My 401k strategy for 2011

A recent read motivated me to put order in the chaos of my 401k.  I realized I needed rules, so I went ahead and defined my long-term entry and exit indicators. But before starting with the mechanics of the rules I will be following like a robot, I need to define asset allocation.  Everyone seems to expect a positive year for the S&P 500, but none imagines that it will be a straight line up.  For that reason, I want to use market timing indicators to avoid the damage resulting from the volatility that will inevitably happen this year.

My favorite choices for equity are a proprietary index fund based on the S&P 500 and NMSAX (based on the Russell 2000 small cap index, aka $RUT).  The rest are managed mutual funds with higher management fees that don't offer any real diversification and are not attractive to me.  

My choices for fixed income are GSHAX (high-yield corporate bonds), MFBFX (investment-grade bonds) and FBIDX (mostly treasuries, indexed, based on AGG).

I wish I had the opportunity to also invest in other asset classes, like commodity, sector, currency, or inverse indices, but these are mutual funds, and it's a limited choice, so we have to make do with what we've got.

This is my planned asset allocation:

• 90% long-term strategy: 50% NMSAX and 50% $SPX
• 10% long-term strategy: 100% GSHAX

The rationale for mixing 50% of each in the long-term strategy for equities is that one index is small cap and the other is large cap, they are correlated but $RUT has outperformed $SPX in the last ten years.  Some say that 2011 will be the year when large cap outperform small cap.  Maybe they're right, maybe not. I am trying to reduce risk by allocating them equally.  The important part will be to follow the rules when the time is right.

The rationale for GSHAX in the fixed income portion of the long-term strategy is that it provides a nice yield. It is highly correlated to $SPX, so it's not a good security to hold in a bear market, because it loses value.

Finally, let's get to the long-term tactical asset allocation, which applies to 100% of my assets. This is based on my long-term entry and exit indicators. Let's start with being in a bull market and fully invested. Every Friday, I should check my exit indicators. If none is giving a signal, stay the course. If one is giving a signal, be on alert. If two are giving a signal move 25% to cash. If three are giving a signal, go to 50%, and so on. 

In a BULL market
One exit signal	-> Be on alert, stay 100% invested
2 exit signals	-> Go to 75% invested
3 exit signals	-> Go to 50% invested
4 exit signals	-> Go to 25% invested
5 exit signals	-> Go to all cash, you're in a bear market now

In a BEAR market
One entry signal	-> Be on alert, stay 100% cash
2 entry signals	-> Go to 25% invested
3 entry signals	-> Go to 50% invested
4 entry signals	-> Go to 75% invested
5 entry signals	-> Go to 100% invested, you're in a bull market now

NOTE: I could use FBIDX instead of cash as a safe haven.  It will depend on what the FBIDX chart looks like at the time of need.

One last thing I need to define are goals. In 2011, I will contribute about 13% of the current 401k balance. In addition to that, I am aiming for a 12% gain. With some approximation, it should correspond to a final balance that's about 20% higher than now.

So now, only one question remains. Based on this strategy, as of today, I should be 100% invested, but I'm not.  Should I buy now, or wait for the next favorable entry point? $SPX and $RUT have been gaining without substantial breaks for the last two months, since the 4% correction in mid-November 2010. I am looking at RSI(5), Wm%R(14) and CCI(20) and they all indicate overbought conditions on both indices. $RUT is at 807 and $SPX is at 1293.  I think they are both ripe for a correction.  I think that a correction will certainly happen, for sure, but the question is, will the price break below today's level? Because otherwise it would be pointless to wait for it.

I have decided that the less risky course of action is to wait for RSI(5) to drop below 30 before going in and for %B to drop below 0.1 before scaling in progressively 10%, 20%, 30% and 40% each day, for as long as it stays oversold. I may have to wait another month, or maybe a week. But at least I have a strategy now, and rules that I can follow like a robot, instead of being driven by emotion.