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Thursday, May 27, 2010

Threading Strategies Together

Several different strategies have been discussed here on Finance Monitor along with numerous individual investments and I thought I would provide some context on how to view the discussions in the context of your own investments. The fundamental goal of this post is to weave several different posts on different subjects together. I will try to provide links so that you can quickly look up the prior discussions.

I guess the proper way to start this conversation was with the prior post on risk reduction in portfolio construction. This is one way of looking at your macro strategy, though there are many potential variations on this broader strategy. Within the core portfolio, either use equity index funds or balanced funds and basically just try to keep your overall allocation right, unless you want to be a little more active here. Then, you can engage in what was discussed on the post on dynamic asset allocation.

To do this, use the SPY and TLT ETFs at a basic level. If you have less than $2,000, I strongly encourage you to only re-balance when interest rates suggest you make a large reallocation from stocks to bonds or bonds to stocks. If you re-balance with every twinge, you'll get eaten alive by commissions. For example, let's say the model changes each month and you re-balance with $7 commissions each time (on both purchase and sale) with a $2,000 balance. You will incur $14 a transaction 12 times for a total of $168 in commissions. That would be 8.4% of your portfolio or greater than your average annual gain. With $20,000, it's 0.84%, which is bad, but not ruinous. If you are so fortunate to get up to $100,000, the fees are very low indeed. The ETF fees for TLT and SPY are also very low. In the case of SPY they are 0.09% per year and 0.15% on TLT.

Then the discussion turned to the "meso-portfolio". Here, if you are very cautious and refuse to have individual stocks in your core portfolio (not necessarily a bad idea), looking at the consumer products companies mentioned early on is a low risk way of trying to juice your portfolio a little bit more. It may sound like a low risk proposition, but buying "safe" stocks at the right time will boost your overall return. UTX falls into that category too. Also, these companies tend to have higher than average dividend yields. The post also mentioned broad based international funds like EEM, which, while somewhat risky, is very unlikely to deliver a devastating loss unless your timing is horrific such as buying in 2008.

We haven't had too many discussions that have exclusively centered on the exploratory portfolio because most of the stocks mentioned that would otherwise fall in here have become somewhat speculative. EWP, for Spain, and EWY for Korea are normally good examples, but in these particular cases they have become somewhat speculative. Similarly focused mutual funds are also in this category. Individual stocks include BUCY and VALE that were mentioned in the post on China. These are in this category because they are highly leveraged to a particular economic trend and are subject to much more volatility than a UTX or a CHD.

Finally, we've had more than our fair share of speculative mentions. The mortgage bond insurers certainly fall into that category, BP in its current mess is in that category, the aforementioned EWP and EWY are speculative in the current environment (though they are not normally), and most investments in Chinese companies are speculative. Of course, speculation is the most fun and it probably will attract a greater portion of discussions on this blog going forward than it should simply because it is more fun to talk about.

Anyway, I hope that did some good in tying the various discussions we've had together into a more comprehensive framework.


  1. BQ, I had mentioned before that the old men at the office were playing recreationally with MVIS. Considering its tendency to, without apparent reason, dive and shoot up, it seems proper to mention its... how you say... short-term speculative potential.

    Anyway, the happy end to this short story is his picking MVIS up this morning and watching it have one of its schizoid sessions (in a positive direction) at the end of the day. Makes a man wish he had recreational funds.

  2. MVIS is a good candidate for reading that post I made on "Why does my stock give me heartburn?" It falls into all three categories mentioned there. I'm not entirely sure how "real" that move even was. As such, it certainly falls into the speculative category.

    Risking being a little judgmental, I would say that virtually all stocks with less than a $500 million market cap are automatically speculative. Their volumes are likely to be too thin and the analyst coverage too light to get a good read on the company.

  3. It turns out it was not "real," as the gains were reversed by half today. Still, MVIS seems a fun stock to pretend to speculate on.