Launching a portfolio when the major indexes are hovering near new highs is intimidating as the probability of losing money right out of the blocks is rather high. While it is nearly impossible to insure one will remain in the black, there are steps one can take to reduce portfolio risk when launching a new portfolio.
- Identify the securities that will be used to populate the portfolio. In the example below, 30 Exchange Traded Funds were selected.
- Prepare to diversify all over the globe.
- Include a sufficient number of low correlated ETFs to serve as risk reducers.
- Include a cutoff ETF. SHY is used as the cutoff ETF in this Sample portfolio. How this is used will be explained later.
- Set up a method for ranking ETFs or other securities one plans to include in the portfolio.
- Consider using one of the momentum models explained in The Feynman Study.
- To accurately measure both portfolio and benchmark Internal Rate of Return (IRR) performance, use the TLH Spreadsheet.
Efficient Frontier: The following graph shows the projected Return/Volatility ratio for the Sample portfolio. An optimized portfolio would have the yellow diamond dot resting on top of the red dot or the optimized portfolio. The optimized number of shares is shown in the last screen shot.
ETF Rankings: Thirty (30) ETFs are ranked below based on performance over the past three and six months. The third metric entering into the performance ranking is volatility. Also pay particular attention to the acceleration or momentum percentages for each ETF as we are primarily interested in ETFs that are doing well.
ETFs ranked below the performance of SHY (tied for #19) are to be avoided. Back testing shows a decrease in draw-downs as lower performing ETFs are avoided. All ETFs are re-ranked when the portfolio next comes up for review. I review portfolios every 33 days.
Buy-Hold-Sell Recommendations: Consider the following table as the decision making table. There are two models one finds in this table. If the investor is creating a portfolio around an optimizer, use the Optimal Shares column for recommendations. Investing in those recommendations will place the portfolio on the red dot in the Efficient Frontier graph.
A second model, and one that has shown better results when back tested, is a weighting momentum model. The recommended shares are shown in the Weighted Shares column. I set the Weighting Filter to 11 so no ETF would hold more than 20% of the total portfolio. The software permits one to concentrate the portfolio into fewer ETFs. The fewest number of ETFs recommended is four.
Should no ETFs outperform SHY, all cash is invested in the SHY treasury.
Several portfolios are experimenting with these models on the ITA Wealth Management blog.
Disclosure: I am long VTI, VUG, VOE, VBR, VUG, VOT, VBR, VEA, VNQ, PCY, BND, DBC, SHY. 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. At some point I will use any or all of the 30 ETFs.