You decide how much risk you're willing to take.
Portfolio Armor presents you with a portfolio of optimally hedged securities constructed to give you the highest expected return possible given your risk tolerance.
You enter the dollar amount you want to invest, and the maximum decline you are willing to risk over the next six months (your "threshold"). Then, Portfolio Armor presents you with a concentrated portfolio of securities built to maximize your expected return over the next six months while strictly limiting your potential downside to the risk you're willing to take.
There are more than 4,000 hedgeable securities (stocks and exchange traded products such as ETFs) trading in the U.S. Portfolio Armor calculates potential returns for each of them every trading day, using an analysis of historical returns as well as options market sentiment to estimate the maximum each security will perform over the next six months. From that, we derive expected returns, which represent more likely returns for each security.
Since you're going to hedge these securities, you don't just want them to have high potential returns - the cost of hedging counts too. So we scan for ones that have the highest potential returns net of hedging costs, the ones with the highest net potential returns.
We back tested this method of security selection by running our analysis every trading day over an eleven year period and then looking at the actual returns of the securities with the highest net potential returns on our daily scans over the next six months. Over that 11-year period, we conducted 25,412 comparisons of our calculated potential returns to actual returns, an average of 9.4 top-ranked securities each trading day. The average six month actual return of our top-ranked securities was 6.84%, versus 4.51% for the leading S&P 500 index tracking ETF (SPY).
Starting in mid-2017, we began tracking the performance of our top-ranked names in real time. So far (as of February, 2021), our top ten names have averaged returns of 6.69% over 6 months, versus 7.25% for SPY. You can see the performance of weekly top names cohorts since then here.
Testing our security selection method was only a start; we had to test that our hedged portfolio method worked as a whole, when taking into account trading costs, hedging costs, and other factors. We backtested our method from 1/2/2003 to 4/30/2014, a time period which included two bull markets as well as one of the worst bear markets in generations, the one resulting from the global financial crisis of 2008-2009. We found that, at certain thresholds, such as 21% (i.e., for investors willing to risk declines of no more than 21% over each six month period), our method generated better returns, net of trading and hedging costs, than the leading S&P 500 index tracking ETF over the time period, with smaller drawdowns, as the chart above shows. You can see interactive versions of that and other backtests here, along with a complete list of the hedges and underlying positions in each portfolio.
Starting in mid-2017, we began tracking hedged portfolio performance in real time - not backtests, but "fronttests", if you will. Some portfolios with decline thresholds as low as 4% posted market-beating performance, as the chart below shows. You can find an interactive version of that tracking portfolio and others here, along with a full accounting of the hedges and underlying securities in each portfolio.
Although Portfolio Armor is a very sophisticated tool capable of providing useful calculations it is not designed to replace the advice of a professional investment counselor or your own independent investment research and independent calculations. To rely solely upon the Portfolio Armor tool for investment decisions would be extremely unwise.