5 Takeaways From My January ETF Portfolio

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Includes: JKG, QLD, SDS, SHY, SLV
by: Jeff D. Hamann

Greetings to the new year!

I've decided to focus on a single portfolio for the month of January to ensure that readers have some basic actionable advice for based on the in-depth fundamental analysis of stocks or ETFs. Each week, I'll post a portfolio of Exchange Traded Funds (ETFs) that looked backwards for 200 days, targets 10% annualized return, and minimized volatility.

For now, I won't explain what an ETF is, what volatility means, how to compute correlations, or how to obtain the minimum volatility portfolio. I'll simply assume that you're interested in watching the portfolio that gave the smoothest ride (ride up over the long term that is) while still shooting for a target return of 10% annually. I compute the portfolio using the minimum mean absolute deviation portfolio concept, with some additional enhancements added to the GLPK example presented by Jeff Kantor. I'll assume you can compute the number of shares based on your investable budget as well.

Here is today's resulting portfolio pie chart and performance plot from Google Finance (click to enlarge images):

Allocations and performance for the portfolio

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The data about the portfolio assets are presented below:

ETF

Annualized Return

Standard Deviation

Allocation

SHY

2.00%

1.20%

68.60%

SLV

117.00%

29.00%

8.60%

JKG

28.00%

22.00%

8.40%

SDS

-27.00%

37.00%

9.10%

QLD

53.00%

39.00%

5.20%

Click to enlarge

These results are for the previous 200 day's worth of data.

You first reaction, like most, is that this method assumes that I had perfect information and prior knowledge, of the markets for the previous 200 days, beginning 200 days ago, which is of course bunk. As an econometrician, the words perfect information (think Information Theory) and prior knowledge (think Bayes Theory) are seriously value laden words and cloud the point I'm trying to make here. These are all true.

These blog entries should be considered as:

  1. A teaching tool to combat the financial illiteracy of investors who make investment decisions based on fear, greed, or lust (respect to Peter J. Feibelman, author of A PhD is Not Enough). When making financial decisions, investors often fail to recall correct, precise, and useful information. They make decisions based on flawed memory and emotional pain as described in the article by Joachim Klement and not on solid objective data and information within the context of constructing and maintaining a retirement portfolio with a policy of long-term consistent returns that many investors want, but rarely get.

  2. A reality-distortion-field detection system to prevent investors, who might not be familiar with appropriate retirement portfolio construction, from being duped and help them make allocation decisions not based on anecdotal information (i.e. 60% stocks 40% bonds), but on actual portfolio analysis from actual assets.

  3. A place for self-directed investors, traders, and savers (including myself) to have an archive of portfolios that are generated using freely available and open source methods as a guide for making solid investment decisions.

The takeaway messages for today's portfolios are:

  1. If you don't have short term bonds in your portfolio like iShares Barclays 1-3 Year Treasury Bond ETF (NYSEARCA:SHY), now looks like a good time to go shopping. Today's proportion is near 70 percent. Bonds have been getting battered, but they're still remain a solid foundation from which to build upon.

  1. The proportion for the commodity pick, the iShares Silver Trust ETF (NYSEARCA:SLV), is still increasing. Today, it's near 9 percent of the investable portfolio. If you don't have a commodity in your basket, get one, pick it and stick with it until further notice.

  2. The US equities (JKG and QLD) are still less than 20% of the portfolio. The iShares Morningstar Large Core Index ETF (NYSEARCA:JKD) and the ProShares Ultra QQQ ETF (NYSEARCA:QLD) seem to be providing solid returns for the past 3 months, and if you've had them, in small proportions over the last 200 days, you're probably doing fine. If you've “been all in” in these two, you've had quite a bumpy ride. Ignore the man, or woman, behind the curtain telling you the recession is over. Time will tell.

  3. The hedge (NYSEARCA:SDS) is a 2x-leveraged ETF. Beware. This is like the box of baking soda in the fridge. You buy it, don't expect to eat it, and eventually throw it out when it's absorbed all the bad odors. Maybe you, once in a great while, use it in something you bake, but for the most part, it's basic insurance against catastrophe. Buy it, watch it drop, and watch your portfolio become more stable in bad markets. Use it to contain your losses, not get rid of them completely.

  4. These portfolios are a combination of assets. You cannot purchase a single asset and “see what happens” or a few assets and expect the volatility to be minimum. The concept of portfolio theory is to determine the combination (more than one) that meets the investor's constraints and achieves their objectives. A single asset is not a portfolio. Period.

  5. If you hate surprises and uncertainty (aka volatility) like I do, you'll be happy to read that the standard deviation has decreased from last week's 3.00% to 2.81%, which provides a smoother ride when compared to the last 200 days of S&P500 returns of near 20 percent.

I hope this helps.

Disclosure: I am long SLV.