Building And Managing That First Portfolio

Includes: DBC, RWX, SHY, VNQ, VWO
by: Lowell Herr

With the advent of a new year what might a fresh start to portfolio construction and management look like? When putting together a portfolio, one needs an investment plan or what is called a Strategic Asset Allocation plan. The following Dashboard lays out such a plan where the global market is divided into eighteen (18) asset classes. In the upper left-hand section of the following Dashboard is the U.S. Equities market. This is split into the nine "Morningstar" boxes where we have different cap sizes as well as value, blend, and growth asset classes.

Boxes with the white background are the target percentages and the colored percentages are the current percentages from a sample portfolio. This color coding is to show when an asset classes is in balance (light green background) or when the asset class is out of balance. For example, Large-Cap Value is over target and is represented by the bright red background. Small-Cap Value is under target and is coded to appear as light purple.

Strategic Asset Allocation Plan: Each investor is encouraged to set up a plan that fits their investment goals. In the following Dashboard the portfolio is skewed toward value and smaller cap asset classes when it comes to the U.S. Equities market. No target is set for Small-Cap Blend as that asset class is covered by the value and growth asset classes. Some investors may choose not to use any of the blend asset classes. The target percentages are a personal choice designed to fit investor goals.

Outside U.S. Equities the other asset classes include Cash, Bonds, Developed International Markets, U.S. Real Estate, Emerging Markets, Commodities, International Real Estate, International Bonds, and Precious Metals. It is not necessary to use all these asset classes and some investors might add additional or different asset classes. Regardless, lay out a plan and the Dashboard presented below is an example of a Strategic Asset Allocation plan.

ETF Rankings: When it comes to populating the asset classes, my preference is to use Exchange Traded Funds (ETFs) as it is difficult for an individual investor to effectively select stocks in all the asset classes shown above. Also, there is abundant research showing the laws of probability are working against successful investing when portfolios are actively managed by the selection of individual stocks. This does not mean there are not successful stock pickers. However, in the aggregate, individuals are bucking a strong headwind when they go the route of building a portfolio by selecting individual stocks.

The following table of ETFs not only includes securities that will cover all eighteen asset classes mentioned above, but there are management principles embedded in the table.

Note the red color coded ETF, SHY. That treasury is our cutoff ETF and what this means is that when it comes to managing the portfolio of 18 asset classes, we do not invest in those ETFs that are underperforming SHY. To illustrate, let's examine four different asset classes. The International Real Estate asset classes is populated by RWX, one of the under-performing ETFs. Now is a time to underweight or stay completely free from that asset class since RWX is underperforming SHY. Three other examples are Commodities (NYSEARCA:DBC), U.S. REITs (NYSEARCA:VNQ), and Emerging Markets (NYSEARCA:VWO). All three are not up to par based on the performance over the past three and six months as well as a volatility measurement.

Additional risk reducing data is presented in the four Exponential Moving Average columns and the table also includes acceleration or momentum data demonstrating which ETFs are currently in a positive or negative mode.

Conclusion: Develop a Strategic Asset Allocation plan and then populate those asset classes with the top performing ETFs. Reduce portfolio risk by under weighting or staying away from asset classes represented by ETFs that are under-performing SHY.

Disclosure: I am long VTI, VTV, VOE, VBR, VUG, VOT, JNK, VYM, IDV, SCZ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.