For over 20 years as an individual investor, my goal has been to develop a relatively simple, conservative, system that would beat the total return of the S&P 500 index, year after year. Since the S&P 500 accounts for more than 92% of the total U.S stock market and is a benchmark for many stock mutual funds, it was selected as a comparison.
Interestingly, more than 75% of U.S. domestic equity funds trailed the S&P 500 index in 2007. This homemade mutual fund has had better total returns than the S&P 500 exchange traded fund (NYSEARCA:SPY) when started at the beginning of any of the past 7 years.
Using standard portfolio ideas of diversification, dividends, buy low, and buy and hold, this Homemade Mutual Fund [HMF] can easily be created by individual investors with $10,000 to invest. This plan uses exchange traded funds (ETFs), which are purchased in the same manner as stocks.
The HMF has 9 categories of asset classes, covering each of the Dow Jones U.S. Total Market Industry Groups: basic materials (NYSEARCA:XLB), consumer goods (NYSEARCA:XLP), consumer services (NYSEARCA:XLY), financials (NYSEARCA:IYG), health care (NYSEARCA:XLV), industrials (NYSEARCA:DIA), oil and gas (NYSEARCA:XLE), technology and telecommunications (NYSEARCA:XLK), and utilities (NYSEARCA:XLU). The only change from the ten standard groups is that Technology and Telecommunications are combined to one, resulting in 9 groups. The Technology Select Sector ETF (XLK) contains both technology and telecommunication holdings.
Dividend rates and management fees were considered in selecting these specific ETFs. The system involves allocating 1/9th (11%) of your domestic stock investing funds into each of the nine ETFs.
If you choose to keep the portfolio going year to year, the only other required action on this account occurs once each year. On the first trading day of the year, a single trade in the portfolio is made. Using the dividends received from the prior year; buy whole shares in the ETF that has fallen to the lowest percentage of the group, as of the last day of the year. This results in only one annual trade, at a total annual transaction charge of $4, based on the fee at the brokerage firm holding my accounts.
To test this system, seven starting dates were used - the first trading day of 2001 (the first full year all the funds were available) through 2007. In all years that are possible to test (2001-2007), this Homemade Mutual Fund has had better total net returns over the year compared to SPY when started: 2001 (+18%); 2002 (+12%;) 2003 (+1%); 2004 (+6%); 2005 (+4%) ; 2006 (+0.3%); 2007 (+4%).
For the most recent example, assume $10,000 was invested on January 2, 2007, with approximately 11 % ($1100) in each of the 9 ETFs. (Only full shares purchased). As a comparison, assume $10,000 was invested in full shares of SPY, the S&P 500 ETF. For the following calculations, brokerage fees and 15% dividend tax are included.
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