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Man! October was a busy month!  Then it bled right over into November.  I’m just a normal guy who has a full-time job that is not in the field of investing (right now).  I have a finance degree and co-founded a fintech investment performance reporting company out of college (in the late 90s).  I’ve always been interested in investing and doing it well.  I’ve read many of the great investing books and built all kinds of tools/models (and fang-dangled spreadsheets).  I’ve been super focused on my investing for the past 2 years.  A little over 2 years ago I started picking individual stocks and tracking my performance.  I began really working hard to get my investments/allocation into assets that I believe will perform well in this crazy world we find ourselves in these days.

I’ve been ‘investing’ for several decades.  Most of the time in index funds/ETFs but I’ve also bought individual stocks at times as well.  When my son got interested in ‘investing’ and wanted to start picking stocks a little over 2 years ago the first words out of my mouth were ’too much work’ and ‘you can’t beat the market’.  He, like many, disagreed and wanted to give it a shot.  I was not particularly happy with how my investments were allocated at that time and wanted to make some changes as well.  Last month was my 25th month tracking my progress.  I keep track of everything and report my progress each month on my website.  I do this mainly for myself (since no one else really cares about my investments..rightfully so).  I do it because I think it is a good practice.  It has helped immensely.  Over the past two years, I have taken a pretty aggressive all-in approach to my investing (investing pretty much my entire portfolio in individual stocks).  It has been fun and I have learned a great deal on many fronts.

Somewhere along the way, I discovered FinTwit and somewhere else along the way I decided to start writing everything I was doing down and publishing it to my website.  I’ve learned a ton along the way (about myself, my methodologies, and investing in general).  Writing things down has also been a game-changer.  No one particularly gives a hoot about me or my money but the discipline of noodling on things and then writing down the thoughts regularly has been extremely helpful.  It has also been excellent to be able to come back later and easily remember why I did a particular thing I did.

All that said, the past couple of months have been like watching The Matrix come to life for me (when Neo started making sense of all the green letters and numbers running up and down the screens).  Part of this was due to some changes in the landscape but many were some timely reminders (via podcast discussions) of things I’ve been reading over the years.

So after:

  1. A lot of big news hitting in the month of October,
  2. Me crossing the two-year milestone of this experiment,
  3. Having some huge wins and some huge losses along the way,
  4. Catching up on a ton of podcasts that I had saved up, and
  5. My mind noodling on all of it for almost 2 years solid…these are my thoughts.

If I could do anything with my investing…what would I do?  What matters?  What doesn’t matter?

  • Fees Don’t Matter Anymore! – One huge thing that happened in October was that many brokerages did away with transaction costs on online trades (mine did).  This means that any limiting constraint I had with regard to transaction costs have gone away.  I still have to consider taxes in my transacting but I already put huge consideration into that (and do most of my transacting in tax-efficient accounts anyway).  Regardless, with no fees to worry about my investment portfolio is a blank sheet of paper.  What would I own (and how might my capital allocation model change) if I had no constraints due to transaction costs?  Would I own what I own today (and as much or as little of it as I own today)?  The biggest answer I see to these questions is I can, now, almost constantly rebalance my investment portfolio.  I can add new money to investments that are down and take small amounts out of investments that are running up…if I want to (and I often want to)!  With transaction fees, this wasn’t as feasible (unless the amounts that I wanted to flow were substantial).  My goal was to beat the expense ratio of a low-cost ETF (I use $VT as a benchmark).  Moving ‘less than several thousand dollars at a time’ didn’t make much sense at $4.95 if you want to beat a .11% expense ratio.  So minus taxes, if I want to trade, in any amount, I now can.  I am no longer limited to adding/exiting full positions or adding/subtracting large amounts to existing investments.
  • Taxes Matter More Than Anything! – If you are not managing your turnover for tax efficiency you are wasting your time…completely wasting your time!  The biggest expense any investor pays is taxes.  No question.  The reason great investors are great investors is because the best of them figure out how to keep their money away from the taxman!  I’m not a tax professional and I’m not going to go any further on that topic (because you may agree or disagree).  I might even be completely wrong about it but it is THE cornerstone of my entire investment methodology.  Every single decision I make is made with tax implications as the first decision point.  Nothing is more important, so if I am wrong, I’ll just be wrong!  BUT…I’ll be wrong paying almost no taxes (or the least I can possibly pay in a given scenario)!  I’m good with that!
  • Position Size Matters (AKA Most People Own Way Too Much Shit!) –  Most people own a mishmash of mutual funds and/or ETFs and have little or no idea of what are in any of them.  They know even less about important things like expense ratios, turnover and portfolio allocation.  They think that just because they own a lot of stuff they must be adequately and properly diversified.  I’d argue with anyone that if you don’t know what you own you are not investing properly.  When I started this a couple of years ago it was one of the reasons that I decided that owning individual stocks was as good (or even better) than owning index funds—I’d know exactly what I owned.  Even better for me is I’d know exactly what I didn’t own.  For me, if I held enough individual positions to be properly diversified it would be easier for me to take whatever Mr. Market threw my way.  For me, this isn’t the case in a cap-weighted index funds.  After reading a lot from a variety of sources (although @ValueStockGeek has a great writeup on optimal position size) I determined that between 20-30 positions diversified across industry/sectors made sense.  I reviewed this again in light of zero trading commissions and confirmed this still made sense in my perfect what-if portfolio.
  • Asset Allocation Matters (Because Anti-Bubbles)! – I recently listened to Diego Parrila (on the MacroVoices podcast).  This podcast was my spirit animal.  My biggest concern when I started really working on my investments was how ‘things just are not right’.  Valuations are off the charts high on a variety of metrics.  Debt is piled on top of debt across governments, corporations, and households.  Sovereigns are printing money hand over fist with QE and it looks like it will continue indefinitely.  It actually looks like it will get worse as the concept of MMT is rolled around.  The ‘wealth gap’ is resulting in more and more populism across the globe.  I’d love nothing more than being 100% allocated to stocks at all times (and have been many times throughout my life).  But all this was causing this equity loving investor to not sleep well at night.  I decided to take action with my investments a few years ago.  In the podcasts, Diego talks about how people become so ‘okay’ with a concept that everyone just takes it for granted (even though it makes no sense and is really an enormous problem).  When this happens, it can cause huge bubbles to form…right there in plain sight.  Everyone can see it but no one does anything about it.  Right now, I believe, that is Quantitative Easing.  Everyone expects it and knows it will work.  But what happens when it doesn’t (or when we finally start to see the ramifications of all this unprecedented activity).  I had already learned throughout my investment life that asset allocation is all that really matters in your investment strategy.  In general, the asset classes you allocate to will dictate what your returns will be more than anything else.  Diego’s response to all this ‘bubble in plain sight’ issue is that you need to be allocated to anti-bubble asset classes (things that play defense not just offense).  These asset classes have not worked recently and will make you look foolish against those playing offense all the time…until they don’t.  His view is that currently, these defensive classes are: gold, cash, derivative tail-risk insurance.  This all makes complete sense to me (and addresses my ‘restless nights’ issue).  I will GLADLY look a little foolish (if that is what it takes).
  • Asset Allocation Doesn’t Matter (Because Reversion To The Mean)! – I listened to Meb Faber on Jesse Felder’s podcast and Michael Mauboussin on Tobias Carlisle’s podcast.  Both were very interesting discussions.  It is fairly common knowledge that most of your return will come from asset class allocation selection versus individual security selection within the asset class.  But even then, Meb Faber’s book on the great capital allocators highlights how they all wind up performing nearly the same over time.  In fact, as discussed by Michael Mauboussin on Tobias podcast, ROIC is mean-reverting for all stocks (unless there is something that keeps it from reverting…usually regulation or something else that maintains a moat or decreases competition).  So, if picking specific securities ultimately doesn’t matter AND picking specific asset classes matters much more (but also doesn’t really matter) why do people spend so much time doing both.  Set it and forget it and get on with your life!  NOTE TO SELF: You’ve wasted a lot of time over the past two years! HA!
  • Market Cap Indexing Is Stupid! – Again, Meb Faber dropping knowledge on Jesse Felder’s podcast.  Market cap is the worst idea on how to invest ever devised.  It is not linked to any fundamentals whatsoever (just price and number of shares).  Ludicrous actually!  You’d never do that with buying anything else in your life…why would you do it with your investments (where the only point is to make money)?!?  I don’t think many people at all actually contemplate this or understand it (which is frightening).  The point he ultimately makes is that some form of factor investing makes much more sense.  I agree completely (with the big caveat that taxes/turnover and expense ratios matter more).  Market cap indexing is the clear winner in both those aspects…no question.  So, if a similar ‘factor’ methodology cannot compete on either of those fronts then they really do not compete at all.  But I agree that market cap indexing is not the way to go even though everyone is going that way.  The reason it is so popular and prominent is because it is a fairly simple way to construct (and maintain) a portfolio.  I’d add that just because something is simple does not always mean it is all that good.  NOTE: There are plenty of people in the investing world who think momentum/market cap is perfectly fine (and actually preferred).  They have looked really smart recently too…I still don’t think they are right, however.  It is not fundamental investing and if you buy something with no regard for any fundamentals you are not really investing at all (price is what you pay, value is what you get).
  • Equal Cap Indexing Must Be Stupid Too! – The antithesis of market cap indexes is just buy everything in equal weights.  There are different flavors of this; equal weight stocks, equal weight sectors/industries…just buy everything…equally.  This really makes no sense either.  It probably isn’t as bad as the alternative but that doesn’t make it far superior.  I wouldn’t call this investing either.  It is just buying a lot of stuff and holding it for a long time.  Again, factor investing makes more sense.  Factor investing portfolio construction is almost always more expensive to implement, however.  It also might not even outperform the index anyway (especially once the higher fees and taxes/turnover are considered).  Factors are definitely ‘investing’ since they involve more than just buying an index (that is based on price and number of shares).  Factors can also be backtested to show how they have worked in the past.  Regardless, no one knows for sure if they are superior and which ones will be superior (and we won’t know without plenty of hindsight either).  Investing is hard, in case anyone never told you.
  • Geography and Size Don’t Matter! – I’ve read Lawrence Hamtil’s posts often.  He was on Tobias Carlisle’s podcast where they discussed a topic he writes about often (and that makes complete sense to me).  Location/geography and capitalization/size has much less to do with valuation/performance than sector/industry.  Generally, stocks in sectors perform like stocks in their sectors regardless of geography or size.  He argues, that the real reason that non-US markets look cheap on a variety of valuation metrics is that their sector/industry makeups tilt them toward sector/industries that have lower valuations.  So, when people are buying international and emerging markets (different location/geography) it really winds up being a sector bet (and about currency hedging) more than anything else.  This might be fine, but not what most people intend when they make this allocation.  Most people think they are buying ‘cheaper’ markets than the ‘expensive’ US market.  In my own portfolio over the past 2 years, I have underperformed the S&P 500.  This has mainly been because my portfolio is heavily tilted towards individual stocks that are in sectors/industries that have underperformed the index’s leading sectors/industries.  I should have fully expected to underperform based on how my portfolio is constructed.  The S&P 500 looks expensive because 1) the biggest sectors in the index have blown the doors out from a performance perspective (think Information Technology), 2) most international indexes don’t even have these sectors represented in their indexes (think Information Technology again).  More on this later…because it is a huge game-changer for me (and my methodology)!  NOTE: I think almost no investors understand how currency fluctuations impact their investments in non-US investments.  More on that…NOW!
  • Currency Is All That Matters With International Investing – Many argue that you should own a good deal of your portfolio in international/emerging market assets to eliminate home country bias.  I’ve always believed this in the past.  BUT see the last bullet (with Mr. Hamtil’s points).  I’ve had a change of heart!  If I’m investing in stocks and geography doesn’t matter then really the only risk I’m managing is currency risks.  By the way, I don’t invest in stocks to manage currency risks (and don’t think anyone should)!  As I said I think that very, very few investors understand how currency fluctuations impact their investment in non-US assets.  I’d even say that very few investment professionals understand this.  Don’t believe me?  Go Google it!  Try to find some articles on the topic.  You won’t find many, even though it has a hugely important impact on your international and emerging market investments (of which many, many people own).  In general, when the US Dollar gets stronger against other currencies it will negatively impact investments held in foreign currencies (and vice versa).  Currencies can (and do often) fluctuate wildly against each other.  It is not rare for major currencies to swing +-10% (or more against one another over the course of a year).  The US Dollar against the EURO has moved -10% to +35% within the past 10-year period from where it is right now.  Even if you get your stock pick correct you still have to deal with the currency movement (which can either make you look smarter or dumber).  This is way too much to keep up with for most people…and a huge variable!  I liken it to why I don’t invest with options (you have to be right about the investment and also the timeframe).  Get either wrong and you lose.  Too hard!
  • Value Is Dead (Well It Might Be…Maybe…)! – Josh Brown and Tobias Carlisle’s podcast was much better than I thought it would be.  If you had ever tried to buy the great companies of today at good/cheap/reasonable valuations you’d probably be still be waiting!  The “value is dead” debate was very interesting.  Value is in the longest underperformance to growth ever and also the largest underperformance ever.  Josh’s point about how things might have changed permanently was interesting and I get it.  If you are a “contrarian” and buying deep value equities, they are deep value for a reason (because they are generally “garbage” companies).  Cap light companies (software) is eating the world and doesn’t adhere to the same multiples as normal investments…and that is just how the world is today.  You can disagree if you’d like but if you do you will be passed by (and actually already have been for a decade-plus).  The long history of the Fama/French three-factor models (which tend to be low price to book and small caps) might just be wrong!?!  Regardless of decades of historical data supporting it.  True!  Book value might not matter anymore?!?  So, price to book might not matter anymore.  It may be a much less important metric to look at since it can vary so much from industry to industry.  Also, True!  Earnings can be gamed very easily by companies.  Additionally, not earning is actually not even bad if the company is reinvesting in growth which is money-losing but growing the business (plenty of great CEOs have proven this and compounded massive returns along the way).  So, price to earnings might not matter?!?  Also, True! Sales growth is skewed due to the super low cost of capital and anti-antitrust.  If you can borrow infinitely and use it to grow rapidly gaining massive market share (and buy out all your competitors and then all your stock in buybacks) you win!  So, price to sales may not matter anymore either!?! Geesh!?!  But!  One thing they didn’t really discuss and that I believe doesn’t change in this ‘new world’ (hasn’t/won’t) is that cash flow matters (and subsequently price to cash flow).  Cash flow is real and cannot be gamed nearly as easy as other financial metrics (the money has to actually flow through to the cash flow statement).  It is real money.  It is in an account (or not).  And…IT MATTERS!  The only reason you purchase an investment is for future cash flows.  That is literally it.  You can choose your investments for whatever reason you like but the reason you invest money is to gain cash flow from it into the future (in hopefully larger amounts).  Investing for any other reason would be ludicrous.  For this reason, I believe that no matter what is going on with macro, the world powers, industry shifts, etc. cash flow is the only true metric that over time matters and must be monitored when investing.  If you overpay for future cash flows you will underperform, if you underpay for future cash flows you will outperform.  Plain and simple.  In my investment analysis, I look at a variety of metrics when I choose an investment.  More and more price to cash flow (and free cash flow) look like the metric to focus on in this new world we live in.  I’m currently adjusting my tools and models to place additional emphasis on this.  So ‘this time is different’…maybe…but probably not.  It never has been before!

So, what am I doing now?

I’ve read many investing books (and continue to do so).  I don’t spend a second reading the news or watching financial news.  I find it very important to learn from people who are doing the same thing I’m trying to do day-to-day.  People trying to translate all the knowledge we’ve gained into real-time, here and now, tactical investing decisions.  There are so many great people putting great information out in the world these days.  I’ve learned a ton from them (and continue to).  Some of my favorite people to listen to (in no particular order) are:

  • Warren Buffett’s Partnership Letters – the original podcasts.  I also count the book Buffettology as the cornerstone of my methodology,
  • ValueStockGeek’s blog – a regular guy kind of like me (but much smarter) doing investing alongside his regular life,
  • Tobias Carlisle’s Acquirer’s podcast – his books/methodology heavily influence my methodology (I tilt towards being a ‘value’ guy),
  • Jesse Felder’s SuperInvestor’s podcast – my favorite podcast hands down because they are always high-quality guest and great discussions (and Jesse is awesome too),
  • Preston and Stig’s TIP podcast – the podcast I listen to the most about investing (I’ve almost listened to all of them now).  I particularly enjoy the quarterly investing roundtables as I think it is great to hear different people discuss a particular investment in their own style,
  • Erik Townsend’s MacroVoices podcast – common sense macro discussion that I never miss due to the excellent guests.  Erik conducts superb interviews of each of them (and Erik is awesome too),
  • Meb Faber’s podcast – a podcast that is outside my normal wheelhouse but has caused me to rethink things more than most, and
  • Lawrence Hamtil’s posts – his posts have done more to help me mold my methodology than anyone (particularly within stock sector weightings and domestic vs. international weightings).

I review all kinds of information from all kinds of people, but I find that each time any of these people introduce new content that I eagerly seek it out and make it a priority to review it.  I am hugely thankful that each of these people do what they do!

One of the reasons I enjoy investing is because there is no right answer.  Actually, there might be but no one knows what it is…or ever will.  Investing is a lifelong pursuit of skills and the proper temperament to be successful.  As I said, a lot of it is knowledge.  Read the books, know the things you need to know.  But another hugely important part of it is temperament.  Successful investing comes down to being able to know how to control your emotions when unexpected things happen (and they always do).  To me investing is the ultimate ‘solo suffer’ activity.  No one cares about your investing like you do or is impacted by it like you are.  I think it is a lot like other ‘solo suffer’ activities like distance running and weight training.  Both of which, when done well, can be hugely rewarding but are incredibly difficult, grueling ‘journeys’ along the way.  Investing is, in my opinion, the ultimate test of one’s abilities.  I can/will continue to spend significant time on my investing throughout my life (as long as my mind allows me to continue to make sound choices).

Anyhoo…I listen, learn and then roll all that into my methodology.  After noodling on all of this for a few years intently (and a few decades prior to that) I feel as good about my methodology today as I ever have.

Asset Class Allocation

I am currently allocated across 3 asset classes (stocks, bonds, and commodities) in my investment portfolio.  Within the stock allocation, the majority of my money is invested in individual equities. 

I am not currently making any huge changes to my actual asset class allocation.  I will continue to allocate across these asset classes.  The percentages I have right now are not exactly where I want them to be (but they are close).  I will, however, be making pretty big changes to how I invest on the stock side (but more on that later).

I have, however, made some pretty big changes in how I come up with my target asset class allocation.  I’ve done a good deal of thinking in the past few months on how I set the allocations over time and have come up with some rules based on:

  1. My ideal position size,
  2. Things I have going on in my life that might dictate a particular allocation, and
  3. Judgment/opinions that might dictate a particular allocation.  These are market timing decisions.  I know, I know, you aren’t supposed to do that.  Try to stop me!  Ha!

These asset allocation decisions are long term in nature and will likely change on a year-to-year timeframe as my life rolls along (and major changes occur in markets).  I’ve felt almost schizophrenic in my investing over the past few months (actually most of the past year) because I didn’t really have a strong opinion on what my target asset class allocation should be.  Since this is probably the most important thing an investor needs to nail down that is a bad thing.  It has caused me some frustration but has also forced me to put a lot of thought into it.  At this point, I feel like I have a better system for setting my asset class allocation than I ever have.  I am more excited about this than anything else I’ve come up with.

Just for reference sake here are my current thoughts on some topics and each asset class.  I use these thoughts in helping to determine my target asset class allocation:

  • Position Size – I’ve determined that the minimum number of ‘positions’ I want to hold is 20.  This means that I will not have more than 5% of my portfolio in a single ‘position’.  This is based on some heavy-duty statistical stuff from several sources.  I’ve also been using it in my current methodology to set position sizes for the individual stocks I’ve selected.  I will likely not have anywhere near that size in my portfolio using this updated methodology (but definitely have in the past).  So, the concept of position size is much less important in my current methodology.  Regardless, I still determine ‘position’ size (and utilize it) mainly so that I can:
    • Make some asset class allocation decisions using it as a reference, and
    • Limit my ‘moves’ when making changes.  I don’t want to ever trade more than one ‘position’ in a single month.  This ensures that I don’t make decisions too quickly and forces time to roll off the calendar (and for my brain to have plenty of time to contemplate things as things play out).  It is a safety valve against my emotions (or maybe stupidity…probably stupidity).
  • Upper/Lower Bound Limits – The tool I have developed to set my target asset allocations allows me to set an upper bound limit and a lower bound limit for each asset class.  The difference between the two is dictated on my own decision making.  I can move my investment portfolio’s capital in a particular asset class within this range at my discretion but I don’t allow myself to go outside the boundaries set.  This tool helps me manage my portfolio allocations in real-time against the target allocation.  It also allows me to review my targets on some frequency (usually annually) to determine if conditions have changed substantially enough to warrant an allocation target change.
  • Stocks – My desire is to be heavily allocated to equities at all times.  I am a stock guy.  I believe stock ownership is the best way to stay ahead of the inflation monster over long periods of time.  The only reason I would allocate money away from equities is if I held an alternative investment/asset class due to my current thinking on a subject (overvalued equities, recession risks, etc.).  I would limit any of those thoughts to a ‘position size limit’ (just like I would an individual equity position).  These ‘decisions’ are just market timing which is proven not to work in the long run.  I can make a call like this but I must limit it to a ‘position’ in order to maintain my position size limits.  When buying individual stocks, if I am buying stock in companies (good ones) at reasonable valuations I will be fine over many years and many market cycles.  I have a long investment horizon (I hope).
    • US Stocks – I generally invest in US Stocks (especially when I’m buying individual equities).  I limit my individual positions to only US Stocks to eliminate the currency risks that I am not trying to manage (but that could have a huge impact on my USD returns).  If I am unable to find individual US Stocks to purchase, I will generally invest in Fidelity sector ETF funds to maintain the appropriate sector allocations.
    • International Stocks – There is one investment account that I have (a tax-efficient account) where my individual investment options are not all that great.  There are two good options that allow me to allocate to international equities and emerging markets equities.  I’m not too sure that ‘home country bias’ matters to me.  I understand the concept but believe that sector allocation and currency exposure matter more than anything related to home country bias.  In case I am wrong, I’ll use this account’s two good options to allocate to these.  I’ll just keep maxing out my contribution to this account over time (into these two investments).
  • Commodities/Other – I’d rather not own commodities (versus stocks) for a variety of reasons but I will if I believe stocks are expensive and commodities are cheap.  I would limit any of those thoughts to a ‘position size limit’ (just like I would an individual equity position).  I do keep an allocation to physical precious metals.  I will likely always keep that as a ‘financial system/financial asset risk mitigation’ instrument (it is an insurance policy against financial assets).  That is currently being tracked as a part of my portfolio’s allocation/performance.  If financial assets get ‘cheap’ in relation to this allocation I might make it smaller (or non-existent) and allocate it all to stocks.
  • Bonds/Fixed Income – I generally don’t want an allocation to bonds/fixed income at all.  I consider social security income to be ‘bond-like’ and this income (whatever it might be) is my bond position.  I am investing for the long-term and bonds have not and will not outpace inflation over the long term.  Therefore, I have no use for them.  I’d rather not own bonds (versus stocks) for a variety of reasons but I will if I believe there is a good reason to own them (overvalued equities, recession risks, etc.).  I would limit any of those thoughts to a ‘position size limit’ (just like I would an individual equity position).  At the moment, I have a larger allocation to bonds because I have 2-3 kids in college at the same time for the past few years (and next few).  I also have a decent amount of risk in my earnings related to my work/business (as it is still a closely held, startup).  I don’t intend to use any funds from my investment portfolio to fund either of these (college or business) but I don’t want to be in the position of having to use my portfolio and having to sell depressed assets if I need the money quickly.  So, I currently have a larger bond/fixed income allocation than I might normally have.  This will change if things play out as I hope they will in the coming years (and I move some little humans off my payroll).
  • Cash and Equivalents – I have a waterfall where I keep enough cash to pay my living expenses liquid.  That money is not tracked as a part of my portfolio holdings.  Once the waterfall is ‘full’ the money rolls into my portfolio for investment.  If I hold cash at all it is because I am in-between positions (and holding time will be measured in days).  I am investing for the long-term and Cash and Equivalents have not and will not outpace inflation over the long term.  Therefore, I have no use for it.
  • Real Estate – I generally don’t allocate/track my portfolio holdings to this.  I can/will hold real estate as an asset (for example equity in a personal residence).  I view this as more an expense than a portfolio holding (they don’t generate income and they take income to ‘feed’ them).  These are not investments in my opinion.  I also don’t like that real estate is hard to diversify, too illiquid, not tax-efficient (the worst tax situation that exists in my opinion), and expensive to transact.  Horrible investment in my opinion…but…they aren’t making any more of it either.  Real estate is a piece of my portfolio allocation, for sure, as it is part of my net worth but not tracked here.  I can/will own REITs or REIT stocks in my stock portfolio.  If I ever decide to buy real estate for investment reasons, I will include it in my tracking but I do not see this happening at any point in the near future (but I’m researching it more as we speak).

Stock Sector Allocation (Within Stock Asset Class Allocation)

Over the past two years, I’ve invested in mainly individual stocks with my stock asset class allocation.  I would only allow myself to own one stock in a particular industry, and only two stocks in a particular sector, and limited my position size.  I had these rules in place to ensure I didn’t take on too much risk with any of the above.  My portfolio generally didn’t match the make-up of the market in any way.  There were several sectors where I had no exposure at all and many where I had a large underexposure and many where I had a very large overexposure.  I somewhat understood this and also understood the risks I was taking and the impact on my performance by doing so.  I understand that all much, much better now (thanks Lawrence!).  It has worked better at times and worse at other times.  My time horizon is long and short-term performance (less than a year) is not really a huge concern (even though I track it all monthly…which might seem strange).

Based on everything I’ve been noodling on in the past few months I’m not sure the way I have been doing it is the ‘right’ way.  The risks I am taking could be larger than I consider them to be due to me just being wrong.  My methodology could have me picking a basket of stocks that are just garbage.  It is unlikely but possible.  Regardless, the likelihood that I am wrong is decently high.  I’m just an amateur guy who might not even know what he does not know.  Even professionals who do this all day every day generally don’t consistently beat the market.  Why in the world would I be able to (try as I may)?

Within my stock allocation, I am going to switch up my methodology a bit from what I’m doing now. 

  1. I am going to still buy individual stocks but not ONLY individual stocks. 
  2. I will also ensure that my stock allocation mirrors the sector allocation represented in the stock market (which is not the case now). 

It might take some time to get my portfolio repositioned this way.  I believe it will take at least a few months (maybe more, maybe less).  I’ve looked at how different indexes are allocated across sectors and how mine currently is.  I reviewed the sector allocation of my portfolio, the S&P 500’s average allocation over the past 25 years, the S&P 500 market cap weighting, the S&P 500 equal weighting, a world index, an international index, and an emerging market index.  You can see that there are some pretty dramatic differences in the different strategies.

I’m going to target my portfolio to match the 25-year average allocation of the sector composition of the S&P 500.  I’m thinking this is a decent strategy to keep from getting too invested in sectors that might be ‘overheated’ and where the current allocation might be too high (and others might be too low).  I also believe it is a better approach than a common approach many use who do not follow market cap weighting, equal weighting.  In equal weighting, you just buy everything equally.  This is an easy approach but not really tied to reality since the amount of capital tied to each sector/company is not ‘equal-weighted’.  The math to come up with following a 25-year average was a little tricky due to the way the sectors have been reworked in recent years but I was able to come up with a decent methodology to make it work.

Within each sector I will buy:

  1. Sector ETFs – I will have between 50% and 100% of the sector’s allocation in these ETFs.  I will use the Fidelity sector ETFs for this exposure.  They have a .08% expense ratio and I can now trade them for free in my accounts, and
  2. Individual Stocks – I will still pick individual stocks just like I have been.  They will just be smaller positions and will also fit within their overall sector allocation.  For simplicity, I will usually select up to 2 individual stocks per sector (limit 1 per industry).  Regardless, I will never have more than 50% of the sector’s allocation in individual stocks (or 25% in a single stock).  For example, if Information Technology is a 15% allocation within my portfolio, I might own 50% of that in FTEC (the Fidelity ETF) and 25% in Stock #1 and 25% in Stock #2.  If I can’t find any individual positions that make sense in a particular sector, I will put the entire allocation (100%) into the Fidelity ETF for that sector’s allocation.

This methodology will allow me to somewhat track the overall market in a way that I’m comfortable with but also allow me to find and invest in particular individual stocks that I believe are better investments than the overall market (or at least within a particular sector).  This methodology will allow me to ‘do things’ in my investing when I think that makes sense but will not allow me to do things that will cause me to be drastically different than the overall market.  It protects me a bit from myself…which is a good thing.

I will review my allocations regularly (usually monthly) and allocate new investment money into whatever asset class or stock sector is currently under-allocated according to the model I’ve built.  The combination of all this should mean I will always be investing new money into the asset class or stock sector (or individual stock) that is currently under-allocated.  I believe that over time this will mean I am investing new money in things that are getting clobbered (or at least underperforming). 

In short, over time, this should translate to buying low and selling high.  In theory, this should lead to better performance over a very long period of time.  I will certainly expect to underperform when a particular sector is blowing the top off (in terms of allocation and performance…which are related) as Information Technology is doing these days.  I won’t be entirely left behind, however, because I will have an allocation to the sector (which will increase over time if it continues).

I’ve built a tool that allows me to easily review all this as often as I want to.  I can easily see where all this stands so that I can act on it at any time.  I will generally update it monthly (as I update my monthly performance) and make my monthly allocation decisions at that time each month.

I’m very excited about all of this.  I feel like this is the best methodology I have ever had in my investing lifetime.  It is also one that will take as little time as a few hours a month to implement all the way up to a full-time effort if I want to devote that much energy to individual stock selection at times.  This is exactly how my life works anyway.  Sometimes I have plenty of time to ‘invest’ in my investing and other times I don’t.  This methodology will work with either.

If you read this, I hope you find it somewhat useful.  I write all this stuff for myself mainly but I share it just in case someone out there might also find it useful (doubtful).  Be sure to read/follow those folks I mentioned earlier (they are much wiser than me and post a lot more great information than I do).  I appreciate that at some point they decided to share information like this so that people like me could one day find it.  It has benefited me greatly and I appreciate it more than any of them will ever know.


Published by deanorolls

Well, if I told you that you wouldn't need to go to my would you?!?!

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  1. You might consider position sizing based on volatility. The lower the volatility, the larger the weight can be. The highest volatility is in options (though you don’t invest in them anyway), next is commodities, next is individual stocks, then fixed income, then the lowest volatility is in foreign exchange. Just some food for additional thought.

    I really enjoyed your article and you got into the “don’t do” weeds very well and explained your philosophy. I would recommend you pare it down somewhat due to most people’s short attention span and keep your updates on point.

    Thanks, and good luck with your investments.


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