Investment Strategies: Backtesting Details

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This page is for those of you who want the nitty gritty details of how the portfolios were tested. We have deep respect for you if you go this deep.

How We "Trade" the Portfolios

Each portfolio has a specific quantitative algorithm that is used to generate the portfolio. First, our system selects "eligible" stocks based on characteristics such as Market Cap, current price, debt to equity ratio, etc. For example no stocks under $50 million in market value are included in any strategy.

After eligible stocks are picked, we sort the stocks based on a metric. Dividend yield is the most common sorting metric.

Finally, we select the top 35 stocks based on the sorting procedure. That gives us the portfolio for the month. In testing, we re-ranked the stocks on the last day of each month and bought at that day's closing price. We buy the same dollar value of each stock as opposed to some other systems which buy different amounts based on the market capitalization of the stock (for those familiar with the terms, we use equal-weighted instead of value-weighted purchases).

Further, each month we re-balance. This means that if any stocks value has grown to more than 1/35th of the portfolio, we will sell some of the stock and use the proceeds to buy new stocks. Then, at the start of each new month, every stock composes only 1/35th of the portfolio.

Summary of Trading Rules

For those who want a quick summary to know what settings we used, here they are:

  • Portfolios were equally weighted (not value weighted) meaning that each month, we started with the same dollar value of each company, regardless of the size of the company
  • We recreated, traded and rebalanced portfolios every month, selling any stock that was no longer in the top 35 by rank
  • Whenever the stock was no longer in the universe of eligible stocks, we sold it
  • 3% of assets were held as cash which earned 1% annually
  • In the Large Cap Value and Dividend Power portfolios, dividends were not reinvested. For other strategies, they were.
  • We assumed a short term capital gains tax rate of 28% and a long term capital gains tax of 15%, which was deducted from returns (1 year was the cut-off between short term and long term holdings)
  • Transaction costs were 2.5 cents per share traded
  • We assumed "slippage" of 0.5% when we executed the trades

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