How I Invest for 20–200% Returns

This article is part of a series on investment strategies:
Part 1| Part 2 | Part 3 | Part 4 | Part 5

Last updated: FEB 18, 2022

INTRODUCTION

It is now possible to easily and cheaply make low-risk investments that take advantage of typical market cycles, and greatly expand your yearly income. The section below covers some of the basics for beginners, introduces common terms and misconceptions, reviews investments with different risk levels I personally use, and lastly covers risk reduction strategies. I have tested all strategies covered, but your results may vary*.

GENERAL PRINCIPLES

• Sell higher than you purchased for — Buy Low Sell High (long): This is almost a cliche, but it is very true. Buy things that provide value to society when they are low (due to factors unrelated to the investment itself, e.g. COVID, ill-advised tweets, elections, mortgage crises, etc). Example: Buy VOO at $205, Sell VOO at $333 = 62% gross profit.
• On average the market goes up over time: When markets drop, investors often fail to take advantage of it, typically because they wonder if it will ever return to previous levels. The stock market as a whole always goes up over time — downturns are temporary buy opportunities. Diversified portfolios typically return to previous highs, and then surpass them, given enough time. The market will always continue to go up (on average) because the overall market is growing, population is increasing, demand increases, new technologies emerge, trade increases, etc.
• Purchase lower than you sold for — Borrow and Sell, Then Buy Low (short): Imagine if you sold your house for 1M, and then after an economic downturn, bought it back from the new owner for 800k. You would have made 200k. Markets go up and down in a cyclical fashion as demonstrated above. The up direction isn’t the only way to make money. Downturns (related: black swan events) are impossible to time, but are certain to occur eventually — if not fairly regularly. When markets are at a bubble point, it is reasonable to bet on the drop, and then wait for it. However, this is a more advanced activity that shouldn’t be your starting point. You just be aware that “shorting” exists as a concept for now.

LEVEL OF EFFORT

The following discussion presumes you are interested in managing your own investments, learning about different types of investment vehicles, and evaluating risk levels for yourself. It does NOT presume that you will need to investigate specific companies at a detailed level. You don’t need to check earnings reports, company valuation, board members, or other details. If that still sounds like too much work, you should use one of the automated app-based auto-investing services such as Acorns or Betterment. They guide you through some of the basic decisions and probably return 10–20% per year. However, you will likely get reduced gains, due to taking insufficient risk and fees — more importantly you won’t learn how to invest for yourself.

I find that many financial advisors don’t view risk the same way as I do, and don’t understand the investment devices as well as I do. They also have numerous conflicts of interest, charge fees, and let lots of psychological factors affect their investment choices. Consequently I don’t really trust them to manage my investments.

DIVERSIFICATION

People typically talk about diversification in the context of owning a selection of stocks (which is what ETFs do for you automatically.) However, diversification can be viewed more broadly. For example you could diversify out of stocks into real-estate or cash. You could diversify across high and low risk categories, or take advantage of both market upturns as well as downturns, or into short-term and long-term investments. Put simply, diversification means “not putting all your eggs in one basket”, or balancing one form or risk with another. It might also mean being able to weather a disaster, by selling things that are up and letting the others sit until they recover.

RISK-LEVELS

Bankers tend to be risk-averse, so anything other than cash, bond, or CD (Certificate of Deposit) is considered risky. On the other side of the coin are trading houses who often make money whenever you trade, and consequently want you to think that frequent investments in single stocks has an acceptable risk-level. In short, you need to form your own risk evaluations — not trust people who are so afraid of losing your money that they won’t make you any, or who are paid to give you bad advice. Higher risk-levels tend to come with higher potential rewards. You need to choose the risk-level commensurate with the amount of profit you want. It is also helpful to look at supposedly “high-risk” investments, and see where you can lower the risk-level if you use the right strategy.

LOW-RISK INVESTMENTS

Examples: S+P 500 ETFs (VOO, SPY), Tech ETFs (VGT, QQQ)

I consider any broadly diversified ETF (Exchange Traded Fund**) in a growth sector, low-risk — because they are diversified. If a few companies in the ETF suffer losses or go out of business, it doesn’t affect the ETF much. Another thing that reduces their risk is that they are liquid (you can get in and out of them fairly rapidly.) ETFs are also fairly simple to use — you typically just buy them and hold them. If your ETF happens to go down in the short term, you just need to wait it out until the market recovers (as the stock market always does.) You can easily compare various ETFs to see their historical returns over time. Some stocks and ETFs (e.g. VGT) offer dividends, which are regular distributions of profits to shareholders. Some investors use dividends as a form of passive income, but they tend to be small (1–2%), and it probably makes more sense to automatically reinvest them, since it is a long-term, gradual buy-in investment anyway.

MEDIUM-RISK INVESTMENTS

Examples: Leveraged Tech ETFs (TQQQ, SOXL), Inverse ETFs (SRTY)

ETFs are already diversified, which significantly lowers risk — so if you want to increase your risk (and returns), you can consider leveraged ETFs. These ETFs take the $1 you invest and borrow $2 or $3 with it to extend the investment. It is very similar to putting a down payment on a house and then borrowing the remainder from the bank to get the full purchase amount. Many real-estate investors buy large houses with borrowed money, wait for appreciation, and then refinance to cash out the gain. They are essentially using someone else’s money to get an investment in place, waiting until it increases in value, and then cashing it out. This is exactly what using a leveraged ETF is like, except your money is diversified across “an entire subdivision”, instead of being concentrated in one house that can burn down. If you want to add slightly more risk, you can buy an inverse ETF when the market is at an all-time-high, which bets that the market will drop***. If it doesn’t happen immediately, you can always hold on to it for a year or more waiting for the event to finally happen, and then get your profit. Waiting might reduce your profits, but you won’t lose the entire investment like in an option put.

HIGH-RISK INVESTMENTS

Examples: Single stocks (TSLA, AMC, ACB), Options

When most people talk about stock market investing, they talk about individual stocks. Out of my experiments with single stocks, ETFs, leveraged ETFs, and real-estate, stocks were by far the most unpredictable and the biggest losses in the portfolio. Sometimes you hit it lucky like Tesla, but more frequently you guess that Canadian pots stocks are going to take off, and then suffer the consequences. Individual companies have a huge amount of factors that affect their success (e.g. COVID, specific CEOs, earnings projections, ability to raise funds, etc), and many of those factors are hidden or unpredictable. I now only invest in individual companies if a) it is extremely disruptive b) there is a huge value proposition c) it is leading in an emerging space and d) there isn’t an ETF available in the space yet. That was why I invested in Tesla — but it was still very risky.

Also in the high-risk category are options. Options are a bet that a stock (or ETF) will go up or down to a given level within a specific time frame. They also start to be worth less before you get to the expiry date. I have made more money with options than I have lost, but they are inherently risky due to the expiration date and the complexity of their structure. I view options as pretty close to gambling, and they tend to induce nail-biting.

Day-trading is another high-risk activity. I don’t have much experience with it, but the taxes are complex, it is highly automated, and it is high-stress. Buying stocks should really be about investing in a company or a sector when it is undervalued, and waiting for it to grow, just like you would expect a house to appreciate (or the reverse if you’re shorting). There’s nothing ethically wrong with investing at shorter time-frames, but you shouldn’t need to check your stocks daily or hourly to make good investments. It has been mentioned that the typical investor lacks patience, and I agree.

Crypto is another high-risk investment. I own some ETH as well as some smaller coins. The large drop in value of Bitcoin in early 2018 prompted many to say it was fraudulent, and didn’t have any real value. However, a new historical high set in Nov 2020 shows that it may have the normal cycle of large drops and bubble points. Crypto (in some format) is probably the future of our financial system. Be that as it may, it remains untested in many ways and is not diversified like an ETF, so it is high risk.

SHORT-TERM (< 1 YR) AND LONG-TERM (> 3 YRS) BUCKETS

I put my investments in short and long-term buckets. “Short-term” for me is typically under a year, “long-term” is typically at least 3 years and potentially stretching into retirement. I rarely sell any kind of investment in under 3 months. Most ETFs are long-term investments. Trying to sell them high and re-buy low isn’t really worth the gains and risk, and they just go up over time, so it’s easier to simply buy and hold. I do this with VGT. Other investments such as leveraged ETFs are short-term (e.g. TQQQ). I expect to exit them after a downturn has recovered, which typically happens in 3–9 months. People will tell you leveraged ETFs are only meant to be held for under 1 day, but I have held them for close to a year with no problems — they act very similarly to any other ETF. People don’t seem to understand the value of paying fees to borrow investment capital, which can in turn be used to earn profits which exceed the fees, which is exactly what a good leveraged ETF does.

WAYS TO MITIGATE RISK

• Risk-level perception: Risk levels aren’t what people say they are. I regularly see business news reports that come to the opposite conclusion as I did after I looked at the source data. Most investment advisors want you to think investing is difficult and risky, and consequently you should trust them to invest for you. Frequently they know less that what you can determine yourself with a little research. You can evaluate risk-level based on historical data quite easily. ETFs are much lower risk than many people think.
• Safety net: Don’t invest what you can’t afford to lose. The one downside of ETFs is that despite being liquid, you don’t want to exit them when the market is down. Sometimes markets take 6–12 mos to recover. During that time you don’t want to have to sell at a lower price and reduce your profits. Use your safety net at these times and wait for market peaks before exiting the short-term investments. You never want to make investment decisions out of desperation or urgent need — that is what other people do, and how you earn money off of their poor investment choices.
  Tip: You should use a HIRS (High Interest Rate Savings account) to store money that is waiting to be invested, or that is your safety net. I am currently trying out Yotta, which annoyingly looks and acts like a lottery, but actually produces fairly high monthly interest rates (~5%). Use code JEFFREY334 and we’ll both get 100 tickets into next week’s drawing: https://withyotta.page.link/16s5LH3d7qRprKEQ7
• Diversify: ETFs are already very diversified. You can own multiple ETFs if you really want more diversification than that. You can also spread your money between stocks, real-estate, and cash. There are also more creative ways to diversify to reduce risk.
• Be patient: Give yourself time to wait it out. Try to never take a loss. Exit some investments that have given a good return, and let low-performing investments sit a few years to see if they turn around and can be exited later, for a reasonable annualized profit. Never panic-buy or panic-sell. Markets always recover eventually if the market is large enough or offers long-term value to the world (e.g. electric, not oil).
• The path of progress: If cars are moving to electric motors, buy into the leading company in that space. Better yet, buy into an ETF offering diversification in that space. Get in front of where society is going and buy into it. Conservative investment strategies that bet on the past, or basic necessities, don’t benefit from huge value creation events such as new markets and capabilities.

TESTING

I put my money where my mouth is. The above strategies evolved through a number of experiments with viable strategies, some winning and some failing. I tried investing in individual stocks, and I now think there are better alternatives in most cases.

• I have run over 1000 back-tests of various algorithms using the Quantopian python-based platform to find optimal buy and sell threshold points, and evaluate predicted returns. So far the predictions are matching fairly well with reality, and were often too conservative (higher returns with actual money.)
• My VGT investment has earned a reliable 20%+ per year and I expect it will continue to do so. Time held: 3 years.
• I have completed two rounds of TQQQ investments netting 65% and 160% respectively. Time held: 8 mos, ~4 mos
• I have completed one round of SOXL investment where I predicted approximately a 200% return and got a 220% return. Time held: ~7 mos. A friend used the same strategy more aggressively (bought lower, held longer) for ~430% return, but you have to factor in annualization.
• I have experimented with shorting VOO (S+P 500) using stock option puts during the last bubble (prior to COVID) and got a $3,240% return. However, not all of my experiments with option puts worked, mostly because of the expiration date. Even if you get the drop percentage right, you could still easily be off by a week and lose it all. Consequently, I’m experimenting with leveraged shorted ETFs such as SRTY which can be held indefinitely. This gets around the main problem with options, which I don’t think are a reliable long-term strategy.
• I am currently running ongoing testing of investments in VGT, TQQQ, SOXL, and SRTY. I typically develop a hypothesis, back-test it using an algorithm, and then if it is solid, invest a small amount of real money to test it. If the real-world real-money investments demonstrate themselves, I put more money into the strategy over time. It’s a darwinian-investment strategy — the fittest strategies survive and expand.

CONCLUSION AND NEXT STEPS

I have covered the basics of how I invest around the cyclical rise and fall of broad categories of the stock market, mostly via ETFs. ETFs help mitigate risk through diversification and automation, while allowing time for markets to correct and make the investment profitable. I am currently experimenting with a range of programmed trading algorithms, all based on the above principles. Please add your questions and comments below. I am considering writing more investment articles. In particular, I am considering a detailed article on the use of leveraged ETFs, which seem to be grossly misunderstood by the mainstream media, as well as another article on optimization techniques for the above strategies.

* I am not a professional money manager, have no financial degrees, and you should make your own investment decisions. I do have a Ph.D. in a computer-related discipline and I like being skeptical of conventional wisdom, particularly when returns are low, conflict-of-interest high, and there is a deficiency of data showing causal relationships. If you read this article, you should realize why hiring an expert might net you worse results than investing by yourself, perhaps using some of the strategies listed above. It is advisable to look at the historical results and come to your own conclusions. Good financial advisors do exist, but they are probably advising the super-rich, not entry-level investors. Also, if a financial advisor finds a winning strategy, they can simply invest instead of working.

** If you want to learn more about the origin of ETFs read A Random Walk Down Wall Street, which outlines the theory behind them and why they were created.

*** I am still testing this hypothesis with real money, but the theory is sound.

**** Thanks to my early reviewers D, L, & L for their constructive feedback.