work for financial stocks or partnerships because their balance sheets are different. This is true of most value oriented portfolios. They ignore financial stocks and partnerships. We have not found a time proven method for choosing the best financial stocks."


Gchin from North Carolina posted 9 months ago:

I have a couple of questions about AAII portfolios -
1) Is this portfolio appropriate for Non IRA account, if one is considering long term view like 10 years?

2) Can any one comment on pros and cons between fund portfolio vs Stock superstar portfolio perfprmane in a non ira account?


Charles Rotblut from Illinois posted 9 months ago:

Gchin - The Shadow Stock portfolio is tax-friendly, so you can use a taxable account.

As far as the Model Fund Portfolio versus the Stock Superstars Report, the answer depends on how much involvement you want. The Stock Superstars Report has better historical performance, but there will be more transactions. About stock one per month, though nearly all of the capital gains are long-term. The Model Fund Portfolio will have less turnover in terms of its holdings.

-Charles


Richard Orwoll from North Carolina posted 8 months ago:

I understand the concern expressed near the end of the article regarding the inaccuracy of backtesting. Yet I feel there are two questions many of us would like to answer. (1) Can an individual investor approach the returns seen by AAII, or does the pop in price associated with the AAII purchase significantly reduce the returns? (2) Are the average returns of all stocks meeting the Shadow Stock criteria consistent with AAII’s returns, or does AAII have a special gift for choosing the best stocks to purchase?

In spite of your disclaimer regarding backtesting, I believe reasonable answers can be obtained. For the first question I would suggest for the purchase price one could reasonably use the midpoint of the stock price range for the two trading days following the announcement of purchase by AAII. This should accommodate the vast majority of member purchases. An analogous selling price could also be used.

The second question is really independent of the disclaimer regarding backtesting. Here I would suggest using the midpoint of the price range the day after the screen for qualifying stocks is run. For this question I want to avoid the impact of purchases and sales by AAII members as much as possible. Each stock would be evaluated based on percentage gain from date of purchase to date of sale, so the result is independent of the size of the investment (i.e. the purchase does not require the sale of another stock in the portfolio).


Thomas Mason from Illinois posted 8 months ago:

In the spirit of Mr. Gaines and Mr. Crane, any bump in market price due to the announcement of a change in the Model Stock Portfolio is the fee we pay for having someone else (i.e., AAII) do all of the leg work. As Mr. Fitko implies, we can avoid that "fee" by using SI Pro to make our own decisions using the same decision rules that AAII does. So back-testing would be done after any impact on the market which is due to AAII's announcement - if you typically wait to make changes in the portfolio until others have made theirs. I believe it is referred to as the "you snooze, you lose" rule. I, by the way, snooze quite a bit...

I use a lazy investor's version of the Shadow Stock Portfolio, an almost true version of the Model Fund Portfolio, and I follow Stock Superstars to the letter. My exactitude is relative to the amount I have invested in each portfolio.


Kennan from Washington posted 7 months ago:

Hello,

I have been a member of the aaii for some time. I have been monitoring the shadow stock portfolio for some time. This is the first time I will invest money in it. If I make $100K investment in the portfolio, do you suggest I buy each stock in equal amounts?

I also read that one can build this portfolio in a few years slowly buying into it. In that case, how do you decide which stocks to start with?


Jean Henrich from Illinois posted 7 months ago:

Kennan,
The portfolio rules state to invest equal dollar amounts in each stock you have chosen for your shadow stock portfolio. You can start with any number you like, but a minimum of 10 stocks is recommended. You can narrow the list using your own criteria, but you may want to first eliminate the ones that are on earnings probation or approaching a size or value limit, as they may be sold in the next quarterly review. Please see the Model Shadow Stock Portfolio Rules for more guidance on getting started and following the portfolio:
http://www.aaii.com/model-portfolios/stock-rules

--Jean from AAII


Vladimir Lomen from Oregon posted 3 months ago:

Hi Folks, I have followed the Shadow Stock Portfolio for over a year with very good returns, however, I am considering subscribing to Stock Investor Pro. Is the annual cost of doing this really worth doing - are there additional returns to be had by selecting my own and buying as the screen indicates than just following the Shadow portfolio? Thanks for any comments!


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