Thomas Jefferson opined that “Eternal vigilance is the price of liberty.” For modern investors, I’d say, “Eternal vigilance is the price of profits.” This being the last installment of my three part series, I want to pull together the key pieces before I segue into the final Q & A.
A) Academic research has confirmed time and time again that proper asset allocation disproportionately contributes to a large portion of an investor’s profits. I am so convinced that this high-leveraged activity must be in essence the first stage of any individual’s virtuous investment cycle that I wanted to do something to make it easier for my readers to assemble their own personalized assortments of asset baskets.
The best way I know to do just that is to gather together a so-called ‘buffet’ of some 59 major asset baskets from which individual investors can choose. I loaded all of these asset baskets into a ChartList, labeled each appropriately and then pre-populated each basket with a suitable ETF. I’ve added this to my ChartPack and labeled it “10.07 Investor Buffet of Asset Allocations – OPTIONS”.
You’ll notice that I placed it above all other ChartLists, both to illustrate its importance in the hierarchy and to encourage investors to consider where they’ll invest before they start deciding what specifically to buy. Your survival depends on this! Learn about asset allocation, embrace it, and personalize it. You, too, will grow convinced that it is indeed a high leverage activity for you as an investor.
B) Once your personal collection of asset baskets has been assembled, please refer back to my opening quote. Eternal vigilance is the price of profits. Your high-leveraged activity now becomes a virtuous circle where you regularly monitor and adjust your asset baskets.
These are complex baskets made up of different financial vehicles that are each impacted by ongoing complex economic and market chains of events. Your eternal vigilance is what facilitates your feedback loop and ensures that you make the necessary rebalancing decisions. Your results should be inspiring if you focus on a manageable number of perhaps ten to twenty asset baskets and harness the power of charts to help you. The caveat, however, is that at no time should you ignore the reality that there’s never really a tendency towards equilibrium amongst your baskets.
In its most elemental form, it is this unique combination of assembling a reasonable collection of asset baskets, applying eternal vigilance and then making ongoing necessary adjustments that produces this virtuous investment circle and the profits you deserve.
C) Finally, let me beseech you to avoid the tyranny of the investor self which so often drives the less profitable behavior of investors. You can be a successful asset allocator of, say, 19 different baskets and still fulfill your needs for cocktail party “coolness” by perhaps only discussing the one asset basket in which you actually trade individual momentum stocks. You never need to disclose that with the other 18 baskets you use ETFs and actively managed professional mutual fund managers. Only another savvy investor like yourself will ever dig deeper and ask about your total asset allocations. The majority of the cocktail party crowd will still label you ‘cool’.
For those of you who missed Part I and Part II, I’d like to invite you to click on these links and get totally up to speed.
Question: You said in the workshop that your methodology allocation is less volatile, and the way you execute it is less risky. How can that be?
Answer: There are two parts to the answer. Because I trade growth stocks (and generally never more than ten positions at a time), I watch that asset basket like a hawk and I’m not afraid to pull the trigger and exit one or most of those positions if I see them turning down. Remember, as individual investors, we have immense advantages over the institutional traders. We have no need to consult with any committees and our selling activities will generally not move the market (unless you are trading stocks below $10 with low volume, high spreads and poor liquidity which I never do).
The second part of the answer deals with human nature and personal bandwidth. From experience, I know I can closely monitor 19 asset baskets and 10 individual equities. My focus is my strength. I acknowledge that I am not Bill Gates. With his bandwidth, he could handle a lot more asset baskets and individual equities. This is where brutal honesty about yourself is required. Human nature will always coax you to trade outside your boundaries. I’ve regimented myself to stay within my fence line and not venture outside my boundaries. With that being the case, I am able to focus on all my asset baskets in detail and make the appropriate money flow adjustments to limit risk, maximize returns and sleep peacefully.
Question: How do you decide whether to use an ETF or mutual fund to populate a particular asset basket?
Answer: One of the best first-cut options available to investors is StockCharts.com’s PerfCharts. Investors are able to plot ten symbols – be they ETFs, indexes, individual equities or mutual funds – all on one chart with an animation bar. This means investors can vary the time period they trade personally and dynamically watch which symbols have outperformed or under performed. Detailed individual ETF reports are available at both ETF.com and Morningstar.com. For mutual funds, I use Morningstar and my brokers’ comparative tools.
The selection criteria will vary amongst investors but a premium should be placed on the following:
1. Relative historical performance
3. Portfolio composition
4. Assets under management
5. Alpha and Beta
6. Management personnel
Charles Schwab has my favorite tool to “Compare Funds” which allows five symbols to be observed side-by-side along with an extensive list of criteria. Most other brokerages do as well.
Question: Why are you so clearly fixated on costs?
Answer: This is one of my hot buttons. Most investors under appreciate the immense impact that costs can have on their returns. Fees can drain your assets in ways you may not imagine. Over time, the magic of compounding will work for you in astonishing ways. Fees work in exactly the opposite manner. Let’s assume hypothetically that both you and your twin brother start investing one million dollars at age 45. Your brother is frugal and pays 1% per year in fees. You are less careful and pay 2% a year in commissions and fees. Assuming there’s just a steady low 3.5% return for the next forty years, your brother at age 85 will have a portfolio that’s grown to $2.7 million which will be 50% bigger than your portfolio of just $1.8 million. Fees and expenses matter.
Question: Can you give some examples of ways investors can reduce their costs?
Answer: There are the obvious expenses to avoid, such as loaded mutual funds and esoteric ETFs with high costs, low volumes and wide bid-ask spreads. The less visible fees can be quite ingenious. One perfect example is a mutual fund that I’ve owned for years – MDISX. Exactly the same fund comes in five different flavors, so to speak. Five different symbols with five different configurations of front load, deferred load, expense ratios and 12.b1 fees. Here is where Morningstar is very useful. They have a tab labeled “Purchase” which shows you all the flavors available for any mutual fund. Always go for the low cost option.
ETFs are the same. A while ago, I bought two ETFs that offer exposure to exactly the same market. As an experiment, I executed the trades simultaneously in the same dollar amounts. Essentially the only difference between the two was that GLD charges 60% more in expenses than IAU. The bottom line is that the value of IAU now exceeds GLD in my portfolio. Over time, this sort of effort puts real money in your pocket, and the only cost is a little bit of extra investigative effort on your part.
Question: Once you’ve chosen the best mutual fund or ETF for a particular asset basket, how often do you swap them out?
Answer: One of the big advantages I’ve found to maintaining a ChartList populated with PerfCharts of each of my 20 asset baskets is that monitoring and comparisons are a snap. For example, my Dividend Yielders Asset Basket PerfChart is populated with VTI (for the total market comparison), DTN (the Wisdom Tree 100 ETF), VIG (the Vanguard ETF) and VDIGX (the Vanguard mutual fund). We’ve had a strong uptrending market, and DTN has proven itself as my investment vehicle of choice for this asset basket. When I read about another possible candidate, I simply plug it into the PerfChart and I can see immediately if I’m maintaining my best-of-the-breed strategy. I do this quite often as it turns out, but I usually dispatch the newbie contenders in a minute or two. It’s very efficient. Try it!
Question: With individual equities, you know exactly what you own. With so many different ETFs and mutual funds, how do you really know?
Answer: If anyone from Morningstar is reading this, you guys should really send me flowers! I enter all my positions into the Portfolio Manager at Morningstar.com. They have a tool called “X-Ray” which magically unbundles all the ETFs and mutual funds into individual equities for you. The insights will take your breath away! It will show you exactly what you own by style, size, foreign, domestic, bonds, cash, stock percentages and so on. It will be explicit and vivid as to what your diversification and allocations really are. Powerful stuff. Where are the flowers?
Question: Has this X-Ray exercise ever had an impact on what individual equities you trade?
Answer: Absolutely – and more than once! I never plow into an individual equity position anymore before consulting the X-Ray oracle. From time to time, it will surprise you to see the specific individual stocks that ETFs and mutual funds actually own on your behalf. You don’t want to be piling into those same equities that they’re already piling into, for many obvious and not so obvious reasons. I’m a momentum and growth investor. I don’t need ETFs or mutual funds to address that basket. I do, however, seek out the very best talent in the other asset baskets that I want covered. Therefore, I can leverage, for example, the exceptional skills of the value managers I’ve found and let them do their thing.
My job comes down to high leverage activities such as monitoring and adjusting asset allocations amongst the twenty different asset baskets. Frankly, I’ve gotten really very good at it, and it no longer takes me much time. Goodness knows I love this job – although it hardly seems like a job!
Trade well; trade with discipline!
-- Gatis Roze
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