Examples of a Plan B.

The Plan B. (or contingency plan) is based on the logical expression of "If...then...else." Specifically, if condition A is present, then do this. Otherwise (else), do that. Since we're talking about portfolio design, the "If" pertains to some condition, like the probability that a bear market will begin soon, or a recession is coming soon. 

A conceptual framework for your Plan B.

The table below shows an example of how this might work.

This is just a framework, not an actual Plan B. It's a jumping-off point for the work ahead.

A simple Binary Plan B.

Next, we need to know what the conditions are before we can take the next step. One very simple example of conditions is the moving average. You may decide that when the market is above its 200-day moving average, condition 1 is true. Then you remain fully invested in your version of portfolio 1. Else, (market is not above its 200 dma) you switch to your portfolio 2. 

For a binary investor, portfolio 1 might be 80% equities and 20% bonds. Portfolio 2 might be 20% equities and 80% bonds. This investor only has 2 conditions - so their Plan B. is as simple as it gets. Now let's add some other conditions.

A 5-Condition Plan B.

The table below uses my own version of conditions, but you can use any conditions you like. Again, this is a framework, although I do have clients who actually use this one.

In this example the conditions are linked to signals from my bear market probability model. When the risk of a new bear market are very low, condition 1 is in play. This means the investor is fully exposed to risk assets like equities, according to their Plan A.

As the indicator begins to change, the conditions will change accordingly. The investor will have specific steps to take at each condition level. When the indicator reaches maximum warning, the investor is in full defensive mode.  

Once you know what your indicators are saying, you can take the necessary steps to re-align your portfolio. The table below shows an example. 

A framework for the 5-Condition Plan B.

Your portfolio allocations will undoubtedly be different from those in the above table, but my point is this. Having a structured Plan B. and following it faithfully will add several percentage points to your average annual returns. I can say this because I've seen the results in my client accounts since I first introduced this idea back in 2005. 

I estimate, conservatively, that your Plan B. will account for at least half of the Alpha you capture with your Killer Portfolio. So, do the work. And leave your comments and questions below.