More build your own ETF

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My post yesterday about building your own ETF had some comments that I think are worth replying to, writes Roger Nusbaum.

First to pass on some info about Sharebuilder that one reader was kind enough to dig up, they have several promotions and programs. A type of portfolio that I put together could possibly done for $25 (as opposed to $40) and if everything lined up properly could even be free (this involves referrals). I am not an expert on what is offered so you can check it out yourself.

The next comment was as follows:

Seems to me that part of the benefit of an ETF is the picking, qualifying, monitoring, etc of an appropriate basket is done by suitibly qualified experts. If the above services arenÂ’t done via an ETF, then you have to pick, qualify, monitor, etc on your own - which amounts to setting up & maintaining your own diversified portfolio. You can always set up your own diversified portfolio, you donÂ’t have to use ETFs, but it takes more time, money, and effort to acquire and support the basket of investments. Seems to me youÂ’re thinking about a diversified portfolio, but youÂ’re calling it an ETF. Wrong?

No offense, but I think the comment misses the intent of the exercise and some of the specific points I made in the original post. The post explores creating a foreign equivalent to an existing domestic based focused on dividends. The foreign equivalent does not currently exist. The current foreign ETFs are either too narrow or do not focus on dividends. I specifically address the issue of picking and monitoring in the third paragraph from the bottom. If you think of this as an ETF, I would ask how closely to follow every component in any ETF you own? With the way I set up the example and the dollars involved, each component in the ETF equals 0.5% of the person's investible assets.

The number of mature dividend paying companies that cut in half has to be quite small, statistically insignificant I might suggest. If you blindly put in a stop loss 50% below the purchase price on every name and somehow you were unlucky enough to pick two stocks that actually do cut in half, you would be down 0.5% in the total portfolio. How long would it take to make that back?

I ended the post with a third reminder that this was just a brainstorming idea, take it for what worth. I do this type of thing a lot on this site; that is explore different things. I try to point out the drawbacks to every one of these I do, and if you read the original post I did that this time as well.

The next comment:

Thanks for sharing some serious homework with us. Very interesting.  A lot of foreign stocks pay dividends only once or twice a year. Could this be an issue for someone relying on an income stream?

The short answer to this one is yes. I have a lot of these types of stocks in client accounts. The primary purpose is exposure to different types of economic demand, low beta and of course the yield. This creates an effect in a portion of the portfolio. This blends with the effect I get from other areas of the portfolio like tech, for example.

The way I think of income need is a little different than the way the question is framed. I think of it in terms of a percentage of the account. If someone has $1.5 million that needs to create an income of $60,000, their income need is 4%. Most years the market will do better than that, statistically speaking. Over time the account needs to grow more than 4% but there will be certain years where the account lags the income need and you would be taking from principal. Peter Lynch has written about this and I would suggest anyone read what he has to say on the subject.

But in this example of 4%, if I can get the entire portfolio to yield 3% I only need 1% of growth to break even. In re-reading this part I have assumed a certain understanding of the reader. Feel free to email with questions.

Next comment:

Don't forget - ETF's with foreign shares tend to be more volatile because of currency fluctuations. If the dollar continues to rally vs. the yen and the euro, some of those foreign shares could decline in price if the companies do not derive a majority of their revenues from the US. Just a thought...

Hopefully if you invest in foreign stocks you realize what is being said here. There are times when currency issues (to widen the reader's comment a little) will help or hinder what you own. This may pertain to earnings, perception of earnings or something else entirely. Of course an American comapny that sells a lot of soda in other countries could also be materially impacted by currency moves as well.

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