Published: February 24, 2010

My friend Mebane Faber stumbled onto the ultimate system for a volatile market.

• It only takes you two hours a year (10 minutes a month) to implement.
  
  
• It's only had one losing year since it started in 1973 (a tiny 0.59% loss in 2008).
  
  
• And it's outperformed the stock market... with substantially less volatility than stocks.
  

Meb has just updated his numbers for 2009. The results over the last decade are downright extraordinary...

If you had invested $10,000 in Meb's simple system in 2000, you would have gotten back nearly $26,000. Meanwhile, $10,000 invested in the stock market would have shrunk to less than $9,100.

The secret, as you can see, is not losing money in the down years:

Just looking at the last decade, you can see how much less volatile this system is than the overall stock market...

The stock market's annual return was about -1% per year. But the actual returns were usually way higher or way lower than that.

Compare that to Meb's system, where the average annual return was about 10% a year. You can see the annual returns were always within about 10 percentage points of that average.

Here's how Meb's system works... There are only five holdings. And there are two modes: in and out.

The five asset classes are: U.S. stocks, foreign stocks, bonds, commodities, and real estate stocks. Your only decision each month is whether you own a fund that tracks that investment, or not.

You want to be in when the asset is going up. And you want to be out when the asset is going down. This idea could hardly be dumber... But it actually works.

First, you divide your portfolio into five pieces. You dedicate each piece to one of these five asset classes... and you are either in or out of each fund every month. So you might be only 40% invested one month, with the rest in cash (earning interest at the bank).

To figure out whether you're in or out, you just have to do some simple math. You can keep track of it by hand with a pencil and paper. You don't need a computer -- or even a calculator.

Once a month, get the last 10 monthly closing prices of the five funds. You can get them from a service like Yahoo Finance. Then calculate the 10-month average.

If the fund is above its 10-month average, keep 20% of your money in it. If the fund is below its 10-month average, sell the fund and move to cash.

Repeat the next month, rebalancing existing positions back to 20% each if they're buys. Never put more than 20% in a fund. For example, if only three are in buy mode, then you're 60% invested with 40% in cash in.

Remember, with the exception of a tiny loss in 2008, Meb's system has never lost money, and it has delivered double-digit compound annual gains.

It's actually delivered the investment "holy grail"... higher returns with lower volatility... all in a portfolio of just five things that you only have to look at a dozen times a year.

-- Dr. Steve Sjuggerud
Editor
Daily Wealth

Note: This article originally appeared on Daily Wealth.