How To Make Active Indexing Work With Buy More Sell Less

I think I’ve found the answer to the question posed in the article “Active Indexing Doesn’t Work With Lump Sums“.

The problem I had with the Active Indexing strategy was the need to constantly re-balance, which would increase frequency of trades through forced liquidation of positions, thus increasing unnecessary commissions that kill returns.

What if the monthly monitoring of how much cash is needed to hedge against each index fund was more of a high watermark rather than a non-compromise decision making mechanism? In other words, to halt all buying and selling until the portfolio accumulates enough cash to meet the amount of cash needed to hedge against each index fund.

This means I’m willing to deviate from perfect allocation between cash hedge and index fund shares as signaled by the index funds’ fundamentals & price versus 2/3 of Earnings Yield of AAA grade Bonds.

The reason why this works is because you basically only liquidate positions under two conditions: 1) Have the amount of cash needed to hedge OR 2) Index fund’s Earnings Yield is less than 2/3 of Earnings Yield of AAA grade Bonds

So when 1) happens, the holdings of index funds are still undervalued, thus there’s no need to panic and rotate funds to more undervalued index funds, which causes unnecessary commissions. When 2) happens, you should be liquidating the positions anyways since it’s “overvalued”, thus freeing up funds to flow to other undervalued index funds and re-balance back to perfect allocation.

[Disclaimer]

Not advice. No offer. Do not rely. May lose value. Risky. Conflicts hidden/obscured. (Borrowed from Terrence Yang‘s Disclaimer on Quora)

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