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Just your average buy and hold investor :)
  • (Part One) A Well Diversified Equity Portfolio In 2-3 Hours A Month 2 comments
    Mar 21, 2012 3:44 AM | about stocks: VYM, DLN, VIG, VUG, EPS, EES, EZM, VGT, IDV, IJH, VBR, AXJL, SCHF, DXJ, SCZ, DEM, VWO, DGS, DRW, VNQ, VNQI, MOO, GNAT, CCXE


    I do all my own investing, and I've hit the wall. Security analysis is fun and often fruitful, but it demands constant attention and simply too much time to be practical. This article is a documentation of my efforts to put together a diversified retirement portfolio - one designed to grow, and to preserve wealth via a methodology that uses less than three hours of my life a month. Because of this time limitation, my portfolio forgoes individual security analysis altogether in favor of broad diversification and general investment strategy. I am a big proponent of cracking open quarterly reports and picking apart balance sheets. But let's be honest, if you are beating the market, then the market is taking up a ton of your attention and time. With long term investments you must know your limitations and what your time is really worth. I can consistently commit two to three hours on a monthly basis, and so I have to face reality and give up the joy (and increased return) that comes from due diligence and intelligent individual equity analysis.

    If you have large amounts of time to invest and are concerned with complex strategies and hair splitting information, this article is probably not for you. If, however, you're one of the 99.XX% of us who don't get a paycheck to do analysis, you just might find the following portfolio interesting and helpful. And please, feel free to comment. I wouldn't be posting this if I didn't want your productive feedback.


    Personal Position Statement

    Everyone comes from a unique position. Understanding and honestly articulating your subjectivity is critical. Prior to deciding your game plan you have to know where you're coming from, how you want to play the game, and what will signify financial victory for you personally. If you have never written out a personal position statement I highly recommend it. Putting words up on the screen has a solidifying quality that really helps to give your investments a firm foundation. For me personally, it was also kind of a check list to make sure I was taking care of those financial planning elements that you should probably get in order before you even start thinking 'retirement account'. I am including this in my article in part because I want to give the total picture of what I am doing, but I also think you need a bit of background to know where I am coming from; something that puts the rest of the portfolio into context and gives a general understanding of why I made certain choices and not others.

    Here it is: I am a young investor, with a 25+ year investment horizon who makes more than he needs to maintain his current lifestyle. I feel confident that I have both the resources and the discipline to put away a set amount of money per month for the foreseeable future. I have an emergency reserve fund in place that can sustain all fathomable unexpected expenditures in the coming year. I have no debt obligations, and have set up lines of credit in the event that they are needed. I understand that markets are not always rational and that the potential for a crisis in the equity market is quite likely given a 25+ year investment horizon. As such, I have created a separate "worst case scenario" portfolio that takes this risk into account. I have some time to dedicate to investing at the moment (as I am writing this now), but this will not always be the case, and thus need a financial plan requiring only 2-3 hours a month of portfolio management. My goal is for this portfolio to serve as my core average scenario retirement fund. If, during my 25+ year investment horizon, the stock market performs similarly to its historical averages, I should have enough to fund my retirement at age 55.

    My Personal investment strategy

    We all have a general investment strategy that pervades our opinions and outlook on the market. It helps if your investment strategy is on a firm logical foundation, but in my opinion personal investment strategies are based as much on inherent individual values as on logical information analysis. I am taking the time to write mine out, so I admit this bias to myself, and lay it out there for your analysis and criticism.

    As an investor, I am biased towards value and dividend paying stocks. There is ample data over the last hundred years to show that value stocks have outperformed growth stocks and that dividends have accounted for most of an investors returns during this period. I understand that there will always be two sides to this debate, and that Apple is a money machine and the Nasdeq has done quite well of late. For me, the core reason for value investing is its lack of sex appeal, and therefor it's tendency to avoid bubbles or run away bull markets. The core appeal of dividend investing is not the steady income, but rather the steady flow of letters sent straight from company headquarters to my bank account saying in the language of U.S. currency, "We remember who were working for - it's you". Quarterly reports and letters from the CEO are great, but in our age of overstretched lines of accountability there is nothing like the language of $.

    I am basing my investment strategy on my personal values. Earnings-weighted funds, dividend funds for the large caps, and a smaller allocation to growth and tech than what is typically help in most cap-weighted indexes. If you're hot on growth stocks and BRIC investing, please don't be bashful, I always like hearing argumentation and just because I'm tilted towards dividend and value doesn't mean I don't want this portfolio to have a growth and tech element as well.


    Diversification is a must for a low maintenance portfolio. In its purest financial significance diversification means reducing risk by investing in a variety of assets. If the asset values do not move up and down in perfect synchrony, a diversified portfolio will have less risk than the weighted average risk of its constituent assets. Whether or not catastrophe synchronizes one's portfolio is another issue, but in general I believe diversification has risk reward benefits in all except the most severe cases. Listed below are some of the ways I am seeking to diversify my retirement portfolio. If you have suggestions regarding diversification in general or believe I'm overlooking an important diversification class please let me know. At the end of this article I'll do a quick rap up showing how the ETF's i selected and the weights I assign to them come together to address the diversification points I bring up below.

    Asset class: There is a lot to be said for diversifying your asset classes. Real estate, stocks, precious metals, commodities, and bonds are all areas that should be part of a long term investment portfolio. For my purposes here, I will be looking to create a portfolio of stocks or equity assets. This is due to the fact that I am investing with a long term horizon, have an investment methodology that is not adverse to volatility, and the additional fact that I am planning on re-evaluating my portfolio in five years' time (at which point I will probably begin to slowly increase my exposure to these traditionally less volatile assets).

    With that said, I am also lying. I have some exposure to all of these investment areas. A portion of my portfolio is dedicated to REIT's; international, domestic, and mortgage. I have selected ETF's that will give me exposure to commodity producing equities, as well as precious metals, agricultural products, and industrial materials. Also, you will also see later in part three, my methodology will at times invest a fair amount into bonds, commodity futures, and like cash assets. However, and this is big, all of these positions are taken either temporarily or within the equity asset class. This is important to state because there is a big difference between owning a piece of land and owning a share in a REIT. Owning a gold bullion fund and owning physical gold. Owning equity in industrial materials companies and having the materials themselves in your possession. Or owning bonds but having an investment methodology that moves you out of them based on equity market pricing.

    I state all this in a flip floppy duality way to make a serious point. My strategy can look to be fully diversified at first glance, it is not. I believe true diversification comes with long term hard ownership, owning land, physical gold, commodities futures contracts, and bond investments made for the long term. I suggest this type of diversification, but I'm not addressing it in this portfolio and want to forewarn any readers.

    Next, from the broad options available within the equity universe, I will further be limiting this portfolio exclusively to ETF's. I do believe there is a lot to be said for cherry picking undervalued stocks, but my main reason for making this portfolio was to get away from the time intensive act of security analysis. ETF's seem to offer a viable tradeoff between returns and time, with 2-3 hours a month to dedicate to my portfolio they seem a natural choice. Of course, this is not to say that ETF's are fool proof. By opting for an ETF you add another level of bureaucracy between you and your money (i.e. the ETF fund and their issuer) and with this addition comes a whole new set of risks. To help to mitigate these new set of risks I have taken a number of steps. Perhaps the most important is the ETF screener which I will go into detail about later. The second precaution is to diversify the issuers I hold in the portfolio. And lastly, I have, and plan on keeping, a separate smaller long term horizon equity 100% non-ETF portfolio as a hedge to ETF's systemic risk. O.K. - so it's solely an ETF systemic risk portfolio, it's also a place for me to set aside some play money so i can conduct security analysis and have some fun when i find the extra time. (but it probably a good idea not to have your whole retirement account in ETF"s).

    Investment size: I believe that investing in different levels of capitalization is important for creating a diversified portfolio. Different market caps contain different inherent characteristics and specific advantages/disadvantages within the market. These are not universal among all equities under a certain market cap, but substantial differences do exist as a collective whole, and are therefore important for diversification purposes. There is some pretty good data out there that shows small caps have the greatest risk adjusted reward over the long term, so I do go a little heavier into this market cap than others, but I am largely forgoing this historical preference in favor of the diversity and security that comes from owning a basket of varying capitalization classes.

    Investment region: Investing in different geographical regions is also an important part of diversification. I am partial to the American capitalistic culture, and believe that investors should in some way bias their investment allocation to take this into account. There are no other markets in the world that can combine the U.S.'s respect for property, history of financial opportunity, and culture of shareholder rights like the good old U.S. of A. However, just because this is how it has been in the past doesn't mean that this is how it will be in the future. And it is hard to imagine more opportunities for business and growth than in the emerging markets. So, my portfolio does have a tilt towards U.S. equities (thought less than most American portfolios), and a full out bias for U.S. firms investing overseas, but it is still quite diverse in terms of geographic regions.

    Investment sector: Certain industries perform better under certain economic conditions, but by building a diverse portfolio I'm hoping to have good overall value under almost any normal conditions. Ideal diversification should hold securities from a mix of companies that serve different roles within the industry. While it would be nearly impossible to for an individual investor to maintain this kind of diversification by picking individual stocks with due diligence, ETF's with screening criteria offer a low cost method to achieving this level of diversification. By having a bias towards value and dividend companies, I end up pushing my portfolio away from technology based companies in general. But as we have seen with the likes of Intel, Microsoft, and IBM this does not necessarily have to be the case. My hope is that as the technology sector matures it will continue on the path of other stable investor centered sectors and move towards better valuations and regular dividends. In the meantime I have allocated a small satellite holding for technology firms. With dividend and value investing you always have to be concerned with sector allocation, as it is subject to become heavy of light in some sector based on market opinions and short term cycles. I've done what I can to keep good sector diversity, but this can be a balancing act that borders on art. If you have the skills and would share your opinion, I'd love to hear it.

    Inflation sensitivity: Inflation and deflation have significant impacts on a company's long term prospects and on the purchasing power of the portfolio itself. I believe that both inflation and deflation should be accounted for in a well-diversified portfolio, and that there is little one can do to protect a portfolio from one of these eventualities once the expectation of it has arose. Therefor the only way to combat the harmful effects of inflation and deflation is to have your portfolio inherently ready for either eventuality all the time. In my portfolio I attempt to achieve this through several well-known methods like investing in real estate, commodities, inelastic price products, and companies that exhibit a competitive moat to competition. (I am always looking for smart ways to combat inflation/deflation, so if you have any ideas please don't be bashful. Also, I'm not yet comfortable with investing in futures contract ETP's. If there is anyone out there who can explain contagion and such I'm all ears).

    Portfolio, General

    Asset classes, geographical location, market capitalization, and sector diversification. Trying to stuff all this stuff into a single portfolio is a tall order. To help give the endeavor some grounding and a nice first step let's start by looking at the "FTSE Global All Cap Index". This is "a free-float-adjusted, market-capitalization-weighted index designed to measure the market performance of large-, mid-, and small-capitalization stocks of companies located around the world. The index includes approximately 7,400 stocks of companies located in 47 countries, including both developed and emerging markets." (indexuniverse) This index lays out the basics without any fooling around and presents a great place to start. For many investors this could be a one stop equity portfolio. I am going to go a little further through and tweak it to meet my individual needs. Here's what I'll be doing this and why.

    1. Because of my investment methodology of Value Cost Averaging (more in part two) I will be dividing up my portfolio into separate investments so that their market valuations can vary independently, and I can benefit when the market undervalues a certain asset classes, sectors, or geographic location.

    Cut up the fund into pieces while retaining a diversified whole.

    2. I have a long term investment horizon and thus don't mind the added risk and reward that comes from owning a greater proportion of medium and small caps.

    Tilt the fund slightly towards smaller capitalization.

    3. Dividends and value stocks are music to my ears. I want my portfolio to represent this part of my personal investment strategy.

    Push portfolio more towards value and dividend indexes while maintaining some exposure to growth non-dividend stocks.

    4. Real estate currently makes up less that 3% of the Index. While this may be representative of the market, I see real estate exposure as a key hedge to inflation. Inflation is one of my key points of diversification and I believe inflation can only be properly hedged before fear of inflation occurs.

    Increase real estate exposure from 2.7% to somewhere closer to 10-15% in my portfolio, and make sure this exposure is diverse itself.

    5. Basic materials make up a good portion of the index with around 8%, significantly higher than the S&P 500's 3%. But here again I want more protection against inflation and I'm not adverse to the increased volatility associated with getting it through basic materials.

    Have a long term tilt towards basic materials with around 10-12% of my portfolio dedicated to this area.

    You have to have some kind of a benchmark for your investment, for me the "FTSE Global All Cap Index" fits the bill. Of course, this is not a benchmark in the context of seeking replication. Rather this index provides a general outline for me to follow roughly while adapting for personal biases and strategies.

    ETF Filter

    Ok, so I have my general outline benchmark, where to go from here? There are over one million ETF's out there and it is hard to find the right one to meet your needs. O.K. so there's less than a million, but it is still difficult to separate the wheat from the chaff. The following is an ETF screener I use to start the separation process and get rid of stuff I truly don't want. It is not complete by any means, but it is a starting point. Also, this is not a filter for determining what ETF's you should own. This process a secondary search eliminating non-contenders from a from a group of stocks I think might be able to fit together to meet my adjusted "FTSE Global All Cap Index".

    1. 25 million + in AUM: This is the level of assets most insiders believe is required for an issuer to break even. "The economics of an industry built around bargain basement expense ratios can be challenging to issuers. It costs money to run an ETF, and a significant portion of the products out there now are losing money…. some will not [make it], and they will ultimately be shut down." While an ETF shutting down is nothing like a business with shareholders shutting down, it does create difficulties I'm not looking for, i.e. potential unexpected tax implications and having to spend more than 2-3 hours a month reallocating resources. For this reason I am trying to avoid ETF's with less than 25 million in AUM.

    2. No ETN's: There are a lot of good tax reasons to go with an ETN over an ETF when investing in currencies, commodities, and other specific strategies. However, I'm not going to be investing in any ETN's. This is because ETN's carry substantial credit risk. I am not against all ETN's in principal but this portfolio is designed to save time. Having to check the financial stability of your ETN issuer on a regular basis doesn't sound like a time saver. Not checking their financial stability . . . well, that sounds stupid. So, no ETN's. I'll have to get my currency and commodities exposure in a different way.

    3. "Lowest fees" + "Best in class": Some ETF's are created equal yet cost something different. As a case in point, EEM and VWO are both linked to the MSCI Emerging Markets Index. Yet EEM charges nearly 50 basis point more in fees. There may be reasons to favor one fund over the other even when the underlying indexes are the same. Such as the funds weighting mechanism, an active options market, or liquidity. However, the expense ratio has to be one of the first deciding factors. If it's not the lowest out there, it ought to be darn close.

    4. Free Commissions: Brokerage companies are now offering the world with free trades on low commission ETF's. Because I am planning on using Value Cost Averaging as my investment method, I plan on making frequent low volume trades. These are trades that I wouldn't be making if they weren't free. For this reason I try to get one ETF in each capitalization class and geographical region that is commission free.

    5. Few cap-weighted funds: I am a fundamental indexing fan, and believe that cap-weighting is often a bad idea, especially in overheated bull markets. "The more overvalued a stock becomes; the more dollars' worth of the stock will be included in the index. This means that wildly overvalued companies tend to dominate the index portfolio." To combat this problem, fundamental indexing uses a company's fundamental factors (such as revenues or earnings) to arrive at a value for the company. As a case in point, check out RSP and the old classic SPY, "The components of these two stocks are identical; both hold the 500 or so equities that make up the S&P 500. But RSP, which gives an equal weight to each, outperformed SPY in 2010 by about 600 basis points. For two products that have identical portfolios, that's a pretty significant gap."(seeking alpha) Of course, there are a few benefits to cap weighting as well; 1.) You get and listen to the entire investment community's opinion about what an equity is worth (Not always bad), and 2.) You generally incur lower trading fees with cap weighted indexes. As a rule of thumb, cap weighted indexes win with lower total expenses when the market is functioning rationally, when it's not fundamental indexes will probably prove a better option. When I invest in cap weighted fund, it must be 1.) A fund with a large number of holdings, 2.) Not be a sector specific ETF, or 3.) Have some other screening mechanism that inherently tilts the selection to less hype driven stocks. (i.e. a dividend or value strategy)

    6. "Tax Efficiency" + "Best in class": A quick look at the home page will tell you if your ETF incurred a capital gains tax as a result of its operations. Generally speaking this only applies to commodity, currency, and certain bond ETF's, but you can never be too sure, and it's always good to check. High dividend yielding REITS are an ideal investment for non-taxable accounts and the same holds true for high yielding REIT ETF's. However, the tax efficiency search should not end with the obvious. You have to check all of your potential ETF's tax implications prior to pulling the trigger. As a case in point, Morningstar has this to say about DEM, a popular large cap emerging markets ETF, "a portion of this fund's dividends will not be qualified, as the United States has different tax agreements with different countries (in 2010, 57% of DEM's dividends were considered qualified). In addition, some of the dividends are subject to foreign tax withholding (in 2010, about 4% was withheld). Investors can claim their portion of the withheld taxes as a tax credit but only if they hold this fund in a taxable account." Once I have two or three ETF's that meet my diversification and investment strategy criteria I like to see how tax efficient they are. Most of the time they are the same, but if nothing else I learn what's going on, and can decide the type of account the assets should be held in. Also, ETFdb does an ETF reportcard each year that gives you the basics, but you should check the homepage to get the exact tax implications. Furthermore, while somewhat off the point, it is good to remember that standard tax implications similar to individual stock ownership also apply. For example, "the looser/closer rule" in which "an investor closes out positions that have losses before their one-year anniversary. You then keep positions that have gains for more than one year. This way your gains receive long-term capital gains treatment, lowering your tax liability." - is a nice trick, if you have the time. (if you've got other let me know?)

    7. Are we looking at options?: I will get into my investing methodology later, but I like ETFs that have the option of options. Having the ability to make a covered call on a position gives you an easy, mechanical, and profitable way to get out of, or reduce, a position you believe overvalued. While this is not a must, I like to have one option-able position within each asset class and region if possible.

    8. How's the spread (short term divergence from NAV)?: As ETF's are traded like stocks in the open market there is no reason that they have to trade according to their NAV. Logic says that they should, arbitrage investors are happy they don't, but the simple truth is ETF's often trade at a significant discount or premium to the securities they represent. While, this does not scare me away as a long term buy and hold investor, it does make me shy away as an investor seeking to optimize his time. ETF's that traditionally trade in the general vicinity of their NAV are a simple double click affair. ETF's that vary from their NAV's in a substantial and frequent manner demand time and patience. In general, I like to see a spread that is pretty consistently within 10-20 basis points, if not I like to check for more liquid alternatives.

    9. How's your record with the index?: As every ETF fact sheet says, ETF's "seek to replicate, to the extent possible the underlying index." To illustrate how extreme the divergences can get, check out the three ETFs registering the worst errors during the volatile year of 2008 (using Morgan Stanley's absolute tracking errors): iShares FTSE NAREIT Mortgage REIT (11.8 percentage points under), Vanguard Telecommunication Services (5.7 percentage points under) and iShares MSCI Emerging Markets Income ETF (4.1 percentage points over). This is different from having a short term deviation from NAV that I discussed in the previous screen point; which is most probably due to poor liquidity. With long term NAV divergence "Management expense ratios (MER) are the most prominent cause of tracking error and there tends to be a direct correlation between the size of the MER and tracking error. But other factors can intercede and be more significant at times."… "when there are thinly-traded stocks in the benchmark index, the ETF provider can't buy them without pushing their prices up substantially, so it uses a sample containing the more liquid stocks to proxy the index. This is called 'portfolio optimization.' This is most common in emerging markets, sector specific funds, and some small/micro-cap ETF's"…. "Dividend ETF's can also miss on long term NAV, but the reason for the divergence is different, because Indexes don't have cash holdings, but ETFs do, cash can accumulate at intervals due to dividend payments, overnight balances and trading activity. The lag between receiving and reinvesting the cash can lead to a variance. Dividend funds with high payout yields are most susceptible." In all these cases the bottom line is simple, you want your ETF to follow the underlying index and if it's not, you probably shouldn't be investing in it. "A quick look at the Beta will show you how well an ETF replicates the performance of it's intended benchmark. Relative to its underlying index, the closer an ETF's Beta is to 1, the better it does its job. It may seem counter-intuitive, but an ETF that routinely outperforms its target index should probably be avoided at all costs. The goal of most ETFs (actively-managed funds are a whole different story) is to replicate the return of a benchmark. Be wary of any funds that have material tracking errors." (ETFdb)

    Individual ETF Selection with Explanation

    And so we get to the good stuff. The following is my anticipated retirement portfolio. I go through each one of my selections and try to give a quick report as to why I choose it over other alternatives. I use the screening method I just described above, and I have tried to diversify my holding based on the diversification areas I mentioned, and i try to follow the "FTSE Global All Caps Index" as a general outline. (with my modifications)

    If you have any comments please do not hold back, I wouldn't be posting this if I didn't want comments that begin with… "How many times did your mother drop you as a baby"….and then followed with substantive opinionated advice. :)


    The Index: "This fund tracks a custom index built by Vanguard and FTSE. The index begins with all stocks in the U.S. market tracked by FTSE, excluding only real estate investment trusts because they rarely pay more favorably taxed qualified dividends. FTSE removes all companies that did not pay out a dividend in the past 12 months from the potential constituent universe, and then ranks the remaining stocks by yield. This index comprises the highest-yielding of those remaining stocks that sum as much as 50% of the total market capitalization of potential constituents. In practice, this ends up producing an index of the highest-yielding third of the U.S. market. The FTSE High Yield Dividend Index is market-cap-weighted, so it incorporates market price information about the current state of businesses and sustainability of dividends. This also makes it easier for Vanguard to replicate the index without incurring taxable capital gains. " (Morningstar )

    This fund is cap weighted and uses dividend yield as a dominant factor in the selection process. Being market-cap-weighted has two advantages, first it incorporates market price information about the current state of businesses and thus incorporates investors opinions regarding the sustainability of dividends. Second, it makes for a dividend fund that is not solely large caps and incorporates dividend paying stocks in all levels of capitalization. (I like cap-weight and dividend yield when used in tandem, never alone) With an expense ratio of 0.13 VYM is among the lowest priced ETF's in the domestic/dividend/large-cap market (some small and medium caps included), and within a few basis points of the low price leader. The fund holds nearly 450 holdings from a wide variety of sectors and is thus quite diversified. Exposure is tilted towards consumer, energy, and industrials when compared to a market index, but this is to be assumed with a value and dividend approach. VYM is offered commission free from TD Ameritrade (one of the brokerage firms I plan on using) and has the added bonus of options being available. VYM did not incur any additional capital gains taxes from its operations in either 2010 or 2011 and there is little reason to believe that will change. Of course, the dividends from this fund will incur capital gains tax, but that is part of dividend investing. The NAV spread is quite small for VYM and this is primarily due to its good liquidity, volume, and quality underlying securities. Since its inception in 2006 VYM has stayed between 10 basis points of its NAV, an extremely strong correlation.

    For all of these reasons I'll be putting (6%) of my portfolio with VYM.


    The Index: "This fund tracks the WisdomTree LargeCap Dividend Index, which compiles stocks that have paid regular cash dividends in the 12 months prior to index reconstitution and selects the 300 largest such companies. Rather than market-cap weighting, the benchmark weights constituents based on projected cash dividends to be paid over the next year. The company projected to pay the most cash to its shareholders over the coming year receives the largest weight. This fundamental weighting methodology balances a company's market capitalization with its dividend yield, so the index isn't dominated by either low-yielding mega-cap stocks or very high-yielding, risky names (as might result from a naive dividend-yield-driven approach). The fund currently holds 297 securities." (Morningstar)

    DLN is extremely comparable to VYM, but for me the dividend-weighted methodology is a preferred means of weighing and I don't mind paying a few extra basis points in fees while getting the added security of a different ETF issuer and different methodology within the sector. With over a billion dollars in assets DLN has good liquidity, but it is less than VYM and you have to watch out for occasionally paying too much over NAV. Options are available on DLN but are thinly traded. Like most similar ETF's, DLN incurred no additional capital gains expenses. Also, DLN is offered commission free on Etrade (the other broker I'm using for this portfolio). While DLN has a good long term track record of following NAV (just two basis point from NAV since inception) it has fluctuated as much as 30-40 basis points at different periods in time, so it is something to keep an eye on.

    I will be assigning (6%) of my portfolio to DLN.


    The Index: "This exchange-traded fund tracks the MSCI U.S. Prime Market Growth Index, which sifts the 750 largest U.S. stocks in terms of free-float market capitalization, for the fastest-growing companies. The index currently holds about 430 constituents. MSCI defines style based on five growth measures (forward earnings per share growth, both long- and short-term, historical EPS and sales growth, and internal growth) and three valuation measures (dividend yield, price/book, and forward price/earnings). MSCI employs buffer zones to limit the migration of stocks between the growth and value camps. The design helps limit turnover and make the ETF a better representation of the growth stock universe. The fund follows a full replication strategy, holding essentially all of the 430 stocks in the index." (Morningstar)

    Companies within the growth segment offer tremendous profit potential since they are still in the early stages of their life cycle, which in turn also raises the risk level associated with this asset class. Historically growth stocks have underperformed dividend or value stocks over the long term. Personally I believe individuals are simply more apt to overpay for shinny possibilities versus probable results an growth stocks are shinny. While I personally believe, and history seems to vindicate this opinion, true diversification is not a study of history but rather a tool for preparing for an unknown future. And so I am including a growth portion to my portfolio. VUG also has the benefit of being more a large-medium cap play; something I personally believe complements my overall portfolio construction. VUG is offered commission free from TD Ameritrade, and has a n ultra-low expense ratio of (0.15%). With over 400 holdings it has the breadth I'm looking for, and with over 6 billion in AUM, it has good liquidity and track record following of NAV.

    I will be assigning (4%) of my portfolio to VUG.


    The Index: "The fund tracks the Dividend Achievers Select Index, which is a subset of the broad Dividend Achievers Index. Dividend Achievers are stocks that have increased their dividends in each of the last 10 years. The index's author, Mergent, crafted this fund's benchmark specially for Vanguard, applying the firm's proprietary screens that weed out non-liquid stocks and companies that may not be able to continue growing their dividends from the broad Dividend Achievers universe. The adjusted-market-cap weighting on this index results in the top 10 holdings comprising nearly 40% of the portfolio, nearly twice as concentrated as broad-market indexes such as the S&P 500. It also places large sector bets against technology and toward service and manufacturing sectors. Unlike traditional dividend-focused ETFs, the fund is underweight financial and utility industries."…"The dividend yield is quoted net of the expense ratio. There is a bit of "black-box" methodology to this fund, as the benchmark's criterion for screening stocks for dividend growth sustainability is a secret."(Morningstar)

    This fund takes value and dividend investing to the extreme. The Dividend Achievers list is a great place to find quality companies with respect for shareholders rights. The unspecified selection method worries me some, as I will have to keep an eye on it as time goes by. But, for the present I really like the funds tilt towards consumer, health care, and industrials, while lightening up on financials and utilities (lots in VYM & DLN). Another plus for me was the funds foreign sales ratio which is extremely high compared to almost any other large cap U.S. equity funds. With 140 securities, it may appear reasonably well diversified at first glance. However, with its current weighting gives the top ten holdings make up 43.5% of the fund. For these reasons it is not a good option for a core holding, but has a lot to offer as a high quality compliment. The fund has incurred no excess capital gains taxes and has good liquidity with over 9 billion assets currently under management. Options are offered on this fund, and it is offered commission free with TD Ameritrade.

    You get a lot of quality and lots of foreign sales with this fund, so I'm giving it (4%) of my overall portfolio.


    The Index: "The WisdomTree Earnings 500 Index is a fundamentally weighted index that measures the performance of earnings-generating companies within the large-capitalization segment of the U.S. Stock Market. Companies in the index are incorporated and listed in the U.S and have generated positive cumulative earnings over their most recent four fiscal quarters prior to the index measurement date. The index is comprised of the 500 largest companies ranked by market capitalization in the WisdomTree Earnings Index. The index is earnings-weighted in December of each year to reflect the proportionate share of the aggregate earnings each component company has generated. Companies with greater earnings generally have larger weights in the index. WisdomTree Investments uses "Core Earnings", computed by Standard & Poors, as the weighting metric. Core Earnings is a standardized calculation of earnings developed by Standard & Poors designed to include expenses, incomes and activities that reflect the actual profitability of an enterprises ongoing operations." (WisdomTree)

    I have always been a fan of the S&P's "Core Earnings" methodology. The earnings stated in quarterly reports have become increasingly susceptible to manipulation, and are becoming almost inconsequential to investing. I believe personally conducted levered free cash flow analysis to be the best option in determining long term financial success, however WisdomTree's core earnings methodology is a great way to get a relatively accurate earnings based fund. I will be using WisdomTree's "Core Earnings" ETF's through all market caps and increasing its weighting in each cap sector as I move down. EPS is offered commission free by Etrade and comes with an expense ratio of (0.28%). AUM is around 65 million which means that you will experience some issues with liquidity (especially compared to other large cap funds). However, correlation with NAV has been good so far.

    I will be giving this fund an overall weight of (5%) of my portfolio.


    The Index: "iShares S&P MidCap 400 Index seeks to duplicate as closely as possible the holdings and returns of the S&P Midcap 400 Index, which gives it a broadly diversified portfolio of mid-cap stocks across industries and the value-growth spectrum. The S&P MidCap 400 Index covers stocks number 501 through 900 of the largest U.S.-listed stocks by market cap, approximately 7% of the market, whereas the large-cap S&P 500 covers the first 75%. The committee that determines the S&P indexes has some discretion over excluding companies based on quality factors. The average mid-cap stock has a market capitalization of about $3.4 billion compared with $50 billion for the S&P 500. This ETF follows a full-index replication strategy, holding essentially all of the 400 stocks in the index."(Morningstar)

    With its low expense structure and high liquidity IJH has a lot to offer investors looking to hone in on mid-cap businesses. With commissions free trades from TD Ameritrade, a large group of underlying securities, and options, this fund is a nice compliment to the more value focused EZM. There have been no capital gains taxes incurred within the last few years and it should stay that way. Liquidity is good, over 10 billion of assets under management, and a good history of following NAV.

    I am assigning this fund (4%) of my total portfolio.


    The Index: "The WisdomTree Midcap Earnings Index is a fundamentally weighted index that measures the performance of earnings-generating companies within the mid-capitalization segment of the U.S. Stock Market. The index is comprised of the companies in the top 75% of the market capitalization of the WisdomTree Earnings Index after the 500 largest companies have been removed. Companies in the index are incorporated and listed in the U.S. and have generated positive cumulative earnings over their most recent four fiscal quarters prior to the index measurement date. The index is earnings-weighted in December of each year to reflect the proportionate share of the aggregate earnings each component company has generated. Companies with greater earnings generally have larger weights in the index. WisdomTree Investments uses "Core Earnings", computed by Standard & Poor's, as the weighting metric. Core Earnings is a standardized calculation of earnings developed by Standard & Poor's designed to include expenses, incomes and activities that reflect the actual profitability of an enterprise's ongoing operations." (WisdomTree)

    I like this ETF because it gives me greater access to the U.S. equity mid-cap market through a non-cap weighted methodology. There is a lot to like about "core earnings" as a selection methodology combined and it's once a year re-balancing that keeps turnover under 20%. One negative issue does arise with this though. Namely, without cap weighting, overlap between cap sizes occurs. Currently approximately 20% of the fund drifts into the high end of small market capitalization. Given my overall portfolio construction and by having all "core earnings" caps I mostly dodge this problem, but it should be noted by other investors. Also of consideration is the mere 133 million dollars of assets under management. This is well above the life or death line for ETF's, but it should be checked periodically. With such low volume, following NAV from day to day can be an issue, and investors will want to check that they are not paying too high of a premium. This fund is offered commission free with Etrade and comes with a slightly higher expense fee (0.38%) than that of cap weighted alternatives. Options are not available with this fund, and it has incurred no additional capital gains taxes through operations. Personally, I believe this fund's methodology is perfectly suited to the midcap sector and don't mind paying a few extra basis points in commissions to get it.

    I am giving EZM a satellite holding of (5%).


    The Index: "The WisdomTree SmallCap Earnings Index is a fundamentally weighted index that measures the performance of earnings-generating companies within the small-capitalization segment of the U.S. Stock Market. The index is comprised of the companies in the bottom 25% of the market capitalization of the WisdomTree Earnings Index, after the 500 largest companies have been removed. Companies must be incorporated and listed in the U.S. and have generated positive cumulative earnings over their most recent four fiscal quarters prior to the index measurement date. The index is earnings-weighted in December to reflect the proportionate share of the aggregate earnings each component company has generated. Companies with greater earnings generally have larger weights in the index. WisdomTree Investments uses "Core Earnings", computed by Standard & Poors, as the weighting metric. Core Earnings is a standardized calculation of earnings developed by Standard & Poors designed to include expenses, incomes and activities that reflect the actual profitability of an enterprises ongoing operations. EES comes with an expense ratio of 0.38% witch is not the cheapest, but comparable to cap weighted indexes in the U.S. small cap category." (WisdomTree)

    This stock is a nice compliment to EZM and EPS, whereby together you get access to the large, medium, small and micro-cap stocks that actually make money. While I like to see dividends from Mega and Large caps, smaller companies have a more justifiable reason to retain earnings in my mind. For this reason I give more weight to earnings than to dividend weighting as I move down in market capitalization. Furthermore, as you go further down in market cap size competitive moats over rival companies tend to evaporate, for this reason breadth of holdings, and less insistence on dividends, becomes increasingly important. With 975 stocks and a diversified method of weighing, EES gives you the diversity and quality you need from a small cap ETF. With only 130 million in assets under management this fund experiences some of the issues with liquidity and following NAV that I discussed earlier, and should be watched accordingly. This ETF is offered commission free with Etrade.

    With its combination of breadth and quality, I am making it a core investment in the micro-small cap U.S. equity sector (3%).


    The Index: "This fund tracks the MSCI Small CapValue Index. The parent MSCI Small Cap 1750 Index, which represents the 751st to 2,500th largest stocks, is split into style buckets based on five growth (forward EPS growth both long- and short-term, historical EPS and sales growth, and internal growth) and three valuation measures (dividend yield, price/book, and forward price/earnings). This index holds full market-cap weights of most pure value stocks but also has fractional ownership in stocks exhibiting both value and growth characteristics resulting in some overlap with the growth index. This ETF follows a full replication strategy, holding essentially all of the 1,000 stocks in the index." (Morningstar)

    VBR gives a nice indexing compliment to ESS's fundamental weighting methodology. It also offers even more breadth within the small and micro-cap sector which is extremely important for diversification. At first glance it may look as though I have abandoned growth in the small cap sector, however this is not entirely the case, unlike many other funds the "S&P's use of stock price momentum as a factor to delineate growth versus value results in some nontraditional sector weightings and greater correlation between styles.[growth vs. value]" , so this fund is at least an attempt to get away from my investment strategy bias. Also, by looking at forward EPS rather than core earnings like EES this fund allows smaller firms some wiggle room, which I am willing to give to the small cap sector. VBR is commission free with TD Ameritrade, has an ultra-low cost of 0.15%, and has great liquidity with a comparably good history following NAV. Options are offered with this fund, and they have a good tax history.

    I'm giving them (3%) portfolio weight.


    The Index: "The FTSE Developed ex US Index is part of a range of indexes designed to help US investors benchmark their international investments. The index comprises Large and Mid cap stocks providing coverage of Developed markets (24 countries) excluding the US. The index is derived from the FTSE Global Equity Index Series (GEIS), which covers 98% of the world's investable market capitalization. The index is calculated in accordance with the Industry Classification Benchmark, the global standard for industry sector analysis. The index is designed for the creation of index tracking funds and as performance benchmarks. Stocks are free-float weighted to ensure that only the investable opportunity set is included within the index. Stocks are liquidity screened to ensure that the index is tradable. The index is managed according to a transparent and public set of index rules, and overseen by an independent committee of leading market professionals. The committee ensures that the rules are correctly applied and adhered to. Regular index reviews are conducted to ensure that a continuous and accurate representation of the market is maintained" (FTSE Factsheet)

    SCHF has close to 1,000 individual holdings in 24 developed countries; this brings the immediate diversification to the large cap developed Ex-US sector I'm looking for. They screen for liquidity and their expense ratio is rock bottom (0.13%). This fund has only been around since 2009 but so far they have a decent record following NAV. Currently they have slightly over half a billion in assets under management, but given the fact that they are a relative newcomer I would expect this to grow. Their exposure is balanced across sectors and countries which is an important consideration for a base holding. With Charles Schwab I diversify my ETF issuers, but I will lose out on commission free trades. There are no options currently available for this fund, but the breadth, oversight, and expense ratio are too good to pass up.

    SCHF is a core developed market ex-US holding at (5%) in my portfolio.


    The Index: "This ETF tracks the MSCI Europe Index, which includes about 460 companies domiciled in developed Europe. The weighted average market cap of this portfolio is $40 billion. The top country holdings are United Kingdom (31% of the portfolio), France (17%), Germany (12%), and Switzerland (12%). Top sector holdings are financial services (23%), consumer goods (15%), materials (14%), and energy (11%). Relative to the S&P 500, VGK has much heavier weightings in financials, materials, and telecoms, and much lower weightings in information technology. This fund does not hedge its foreign-currency exposure." (Morningstar)

    This fund is fairly diversified and holds many high-quality, strong global players that boast competitive advantages, or economic moats. This ETF is not currency adjusted so the portfolio will diversify its currency holdings with three global common tenders. This fund is high on financials and European financials are still not the hot spot to be, however over the long hall I see this as an important position for my portfolios diversity. VGK offers exposure that is balanced across countries, sectors, and individual holdings; with nearly 500 component securities, concentration to any one name is minimal. VGT is offered commission free with TD Ameritrade and has the ultra-low fee of (0.14%). Options are available with this fund and with almost three billion in AUM there is plenty of liquidity.

    I will be giving VGK a (3%) weight in my portfolio.


    The Index: "The Wisdom Tree Asia Pacific ex-Japan Index is a fundamentally weighted Index that measures the performance of dividend paying companies in the Asia Pacific ex-Japan region. The Index is comprised of 300 largest companies ranked by market capitalization that are incorporated in Australia, China, Hong Kong, India, Indonesia, Malaysia, New Zealand, Philippines, Singapore, South Korea, Taiwan and Thailand and that pass Wisdom Tree Investments market capitalization, liquidity and selection requirements. The Index was established with a base value of 200 on June 3, 2011 and is calculated in US dollars and updated to reflect market prices and exchange rates. Closing or last-sale prices are used when non-U.S. markets are closed." (WisdomTree)

    I like this fund because it is a good mix of developed or nearly developed Asian countries. As such it is a counterbalance to VGK which focuses on developed Europe. this fund has an expense ratio of just (0.48%) and is offered commission free from etrade. With less tha 100 million in AUM there are some liquidity issues, but there is a reasonable track record with NAV. (on a side note; I would like to get some exposure to Japan, but just can't seem to find the right mix, any Ideas?)

    IJXL will have a (3%) holding in my portfolio.


    The Index: "The WisdomTree Japan Hedged Equity Index is designed to provide exposure to Japanese equity markets while at the same time neutralizing exposure to fluctuations of the Japanese Yen movements relative to the U.S. dollar. In this sense, the Index "hedges" against fluctuations in the relative value of the yen against the U.S. dollar. The Index is designed to have higher returns than an equivalent non-currency hedged investment when the yen is weakening relative to the U.S. dollar. Conversely, the Index is designed to have lower returns than an equivalent unhedged investment when the yen is rising relative to the U.S. dollar. This index is based on the WisdomTree Japan Dividend Index." (WisdomTree) This fund tracks the WisdomTree Japan Hedged Equity Index, which is a fundamentally weighted index that measures the performance of dividend-paying companies incorporated in Japan and listed on the Tokyo Stock Exchange. Companies are weighed in the index based on annual cash dividends paid. The index is reconstituted annually in June. (Morningstar)

    I normally do not go for currency hedged funds. In my opinion another currency is normally an additional positive in terms of diversification. So why am I going with a hedged currency fund here. Well Japan is special, they have the largest debt in the world (200% GDP) and yet ultra-low bond rates and over a decade of deflation/slow growth. There are many analysts who believe "there is a negative relationship between Japan's equity markets and its currency whereby a strong yen was connected to equity market weakness. Whereby revenues for Japanese companies selling goods and services globally have been under pressure as the yen has strengthened, so much that now the most significant long-term hurdle Japan's recovery faces may not be related entirely to the tsunami or earthquake but rather to continued gains in the yen." The basic idea for me investing is that in order for Japan to succeed it must depreciate its currency and become competitive in the global marketplace. If one cannot happen without the other, you might as well get the benefits of both, thus the hedge. This fund is offered commission free from etrade has a fee of (0.48%) and has decent liquidity with half a billion AUM.

    Given Japan's weight in the world economy I am giving this fund (2%) of my portfolio.


    The Index: "The Dow Jones EPAC (Europe, Pacific, Asia and Canada) Select Dividend Index SM measures the stock performance of high dividend paying, non-U.S. companies in developed markets. Represented markets currently include Canada, Western Europe, Japan, Australia, Singapore and Hong Kong. The index universe is defined as all companies in the Dow Jones Developed Markets ex-U.S. IndexSM that pass the following screens for liquidity and dividend quality: 1.) The security must have a three-month average daily dollar trading volume of at least $3 million. 2.) The company must have paid dividends in each of the previous three years. 3.) The company's previous-year dividend-per-share ratio must be greater than or equal to its three-year average annual dividend-per-share ratio. 4.) The company's five-year average payout ratio must be less than 1.5 times the five-year average payout ratio of the corresponding DJGI country index, or less than 85%, whichever is smaller. The top 100 stocks by dividend yield are selected to the index, subject to buffers designed to limit turnover by favoring current index components: 1.) Stocks in the index universe are ranked in descending order by indicated annual dividend yield, defined as a stock's unadjusted indicated annual dividend (not including any special dividends) divided by its unadjusted price. 2.) All current component stocks that are among the top 200 stocks are included in the index. 3.) Non-component stocks are added to the index based on their rankings until the component count reaches 100. The index composition is reviewed annually in December. In addition, the index is subject to the following quarterly review process: Components with significant negative dividend growth or negative earnings from continuing operations over the past twelve-month period are reviewed to determine if the affected company can sustain an appropriate dividend program to remain in the index. If the Dow Jones Indexes Oversight Committee determines the company's dividend program is at significant risk, the company will be removed from the index after the close of trading on the third Friday of March, June, September or December. The component will be replaced by the highest-ranking non-component on the most recently published selection list. The companies under review for possible deletion are indicated on the selection lists posted to at the beginning of March, June, September and December." (Dow Jones)

    I like these issues due to their combination of dividend yield and screening/oversight committee approach. With international stocks there is less in the way of continuity with dividends than you'll find with American securities. Also accounting practices and business conditions can be geographically nuanced. For these reasons, I welcome the hands on approach and I'm willing to pay a little more to get it. These iShare issues have an expense ratio of (0.50%.) which is high, but like VIG in the large cap U.S. equity sector IDV is a value, dividend, and quality play for the Developed international sector. I have some concern with the funds use of dividend yield as an investment criteria, as it can be an indication of reduced quality amongst dividend paying funds. However a quick look at their current holdings shows a distinct appreciation for quality, I am counting on this trait to continue into the future. (But I'm would like to hear opinions on this one) With only 113 holdings this fund is not diversified enough to be a core holding, but its emphasis on quality makes it a good supporting investment for the foreign developed large cap market. IDV does offer options, but it is not offered commission free from any of the brokerage firms I am planning on using.

    I have decided to give it a (4%) overall portfolio weight.


    The Index: "This fund tracks the MSCI EAFE Small Cap Index, which aims to capture the performance of small-capitalization stocks from the countries represented by the MSCI EAFE Index, which includes about 20 developed markets in Europe, Asia, and Australia (Canada is not included). Whereas the MSCI EAFE Index tracks the large-cap and mid-cap companies comprising the top 85% of the total market capitalization, the small-cap index tracks the next 14% of the market. MSCI defines the small-capitalization universe as all listed securities that have a market capitalization in the range of $200 million-$1.5 billion. This fund employs a representative-sampling method to track the index, holding about 1,364 stocks compared with 2,407 in the index. This fund has no overlap with iShares MSCI EAFE Index and has similar geographic exposure, although SCZ a heavier weighting in Japan and U.K. and a smaller weighting in France. SCZ does not hedge its foreign-currency exposure." (Morningstar)

    SCZ will have some overlap with SCHF giving my developed ex-U.S. sector a tilt towards smaller caps. I believe smaller cap companies in the ex- U.S. sector are important for portfolio diversity because they often derive their profits from the market area in which they are listed and are therefore more tied to local rather than strictly global demand. This also further helps to hedge the overall portfolio against the dollar. On the tax front, "this ETF pays dividends semiannually, and that historically only about 50% of the dividend was considered qualified. Dividends from companies domiciled in countries that do not have an income-tax treaty with the U.S. are taxed at ordinary income-tax rates." SCZ is has a market cap of 1.4 billion, offers good liquidity, and has a reasonably good following of NAV. This fund is offered commission free with TD Ameritrade and comes with a low commission fee of (0.57%).

    I am giving SCZ a total portfolio weight of (4%).


    The Index: "DEM tracks the performance of the top 30% highest-dividend-yielding stocks from the WisdomTree Emerging Markets Dividend Index. The stocks are weighted based on annual cash dividends paid (as opposed to dividend yield), tilting the index toward large-value companies. This index is part of a family of WisdomTree fundamental indexes, which uses a number of investability screens and weighs holdings based on annual cash dividends paid. The index is rebalanced once a year on May 31, which results in a shift to companies that paid relatively higher cash dividends in the past year, a slightly lower portfolio P/E, and different country and sector weights. This ETF does not hedge its foreign-currency exposure. Investors should note that a portion of this fund's dividends will not be qualified, as the United States has different tax agreements with different countries (in 2010, 57% of DEM's dividends were considered qualified). In addition, some of the dividends are subject to foreign tax withholding (in 2010, about 4% was withheld). Investors can claim their portion of the withheld taxes as a tax credit but only if they hold this fund in a taxable account." (Morningstar)

    When it comes to developing market equity stocks the dividend is extremely important to me. The developing world has less of a track record when it comes to investors' rights and I believe regular dividends are the best way to quickly screen for this. This fund also carries a substantial amount of developed Asian equities, a region I felt I was slightly lean on within the developed market sector and am thus happy for the crossover. With around 280 holdings this fund is not quite big enough to be a core emerging market position on its own, but its breadth combined with its quality make it a good candidate for a due core holding position. There are options available with DEM, it is commission free with Etrade, and there is good liquidity with a NAV ratio that is not bad for an emerging market ETF. There are some interesting tax implications with this fund that are worth noting, which make this fund best suited for a taxable account.

    I have decided to give this security a (5%) overall position in my portfolio.


    The Index: "This fund tracks the MSCI Emerging Markets Index. This benchmark is a free float-adjusted, market-capitalization-weighted index designed to correspond to the price and yield performance of about 20 emerging markets. The index's heaviest country weightings are China (which accounts for 17% of the index), Brazil (16%), South Korea (15%), Taiwan (11%), and South Africa (8%). Top sector weightings are financials (24%), energy (15%), materials (14%), technology (13%), and industrials (8%). This fund does not hedge its foreign-currency exposure. This ETF's expense ratio of 0.22% is the lowest among its emerging-markets ETF peers. VWO invests in approx. 900 stocks from across dozens of different emerging markets in all corners of the globe, ensuring that no one market or sector has too significant an impact on performance." (Morningstar)

    This fund has the breadth needed in a core holding, its liquidity is good, and it has a good history following its NAV. It is commission free through TD Ameritrade and has options available. As with DEM this fund offers access to developed Asia, which for my portfolio construction is a plus. Unlike DEM this fund gives a considerable amount of weight to China, which previously had been missing. VWO also offers a good mix of market caps, though not as many small caps that DEM holds.

    I am assigning this index weighted fund (5%) and considering it as a dual core holding along with DEM.


    The Index: "This fund employs representative sampling to track the WisdomTree Emerging Markets SmallCap Dividend Index, which includes about 700 small-cap companies across 19 countries. This index is part of a family of WisdomTree fundamental indexes, which uses a number of investability screens and weighs holdings based on annual cash dividends paid. The index is rebalanced once a year on May 31, which results in a shift to companies that paid relatively higher cash dividends in the past year, a slightly lower portfolio P/E, and different country and sector weightings. This ETF does not hedge its foreign-currency exposure. Investors should note that a portion of this fund's dividends will not be qualified, as the United States has different tax agreements with different countries (in 2010, 57% of DGS' dividends were considered qualified).In addition, some of the dividends are subject to foreign tax withholding (in 2010, about 4% was withheld).Investors can claim their portion of the withheld taxes as a tax credit but only if they hold this fund in a taxable account. This fund's expense ratio is 0.63%, which is in line with other emerging-markets small-cap ETFs." (Morningstar)

    Small cap ETF's are an important aspect of a well-diversified portfolio. Unlike domestic small caps I like WisdomTree's dividend approach as it requires companies to state in cash that they respect shareholders rights; something that can be difficult from the other side of the world. Also, due to the smaller markets in which they operate, smaller cap emerging market stocks tend to exhibit market to cap characteristics more in line with mid cap domestic stocks, another reason why I feel justified in a dividend focused ETF. Small caps are generally more reflective of domestic consumption patterns and they are also more likely to not be under partial state control, an increasing occurrence in developing markets, another plus in my opinion. Also, this fund's has a relatively low allocation to financials when compared to VWO or DEM. DGS is offered commission free through Etrade, has decent liquidity but occasionally has troubles following NAV. There are currently no options being offered on DGS and some tax issues, but overall it is a unique fit for my portfolio.

    I am giving it an overall weight of (4%).


    The Index: "The index consists of large, medium, and small U.S. companies in the information technology sector. This sector is made up of companies in the following three general areas: technology software and services including companies that primarily develop software in various fields (such as the Internet, applications, systems, databases, management, and/or home entertainment), and companies that provide information technology consulting and services, data processing, and outsourced services; technology hardware and equipment, including manufacturers and distributors of communications equipment, computers and peripherals, electronic equipment, and related instruments; and semiconductors and semiconductor equipment manufacturers. VGT tracks the cap-weighted MSCI U.S. Investable Market Information Technology 25/50 Index, which includes the technology companies of the MSCI U.S. Investable Market Index (a broad, cap-weighted index representing approximately 98% of the U.S. market capitalization). VGT contains 409 stocks. The top-five holdings are Apple (comprising 15% of assets), IBM (9%), Microsoft (8%), Google (5%), and Oracle(5%). The largest subsector weightings are software (21%), computers and peripherals. (21%), IT services (18%), semiconductors (13%), and Internet (10%)." (Morningstar)

    VGT has a 0.19% expense ratio, which ties for being the cheapest technology ETF on the market. With my portfolio tilted towards value and dividend stocks, large parts of the tech world often get left out. While companies like Amazon, Google, and Apple have shown the world that tech and internet stocks have the ability to produce regular profits, lofty evaluations and scant dividends normally get them excluded from the ETF's I'm utilizing. This is unfair given their growth rates and the long term tech path the world is taking. VGT gives me a nice breadth of the tech scene with over 400 securities, while it's weighing mechanism assures that the portfolio is largely guided by established firms I want, rather than garage startups I don't. With free trades through TD Ameritrade, a low commission of (0.19%), good liquidity, good NAV ratio, and options available, this fund has all its fundamentals in order.

    I am giving this equity a (3%) satellite holding in my portfolio.


    The Index: "DRW is linked to the Global ex-US Real Estate Index; a fundamentally weighted index that measures the performance of companies from developed and emerging markets outside of the United States that are classified as being part of the "Global Real Estate" sector. The Index is comprised of real estate companies with market capitalizations greater than $1 billion. Companies are weighted in the Index based on regular cash dividends paid. The Index includes the following types of companies: real estate operating companies; real estate development companies; and diversified real estate investment trusts or "REITs." The Index also includes companies that may be classified as Passive Foreign Investment Companies (PFICs)." (WisdomTree)

    I am seeking to make DRW a small satellite holding that fills a void left by my international equity funds. International real estate securities can exhibit significant risk, but are also capable of delivering both meaningful capital appreciation and current returns. DRW maintains a broad-based portfolio of REITs, but has a significant concentration of a few big names in the portfolio. Personally, I am wary of smaller participants in the foreign real estate market and enjoy this tilt towards the larger players. Less exciting to me is the big chunks allocated to increasingly sensitive real estate markets in places like Australia and Hong Kong. But taken as a whole, and compared to alternatives I believe this is a quality fund. With just over 100 million in AUM they are small, but their liquidity is decent, so I'll just have to be careful not to spend too much over NAV. The equity is offered commission free from Etrade but will likely never offer anything in the way of options. I like this holding as a means of international emerging and developed market diversification.

    I'm giving it a (3%) position within my portfolio.


    The Index: "This fund tracks the S&P Global ex-U.S. Property Index, which includes publicly traded real estate companies domiciled in developed and emerging markets. This fund holds about 375 companies, and the top 10 holdings account for about 25% of the total portfolio" (Morningstar)

    With a good expense ratio of (0.35%) and a good breadth of securities VNQI is well equipped to be my duel core along with DRW in the sector of Ex-US real estate. With 200 million in assets under management VNQI is only a tad bigger than DRW. As such, all of the liquidity and short term NAV issues are only marginally better. The fund is slightly less top heavy, and less large cap focused, and more diversified than DRW. However there is significant overlap between the regions, and thus the companies they invest in. The fund is currently only available commission free with Vanguard, but traditional ties between Vanguard and TD Ameritrade may make this a commission free candidate in the future. As with DRW high dividends make this a quality candidate for a sheltered or tax free account.

    VNQI will be (2%) of my overall portfolio.


    The Index: "This ETF tracks the MSCI US REIT Index, which is a cap-weighted index and covers approximately two thirds of the U.S. REIT market. The fund holds about 110 names. This fund is fairly top-heavy, with the top 10 firms comprising more than 45% of total net assets. Top-three holdings include Simon Property Group, Equity Residential and Public Storage. Main subsector weightings are specialized REITs (26%), retail REITs (26%), residential REITs (17%) and office REITs (17%). This index does not include mortgage REITs." (Morningstar)

    With an expense ratio of (0.12%) and over 10 billion in AUM this fund has the liquidity and correlation to NAV needed to be a core U.S. real estate investment. It is offered commission free through TD Ameritrade, and offers options. While the dividend yields are traditionally high with REITs VNQ currently only yields about 3.3% and so there might be better candidates for the tax free portfolio. I am planning on using both VQN as my core real estate holdings.

    VNQ gets (5%) of the total portfolio.


    The Index: "This fund tracks the WisdomTree International Basic Materials Sector Index, which is a fundamentally weighted index that measures the performance of dividend-paying basic materials companies listed in developed markets, excluding the U.S. and Canada. Companies are weighed in the index based on annual cash dividends paid. The fund contains 115 companies, and its top-five holdings are BHP Billiton, BASF, Air Liquide, Lafarge, Rio Tinto, and Syngenta. CCXE's top country weightings are Australia (22% of the portfolio), the United Kingdom (17%), Germany (15%), Japan (12%), and France (10.5%). However, given that many of these companies have global operations, these weightings are not indicative of this fund's geographic revenue exposure. The average market capitalization of the companies in this fund, measured on a holdings-weighted basis, is about $22 billion. CCXE is a good vehicle to gain exposure to both non-U.S. dollar assets and globally priced commodities." (Morningstar)

    It is difficult to gain protection from inflation while maintaining returns. CCXE, HAP, and GNAT are my attempt to do just that. CCXE focuses on companies that are based in commodity producing countries, a lot of these companies are directly tied to commodities themselves, but there are a good number of non-commodity businesses as included well. This is shown by the fact that the top five holdings listed by Morningstar in 4-19-11 (BHP Billiton, BASF, Air Liquide, Lafarge, Rio Tinto, and Syngenta) have since been replaced by five totally different companies (Statoil, Gazprom, Telcom New Zealand, Kumba iron ore, and petro brazil). This occurs because companies are weighted within each country allocation based on annual cash dividends paid and not the sector in which they operate. I believe these firms should benefit during times of high U.S. inflation because the businesses are based in commodity producing countries and are therefore tied to economies that are less inflation sensitive, it's also nice because they have a currency other than U.S. dollars or other upmarket currencies. The fact that they are dividend screened and come from a variety of sectors is something I like as it gives more sector breadth. CCXE is offered commission free from Etrade and has a reasonable fee of (0.58%) given the sector. This fund currently operates with just over 32 million in AUM and is a possible candidate for liquidation. As with any lightly traded fund, liquidity is minimal and its history with NAV has been a bit erratic.

    This fund will be a satellite holding with (3%) of my total funds invested and I will be looking at possible alternatives.


    The Index: "Tracking the Rogers Van Eck Hard Assets Producers Index, HAP looks to invest no less than 80% of its assets in companies that derive more than 50% of their revenues from the production of commodities. Furthermore, the fund will invest no less than 80% of assets in accordance with its index. The index holds roughly 340 securities across all six hard-asset sectors. Sector weightings are determined by global annual consumption and rebalance quarterly. In line with its energy and materials heavy tilts, the United States and Canada grab the largest national weightings within HAP's portfolio." (Morningstar)

    This fund has the sector diversification and the global presents to offer what I need in an asset producer ETF. With less that 50% of the fund coming from inside the united states I gain some currency protection, but the main goal of this fund is to own the companies that own the resources that make the world run. During times of increased economic activity this fund should do well, but perhaps more importantly, during times of inflation these companies should be the quickest to adapt and survive. With over 340 securities under management and an AUM of 180 this fund is more established and more diversified than CCXE and GNAT. The issuer of this fund is Van Eck, which does not offer commission free trades with my brokerage firms, but does further diversifying my issuers.

    I am giving HAP (3%) of my overall portfolio.


    The Index: "The WisdomTree Global Natural Resources Index is a fundamentally weighted index that measures the performance of global dividend-paying companies in natural resource industries. These companies include energy companies, such as oil and gas producers, basic materials companies, such as metal and mining companies, and agriculture companies. The index is comprised of the 100 largest qualifying companies ranked by market capitalization. Companies are weighted in the index based on their dividend yields. With an expense ratio of 0.58% this fund is typical for the sector." (WisdomTree)

    With the possibility of inflation, it is good to be as close to the resources themselves as you can get. This ETF offers exposure to the global natural resources industry, targeting a corner of the world economy where the resources are and including the companies that are engaged in the extraction and production of raw materials. These material run the gambit from metals to timber, to oil and gas producers. As such, GNAT can be expected to exhibit a reasonably strong correlation to commodity prices. There are many other ETF that offer more direct commodity exposure via futures trading, however these intangible assets offer a complex set of considerations, and with a long term investment horizon I feel that direct equity ownership is the best path to risk adjusted gains. There will be some serious volatility with this fund, but short term volatility is not a problem for my investment methodology and I like the long term prospects. There will also be a fair amount of overlapping assets between GNAT, HAP, and CCXE, however given my overall portfolio construction I am fine with this. With an expense ratio of (0.58%) and free commissions on Etrade this fund is relatively inexpensive. However, like CCXE this fund is operating near the bottom of where funds are deemed to be sustainable. As such, liquidity is poor and there is a history of divergence with NAV.

    This fund will be a satellite holding within my portfolio at (3%).


    The Index: "The investment seeks to replicate as closely as possible before fees and expenses the price and yield performance of the DAXglobal Agribusiness Index The fund normally invests at least 80 of total assets in equity securities of U S and foreign companies primarily engaged in the business of agriculture which derive at least 50 of their total revenues from agribusiness Such companies may include small- and medium-capitalization companies It is non-diversified" … "The DAXglobal® Agribusiness index relies on a selection approach taking into account companies active along the entire agribusiness value chain, thus increasing the diversification potential within this sector."…"[indexing methodology] All companies that generate more than 50% of their revenues in the agribusiness sector are eligible for inclusion in the DAXglobal® Agribusiness index. The selection is based on market capitalization, average daily trading turnover and volume. Components are weighted according to their market capitalization. The index is reviewed semi-annually in March and September. Rebalancing takes place on a quarterly basis." (Dax Index)

    This ETF gives my portfolio worldwide exposure to a basket of equities that are involved in the agriculture business. Holdings are primarily in developed regions, although the fund still has emerging market exposure in Brazil, Singapore, and Malaysia. Currently the top equities held are Montesano, Potash, and Deere, with a combined weight of 23%. Agricultural commodities are often among the first to rise in inflationary environments, and that is the main reason I have included MOO in my portfolio. Also of significance is the inelastic nature of food, thus giving MOO some value in a dire worst case scenario future. This ETF has grown quickly to over 6 billion under management and thus follows NAV well and has great liquidity. MOO has an expense ratio of (0.56%) and is not offered commission free by anyone.

    I will be giving MOO a (3%) total holding in my portfolio.


    Well that's the portfolio. To do a little recap, here is what this portfolio is attempting to accomplish. My goal is for this portfolio to serve as my core average scenario retirement fund. If, during my 25+ year investment horizon, the stock market performs similarly to its historical averages, I should have enough to fund my retirement at age 55. As an investor I am bias towards value and dividend paying stocks and so I'm trying to build a portfolio that reflects that preference while remaining diversified in areas of competing investment strategies. In terms of diversification I am concerned with; Capitalization size, geographic location, sector diversification and sensitivity to inflation/deflation and have attempted to construct my portfolio accordingly. Asset class is another form of diversification I am interested in, and attempt to address partially within the equity asset class. Lastly, this is a portfolio that should be able to be maintained with 2-3 hours or work a month, much of this maintenance time will come from my Investment Methodology in part two, but I have attempted to consider these time constraints while making my portfolio allocations as well, I.E. all ETF's. If you've got opinions, I'd appreciate hearing them- and thanks for reading.

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  • This is quite informative. but you are leaving out some vital information that I need. What is the total value you recommend on this portfolio...can you limit your focus to a few stocks instead of all of them.
    smart way for new investors...
    25 Jun 2012, 10:30 AM Reply Like
  • Author’s reply » Hi Wbress,
    Thanks for your comment. Let me see if I can answer your questions.
    I believe that when you say “Total Value” you mean the percentage of funds I allocate to the “VCA equity portfolio” verses the “Cash/Cash equivalent” portfolio I talk about in Part Three. I have put 60% of my allocated funds into the” VCA equity portfolio” and 40% into the “Cash/Cash equivalents” portfolio. My portfolio's standard deviation is approx. 21% and this, along with historical market norms, lead me to believe 60/40 is the most equitable distribution. (More on this in Part Two if your interested) But, really it’s up to the individual investor. Just look at it this way, too much in the VCA account and you’ll run out of funds in your “cash/cash equivalent” portfolio just when the market is at its best prices. Too little in the “VCA equity” portfolio and you will lose out on the capital appreciation that has you in the equity market to begin with. I like a 60/40 split, but other options are definitely out there.
    I’m not sure but you might be saying “total amount” when you say “total value”. If you are asking how much should be dedicated to this portfolio. I would say that the amount dedicated to any portfolio depends on the particular situation and predisposition of the individual investor. As I said in part one of my article series this Value Cost Averaging portfolio is designed for myself and I am a; buy and hold investor, with a 20+ year investment horizon, a good appetite for volatility, and a 2-3 hours a month to dedicate to my portfolio’s management. For me personally, what you see above is my retirement portfolio and this is where I keep the majority of my invested funds. I have a separate emergency fund which is designed to have less volatility and thus modest returns that are quickly and easily accessible. I also have a hedge portfolio which is designed to protect me against systemic failure and monumental change in the equity markets. And I also like to keep a small “fun times” portfolio that allows me to test trading ideas in the open market. But, most of my capital is in this “Value Cost Averaging” portfolio that you see above. Because this portfolio is designed to make numerous small volume trades, it is easily replicated in small accounts. The one thing to watch out for here is the commissions! I personally have this portfolio split between Etrade and TDAmeritrade brokerage accounts so that nearly all of my trades are commission free. The few ETF’s included in my portfolio that are not commission free, I reevaluate only once a year, so I can minimize commission fees.
    In regards to paring down the portfolio so that it contains fewer ETF’s, this is definitely possible. VT (total market) is a wonderful ETF put out by Vanguard and this could easily serve as a one stop ETF for the equity portion of the VCA portfolio. I actually use it as a rough outline for weighting my VCA portfolio. However; what you lose by consolidation are;
    1.) The benefits of volatility within geographical, market cap, and market sectors. (VT goes up and down in one package, VCA allows each ETF component to float around on its own)
    2.) The improved risk/reward that comes from owning more underlying businesses (VT is well diversified, but way less than the VCA portfolio)
    3.) The added security of having multiple funds and issuing banks. ( why not put your egg in a few different bank baskets given today’s financial status)
    4.) Perhaps some Alpha gained by choosing ETF funds that have a strong record in their perspective area. (Wisdomtree does a great job with foreign small caps in my opinion)
    5.) You have the more ability to custom fit your portfolio to meet your specific goals. (I like getting exposure to different currencies, but I don’t want to invest in the appreciation of the yen, I can do this with a personally constructed VCA portfolio)
    6.) As an opposite to number five; with the VCA portfolio you have more options of getting out of particular positions that you just don’t have the option to when you own something all-encompassing like VT.
    Well I hope that answers your questions. Thanks for the post.
    13 Jul 2012, 12:51 AM Reply Like
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