SMI's Upgrading Portfolios Expand
Their Lead Over the Market

After racing ahead more than 10% in the fourth quarter last year, stocks took a breather at the beginning of 2005. With some recent gains in their pockets and the euphoria of the post-election "relief rally" fading, investors surveyed the landscape as the New Year began and saw a trend of sharply higher energy costs and rising interest rates. That was enough to cause the bulls to pull in their horns a bit, and the stock market drifted modestly lower.

Before looking at our first quarter results in detail, let's review for the benefit of newcomers how the performance data that appears here quarterly is organized. Across the top of the Historical Performance Table, the portfolio allocations are shown. (Which is best for you? See Upgrading: Easy as 1-2-3. ) As you move to the right, the portion of the portfolio devoted to stocks decreases. During good market years this hurts performance; during weak years this helps performance. Over the long haul, you'd expect higher stock allocations to prove more profitable due to the historical (1) upward bias of the U.S. economy and (2) performance superiority of stocks versus bonds.

The "100% Stocks" section of the table (reproduced below) shows how the results of our two model portfolios compare with the overall market. We expect our Just-the-Basics indexing strategy to track the market closely. This passive strategy is recommended for those wanting a simple set-it-once-a-year-and-forget-it approach. It has a higher percentage of small company stocks than the weighting for the market overall, plus it includes an international component. If small company stocks and foreign stocks do better than the larger Fortune 500 type companies in any given year, as they have recently, JtB will slightly outperform the market. As you can see, at each time interval shown Just-the-Basics has had returns similar to the broad stock market (as measured by the Wilshire 5000 index). It's done unusually well since the 2003 market bottom, outperforming the market by a decent margin. That's primarily because small company stocks have been good performers in recent years. Nothing tremendously exciting, but JtB has accomplished what it's designed to do—match or exceed the market's return.

Now, on to our all-stock Fund Upgrading portfolios. These portfolios are more active, clearly attempting to "beat the market." Most years, the extra effort is well rewarded. As long-term readers have come to realize, however, Upgrading isn't a magic bullet that protects them from all harm. In the first quarter of 2005, as in two of the three bear market years earlier in the decade, Upgrading tallied a loss. However, as was also the case in those earlier periods, our loss was less than that experienced by stocks in general. Thus, our performance edge over the market once again increased. That ability to minimize losses has been a key to Upgrading's superior long-term track record. It's shown an amazing ability to gain more than the market during up years, while losing less than the market in down years.

Measuring from two important market benchmarks illustrates this vividly. It's now been five years since the market peaked in March of 2000. Looking at the second line of the table, we find that the broad stock market is still down 12.5% from that earlier high point. However, by losing less than the market during the subsequent bear market, then gaining more in the bull market that has followed, Upgraders are a substantial 35.1% ahead of where they stood at the previous market peak. Glancing one line below, we see that since the current bull market really began getting untracked two years ago, overall stock prices have advanced sharply, but Upgrading's gains have been even more impressive.

Putting it all together in the six-year performance section of the table, we see that Upgraders have nearly doubled their money over the past six years (gaining profits of $23,580 on an initial investment of $25,000). This despite going through the most severe bear market in 75 years during that period. When compared to the market's return, it's no contest: Upgrading has earned profits more than 10 times greater than the broad market over the past six years!

That type of long-term track record, and particularly the consistency of above-market returns through both up and down markets, gives us plenty of confidence to sit back and relax when the market treads water for a while as it has lately. If you don't have that type of confidence in your current investment strategy, maybe it's time to give Upgrading a try with at least part of your portfolio. The instructions in Upgrading: Easy as 1-2-3  provide everything you need to get started.

• Overview of SMI's Fund Upgrading Strategy
• Overview of SMI's Just-the-Basics Strategy
• Performance History of SMI's Model Portfolios
• SMI Subscription Information

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