Good morning. I have only 3 options in my 401k other than the target date funds. Basically I can choose between IWV,AGG, and EFA. So I made a rule limiting the ticker to these three options. Then I am ranking based on 70% momentum and 30% volatility. However, I wonder with only three funds if the momentum is a factor in the results. If I change the weighting to 100% momentum, I do get different results. However, I’m not sure how the scoring system works, because with only three funds, I would expect the ranking system to pick the highest momentum etf to score first every time.
For example if IWV is #1 for momentum, but third in volatility, I would expect the following total score. If EFA is second in momentum, but first in low volatility, wouldn’t it still have a higher total score? Maybe the ranking considers the nominal values as well?
IWV Total Score = 10.7 + 30.3 = 1.6
EFA Total Score = 20.7 + 10.3 = 1.7
Your fund selections are (and should be) decided by your ranking system.
As you might already know, your ranking system depends on how you
design it, that is how you combine the various factors that you choose to combine,
such as momentum and volatility. On this subject I could and would say more;
however, at this point I’ve got very little or no info on your ranking system.
Example: If your ranking system is a simple and easy formula of “70% momentum
and 30% volatility”, then that is exactly how it should pick your fund.
However, if you find your ranking system uses (or appears to use) a different (erroneous)
math formula, then you might want to do some additional testing, so that you can tell
for sure what it is the actual formula that your ranking system uses.
Generally speaking, the trouble with most ranking systems is that they tend to be
so terribly complex that, if in the unlikely event they don’t do exactly what they were designed
to do, few of us are able to notice any of their abnormal behaviors.
However, if indeed your ranking system is just a simple one, such as “70% momentum
and 30% volatility”, then for you this is a great opportunity to thoroughly test it.
Example: For the purposes of testing, why don’t you:
Use only two funds, just to keep it simple, and make your job a lot easier.
Keep changing the list of funds that your system is allowed to buy.
Keep modifying the percentage figures within your ranking system. And
Keep verifying that your ranking system makes (or doesn’t make) the (right and) correct decisions.