A friend of mine gave me a (wake up) flashback to my own wayward introduction to self-directed investing. And when I write introduction, I mean to my own mistakes. You can discover how I became the Scaredy Cat Investor in this article.
My friend called me this week and asked that we get together for lunch as he wanted to talk about his investments - again. We've chatted about simple investment ETF model portfolios for a few years. I've directed him (let's call him Carl) to a few sites that offer some basic background knowledge and model portfolio theory, and model portfolios. And when asked I certainly gave him a recommendation on ETFs to combine.
Carl's not that interested in managing his own portfolio to the extent that he opted to go with ING Direct and their pre-packaged ETF portfolios. Not a bad choice for a self-directed investor with modest funds to invest. The dividends are reinvested at no cost. And any additional monies invested each year come without trading fees. There is a flat fee of 1%. And he reported that those funds have done reasonably well for him over the last two years or more. And the funds are up 7-8% to date.
But then Carl confessed that his other portfolio was not doing that well. He said he also bought some index funds in a self-directed brokerage account, but … and then he had a guilty look on this face. Carl had some other "stuff" that wasn't doing very well. OK what stuff I asked.
He purchased a couple of index ETFs with lower fees than his ING Direct holdings. A good move of course. And he made a few sensible choices. He holds a balanced bond fund that holds some corporates. And an index fund that holds a nice mix of government bonds. And on the equity side he bought the broader Canadian market. And he weighted those three funds at 50% bonds and 50% equities. Check, check and check.
But then he started to go cowboy. He has some friends that work in the oil and gas industry and that he had to purchase Horizon Northern Logistics and Bankers Petroleum. Quite quickly, Carl is down 16% and 11% in those two must haves.
He also bought a Bond Mutual Fund that had incredible fees - coming, going and fees for just hanging around.
Carl broke a few "rules" in my opinion - assuming that I'm any position to make rules. First off, he did not stick with the plan. He probably didn't even acknowledge that a plan was sitting in front of him.
Carl bought two individual stocks to combine with his funds. That's a big no-no in my books. Although I wrote an article called the One Stock Portfolio, featuring Royal Bank of Canada (RY) it is a rare case and of course I was suggesting that investors look at the Canadian banking sector as a whole. That said, Northern and Bankers Petroleum could turn out to be the play of the decade. But owning just a few companies can be very dangerous for obvious reasons. If they tank and they are a considerable holding in your overall portfolio, you take a big hit.
Pick a lane. Buy ETFs and funds and stick with it, or if you're going to build your own portfolio of individual companies, make sure you have enough exposure across sectors (and within each sector) and diversify geographically. Personally I don't think one can monitor a portfolio of stocks (sufficiently) to cover all of the bases. But that's another article.
And Carl did not check up on the fees on his mutual fund. Those funds would likely have eaten up over half of his gains. Fees are an investor's buzz killer. Avoid 'em as much as you can.
If you don't have a lot of time, or interest in investing (aka most people), build a very simple portfolio. If you don't think you can handle a lot of volatility in your portfolio, overweight to bonds and add some gold. In my article Confessions of a Scaredy Cat Investor I highlight the incredible Permanent Portfolio that offers equity-like returns with very low volatility. The portfolio has had only two very small down years in the last 40.
You can find some incredible info and portfolio suggestions on sites such as Vanguard. It's not that hard to create your own balanced ETF portfolio.
Seeking Alpha writer Paul Allen offered a very balanced and well diversified portfolio in this article. With nine ETFs Paul covered U.S. and international equity markets, the bond universe with some added Gold exposure.
- Vanguard Total Stock Market ETF (VTI)
- Vanguard MSCI Europe ETF (VGK)
- Vanguard MSCI Emerging Markets ETF (VWO)
- SPDR Gold Shares ETF (GLD)
- Vanguard REIT Index ETF (VNQ)
- iShares Barclays TIPS Bond ETF (TIP)
- Shares Barclays 20+ Year Treasury Bond ETF (TLT)
- Shares Barclays Aggregate Bond ETF (AGG)
- Shares iBoxx $ Invest Grade Corp. Bond ETF (LQD)
To many, purchasing and managing a nine-ETF portfolio could be overwhelming and not cost effective. One could potentially use two products to create a reasonably diversified (starter) portfolio though with minimal foreign or currency exposure. The S&P500 ETF (SPY) and 20-year Treasuries. From 2005, SPY would give you 37%. TLT 94%. from 2005, and that's without rebalancing the weighting between TLT and SPY. There are certainly interest rate risks with TLT as it's a longer dated bond ETF, and the price will fall when interest rates rise. That said, those price drops are likely to be offset by price gains in SPY if they provide their low correlation or negative correlation magic. And investors who fear that interest rate increases are imminent have the option of selecting a shorter dated ETF or 1-5 year laddered corporate bond ETF.
And on the equity side, while it's "only" 30 companies, the Dow Jones Industrial Average (DIA) is a wonderful basket of U.S. multinationals with foreign exposure and a higher (and very attractive) dividend yield listed as 2.9% on a few sites. DIA would have netted you 47% from 2005.
Combine DIA with TLT from January 2005 and you have yourself a tidy 70% gain to November of 2012. Take that one-two punch portfolio back ten years to November 2002 and you would have a 110% total return. And another important measure is that the two investments have a correlation of just .66 over that period. A figure of 1 would mean they move together, absolutely.
Now let's add one more asset class, gold, to this simple starter portfolio mix and see what happens. Sprinkle in some gold and this trifecta portfolio delivers a return of 140% from 2002. Go to low-risk-investing.com where you can type in tickers and get instant total portfolio returns - punch in GLD, TLT, and DIA and you'll find that you get very impressive returns from any year, from 2002, even through the market meltdown of 2008-09.
The lesson that Carl teaches us is, first get a plan. Second, stick to that plan. Third, keep it simple.
Additional disclosure: Please note that Dale Roberts aka cranky, the crankywriter, the scaredy cat investor, is not a licenced investment advisor, and the above opinions should only be factored in to an investor's overall opinion forming process. Consult a licenced investment advisor before making any investment decisions.Please note that Dale Roberts may have exposure to companies or ETFs listed in this article, through the holding of ETFs on the Toronto Stock Exchange.