Tag Archives: vti

My Rules For Portfolio Strategy

Summary The list of rules below comes from my personal investing experience. By preparing a set of rules in advance investors can be ready to make better decisions. A major change in my personal views is the inclusion of a rule to not be scared of sitting on cash. When a high quality ETF drops in price I view the drop as a sale, but when a company is trading down on good cause, I’m less attracted to it. Lately I’ve been finding more and more messages coming to my inbox. It’s great to hear what my readers are thinking, however I’ve noticed a trend in reader messages. Since I frequently cover the mREIT sector, readers want to know about how attractive the sector is as a whole and how I’m modifying my holdings and my portfolio strategy. This is a great area for research and it is an area that has been on my mind quite a bit lately. Therefore, I’ve come to a few rules for portfolio strategy that I believe will help me avoid mistakes and that I think readers will want to consider in designing their own portfolio strategy. Rule #1 Contemplate your portfolio goals before deciding how your money should be allocated. Frequently we here that all investors really care about is “total return”. I’m not saying that the source of return is a huge factor, but the volatility of the returns is a meaningful factor. In seeking risk adjusted returns I think investors often forget that the returns need to be measured on the basis of the risk involved in achieving them. Rule #2 All volatility is not created equal. I expect to see some volatility in my portfolio but the cause of the volatility matters. When my holdings fluctuate with the values on the major indexes it does not bother me as much as when individual holdings are moving dramatically. When Freeport-McMoRan (NYSE: FCX ) plummets on weak demand for commodities and commodity futures take a nose div, it bothers me more than when shares of the Schwab U.S. REIT ETF (NYSEARCA: SCHH ) drop on interest rate movements. This is a purely human response. I have a very strong level of faith in the future of equity REIT indexes, but I don’t have that same level of faith in commodity pricing. If someone asked me about the difference in these scenarios even a year ago, I might have had a different answer. I might have said that the volatility at the portfolio level was what mattered. Under “Modern Portfolio Theory” it would be precisely correct to focus only on the volatility at the portfolio level. However, the simple facts remain. When SCHH drops significantly, I see the low price precisely the same way I would view a discounted price at the grocery store. It looks like a sale and I toss more of it into my basket (portfolio). Rule #3 Focus on what you know. I discovered that the mREIT sector was a great fit for me because I enjoy math and prefer the harder sciences to the softer sciences. The construction of mREIT portfolios as leveraged option-embedded bond funds fits in precisely with how I like to do research. For many investors the mREIT sector is simply too dangerous for involvement and those investors should follow their allocation rules rather than go chasing yield. Rule #4 Index what you don’t know. There are thousands of investable equity securities in the U.S. market. It would be impossible for a single investor to know enough to be competent on every single security. Being truly competent (rather than merely arrogant) on a sector requires an intense time commitment. Only investing in that sector though would create a great deal of risk for the portfolio. Therefore, I believe the core of the portfolio should be held in funds that track a diversified portion of the equity market. For instance, I’m long the Vanguard Total Stock Market ETF (NYSEARCA: VTI ) as a major holding in my portfolio. I want to complement my indexing strategies with buying the most attractive options. This rule should not be construed as saying that if you don’t know “Chinese Solar Stocks” you should buy an index to represent them. If you don’t know that part of the market and it is not highly relevant to your investing strategy, then it should be avoided entirely. The goal with this rule is simply to fill in the desired allocations with low fee index funds to reduce the volatility. Rule #5 Don’t be scared of cash. I’ve been guilty of allocating my cash to equity rapidly on the basis that cash earns very poor returns when interest rates are very low. This becomes a situational issue. If we are talking about an employer sponsored 401k plan, it makes sense to pick the appropriate allocations (which would usually be low on cash) and to just “set it and forget it”. Since these accounts are using dollar cost averaging this can be a great strategy so long as the 401k plan has at least a couple excellent options. For instance, I’m using the Fidelity Spartan Total Market Index Fund (MUTF: FSTVX ) and the Fidelity Spartan Real Estate Index Fund (MUTF: FSRVX ) in an employer sponsored account. They have an enormous overlap with some of my other holdings, but when it comes to a passive account using dollar cost averaging I simply want a diversified U.S. market fund and a diversified U.S. REIT index fund. In both cases I care a great deal about expense ratios which were huge factors in picking the funds I did for that account. When I’m adding to my other holdings which are going to be more actively managed, I’ve revised my strategy to be more willing to hold cash. I’ll hold onto the cash until I find very attractive opportunities. One example of this scenario is being willing to pass on attractive opportunities when there may be even better opportunities right around the corner. Missing out on a good investment is an acceptable tradeoff for me if the discipline also keeps me from making bad investments. Rule #6 Define attractive opportunities. This builds upon the rule of not being scared to hold cash. If the goal in holding cash is to have some dry powder to load up on the investments that appear to be on sale, then you should know in advance what you consider to be a sale. For instance, I consider shares of SCHH at about $36.00 to be on sale. If shares of SCHH drop under $36.00 then I will happily spend my cash on buying more. I am perfectly willing to be overweight on the equity REIT sector despite the interest rate sensitivity because I have such a strong belief in the underlying fundamentals. I am also willing to buy up mREITs when I see them trading at what I consider to be a material discount to the market leaders. I generally view Annaly Capital Management (NYSE: NLY ) and American Capital Agency Corp. (NASDAQ: AGNC ) as the big players in the sector and I view other mREITs in relation to those companies. Due to the sheer size of NLY and AGNC, I believe the market will usually be more efficient in pricing them than in pricing the smaller players. Since I view mREITs on the basis of relative attractiveness, NLY and AGNC will usually be rated near hold in my view. The smaller mREITs can range from “strong buy” down to “short” based on their prices relative to the big players and their sustainable level of dividends. I may occasionally see AGNC or NLY as a very attractive company to go long or short as part of a pair trade. In those cases I’m seeing an attractive opportunity based off the other mREIT in the trade being too expensive or too cheap and I see the offsetting position in AGNC or NLY as an effective hedge to make the position market neutral so the investor is strictly seeking the alpha from correcting the pricing differences between the two mREITs. Conclusion The times when I’ve got burned the worst on a trade are precisely the times that I violated these fundamental rules. Each investor should know their own boundaries before selecting securities and they should remember that the rules they make are there to protect them. Those are the rules I attempt to follow in handling my investments. What rules do you follow in yours? Disclosure: I am/we are long VTI, SCHH, FSRVX, FSTVX, FCX. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.

Sell Your Employer, Get VTI Instead

Summary Many employees hold stock in the company that employs them. Taking advantage of plans that offer a discount on stock makes sense, but don’t let it overwhelm your portfolio. By not rebalancing frequently enough, employees may find themselves with diversifiable risk. The excess risk provides no excess (expected) return, and the risk isn’t just having too much of one company in your portfolio. I’m suggesting investors take a better look at replacing their employer’s stock with VTI whenever the option is available. The last week I’ve been doing a great deal of research on behavioral finance. There are several potential pitfalls for investors to avoid, but most investors are not familiar with behavior finance. I’ll be highlighting several of those pitfalls so readers can watch out for them. My focus in this article is why the Vanguard Total Stock Market ETF (NYSEARCA: VTI ) is a better investment than your employer. I can’t say that VTI will provide better returns, but I am confident that the expected return for the level of risk will be superior. Two problems with owning your employer: Problem #1 The first problem should be fairly clear to most investors. Holding individual companies is a fine way to invest, but it creates a substantial amount of diversifiable risk if individual companies are a large part of the portfolio or if multiple companies within the same industry are being selected. When the position in the employer reaches higher levels, say 10 or 15%, it becomes a substantial risk factor for the portfolio. Two problems with owning your employer: Problem #2 The second problem is one that many intelligent people manage to completely overlook. The second risk factor is that you are exposing the value of your portfolio to the same risk factors that are impacting the value of your lifetime earnings. Let’s start with an extreme example: Enron Long-term employees had ample opportunity to build up substantial positions in the company stock. When a company goes out of business, the employees are facing unemployment. If they also held the stock, they risk seeing the value of their portfolio decline substantially. If the firm employs a substantial number of people with their skill set within the geographic area, several former employees may be faced with needing to move in order to find new work. The concentration of that skill set exceeding the number of available positions makes it an unfortunate situation that is even more significant for employees that own their home and will be facing transaction costs on selling the house. Industry risk On top of the company-specific risk, there is also a level of industry risk. If the company is closing locations because the industry is less profitable, finding a job with a competitor will be more difficult. It would be preferable for the employee to have less than normal exposure to his industry within his portfolio. Whether the firm is in biotech or car manufacturing, the price that the employee’s skill set can command in the free market is still dependent upon supply and demand within the industry. Solving the problem There are two ways to solve this problem. An investor can either attempt to build a diversified portfolio that intentionally has less than normal allocation to their industry. However, I think it is much simpler and more cost efficient, due to trading commissions, to simply buy the Vanguard Total Stock Market ETF. I’ve heard people lately talking about how the stock market is being valued too highly. I think some of those analysts raise very legitimate concerns. However, I also believe that market timing has a negative expected value. Attempting to find the right time to jump in may be viable for individual companies, but trying to find the right time for buying the entire market is another challenge entirely. When was the right time to buy? In my opinion, several decades ago would have been great. Since that isn’t an option, I favor investing in the total market at the present time. Is this the perfect moment? I doubt the timing is perfect. Whichever day you buy into the market, there may well be a day in the future that offers a lower price. Buying into the market and having the value never dip under the entry price has more to do with being lucky than good. How I’m doing it Over the next couple months, I’ll be overhauling my positions. The vast majority of my positions are in tax advantaged accounts, so I’m not concerned about the ramifications of capital gains. I’ll do the rebalancing as soon as I finish with filing taxes for 2014. I need to know how I’m going to split up my contributions to Traditional and Roth IRA accounts. I don’t know if the market will move up or down during that time, but I expect VTI to be trading right about NAV due to the enormous trading volume. For investors not familiar with VTI, the average is over 3 million shares per day. I’ll buy at whatever the price happens to be at the time, and I’ll be investing over half of my total investment portfolio. Why VTI? When I started looking at ETFs for my portfolio, I started looking at SPDR S&P 500 Trust ETF (NYSEARCA: SPY ). I started running historical numbers comparing the volatility of portfolios that included ETFs with exposure to several investing factors. I included emerging markets, precious metals, bonds, and bonds in other currencies. What I found was that it was possible (historically) for an investor to find better returns and lower risk through a global portfolio. However, the returns did not take into account any trading costs and the difference was not very substantial. After seeing how well SPY was able to do against the much more complicated portfolios, I decided it would be better to try to replicate it. VTI offers extremely high correlation to SPY, which isn’t surprising given how many of the same equities are being held. However, VTI is offering exposure to smaller cap companies without having such a large position that it would substantially alter the returns. The result is an ETF that offers extremely similar performance to SPY with a slightly lower expense ratio. For VTI it is .05%, for SPY it is .09%. Conclusion If an investor is holding stock in their employer, it would be prudent to consider swapping the position for VTI or SPY. If the position is required as part of a program that allows employees to buy the company stock at a discount to the market price, it may be reasonable to retain the amount of stock required by the program. For any excess cash being invested, VTI or SPY offers dramatically lower risk for the investor’s life. The risk is not simply the standard deviation of the portfolio value. Investors need to be aware that holding their employer exposes their portfolio to precisely the same risks that their career is facing. That is a risk that all investors should seek to diversify. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis. The analyst holds a diversified portfolio including mutual funds or index funds which may include a small long exposure to the stock.

4 ETFs You Can Hold Forever

Summary The trend of money flowing towards robo-advisers and passive asset allocators is one that is likely to continue in the current market environment. ETFs offer real diversification, low cost, and a global reach for those that want to buy and hold for the long-term. Several funds on this list offer a compelling value proposition when composing your asset allocation strategy. The trend of money flowing towards robo-advisers and passive asset allocators is one that is likely to continue in the current market environment. Amid the more recent back drop of low volatility capital appreciation in stocks and bonds, it seems that the natural evolution is to put your portfolio on auto-pilot or give it to someone who is just going to rebalance it quarterly. That’s not necessarily my philosophy on investing , but I understand that some people want to stay fully invested at all times or use continual dollar cost averaging to their advantage. In order to do so, you may find yourself searching for the “perfect investment” or asset allocation to hold for the long-term. Instead of paying someone to do that for you, I recommend taking a simpler approach that incorporates multiple asset classes through a flexible investment vehicle. A favorite individual stock such as Apple Inc (NASDAQ: AAPL ) might be suitable for some investors. However, if you want real diversification, low cost, and a global reach, I would consider using an exchange-traded fund instead. The following funds represent excellent opportunities for long-term investors. Vanguard Total Stock Market ETF (NYSEARCA: VTI ) You can’t go wrong with VTI for complete coverage of the U.S. stock market across multiple styles and market caps. This ETF charges a rock bottom expense ratio of just 0.05% for access to 3,800 U.S.-based publicly traded companies that include large, mid, and small-cap segments. While that level of diversification may seem overly broad to some investors, it is perfect for those who are looking for a core position in a small account or to simplify many overlapping funds down to a single entity. VTI has over $50 billion in total assets and a current 30-day SEC yield of 1.88%. The best thing I can say about this ETF is that it is low cost, extremely liquid, and will provide a passive vehicle for tracking the entire U.S. stock market. In addition, it has very little turnover to minimize tax implications for investors that wish to hold this fund in a long-term taxable account. Vanguard Total International Stock ETF (NASDAQ: VXUS ) Often times I see investors trying to get cute with their international exposure to overweighting certain areas of the globe in order to try and capture the best performers. However, if I was to pick just one ETF to bet on the entire market outside of the U.S., it would be VXUS. This ETF contains over 5,800 securities of both developed and emerging market nations around the world. That includes everything from Canada to China and everywhere in between. VXUS also follows a passive index approach similar to VTI with a minimal expense ratio of just 0.14%. Pairing an international fund such as VXUS with VTI can provide you with full coverage of global stocks in just two positions that are easy to track over time. If you wanted to pair that down to just one vehicle you could always select the Vanguard Total World Stock ETF (NYSEARCA: VT ) as well. PIMCO Total Return ETF (NYSEARCA: BOND ) Picking a single bond fund to pair with my stock exposure is not an easy task considering the challenges facing fixed-income over the next several years. Ultra low yields around the globe have made the way forward a potentially treacherous one given the expectation of interest rate cycles changing over time. Despite the turmoil associated with its portfolio manager leaving last year, I would be inclined to incorporate BOND in my portfolio as a solid long-term holding. The reason I selected BOND has to do with a number of complex factors that include the fact it is one of the only truly global broad-market offerings in the ETF space with sufficient size and history. The newly established Fidelity Total Bond ETF (NYSEARCA: FBND ) may be a suitable alternative. However, I don’t believe that Fidelity has the same level of sophistication when it comes to fixed-income research and security selection as compared to PIMCO. In addition, I like the active style of the BOND portfolio that gives the manager flexibility to target specific duration, credit quality, country, and sector exposure. I truly believe that these factors are important when competing with passive “total bond market” indexes from the approach of managing risk to enhance returns . Cambria Global Asset Allocation ETF (NYSEARCA: GAA ) If you are looking for the structure of a global multi-asset index that takes care of rebalancing your asset allocation, GAA should certainly be on your radar. This “fund of funds” is the first ETF of its kind to offer exposure to stocks, bonds, real estate, and commodities with zero expense ratio. While there are still minimal “acquired fund expenses” to own the 28 underlying ETFs, GAA is focused on low-cost indexes to achieve its goals. The current asset allocation of GAA is 51% bonds, 43% stocks, and 7% commodities. The majority of the underlying holdings are Vanguard, iShares, State Street, and Market Vectors products. The benefit to GAA is that their model is created using not just a market cap weighted methodology, but also incorporating value and momentum as well. The ultra-low fees to own this fund combined with the added bonus of automatic rebalancing make this an attractive position for moderate or conservative investors looking for a long-term core holding. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article. Additional disclosure: David Fabian, FMD Capital Management, and/or clients may hold positions in the ETFs and mutual funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell, or hold securities.