Investment Help

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Monday, August 18, 2014

Portfolio Mechanics

Many times, when reading financial help books, I come across a recommended portfolio and wonder if readers know how to actually implement the portfolio.  There used to be (and may still be) a popular book series called "the Missing Manual" in the computer help area. To me, there seems to be a "Missing Manual" issue here.

For example, I recently read a review of the book by Spencer Sherman, The Cure for Money Madness, on The Simple Dollar site.

Here is Sherman's recommended portfolio:

25% bonds (VBMFX)
12% U.S. large cap stocks (VFINX)
12% U.S. large value stocks (VUVLX)
6% U.S. small cap stocks (NAESX)
6% U.S. small value stocks (VISVX)
7% international large value stocks (VTRIX)
3.5% international small cap stocks (VINEX)
3.5% international value stocks (VWIGX)
2% emerging markets large cap stocks (VEIEX)
2% emerging markets small cap stocks (VEIEX)
2% emerging markets value stocks (VEIEX)
11.5% U.S. real estate (VGSIX)
3% international real estate (VHGEX)
4.5% commodities (VAW)

Observations:
  • this portfolio is, IMHO, way too complex - a lot of the Funds could easily be combined using broad market Funds
  • no single asset allocation is right for all investors 
  • some readers will be able to execute the portfolio as listed; BUT many others, I believe, would be stumped on what would be the next move.
I haven't read the book, so some of this may be explained by Spencer Sherman.  I do know that in similar books the next steps, i.e. the mechanics of setting up a portfolio, are not discussed.

Understand that (this is sort of outside the box) money management is not like buying a car.  In buying a car, you go in and tell them you are interested in a sedan or SUV, color, 4WD or not, etc.  In money management, you take the investment style of the advisor you use.  In other words, it is not possible to go in and say, "I like the philosophy presented in The Cure for Money Madness, set me up a portfolio matching it."

Your best chance to get money management help for this approach is to first establish that a particular advisor uses a low-cost, well-diversified market indexing approach.

But back to doing it yourself.  You are in one of two situations.  You are taking over a portfolio of investments, or you have cash to invest.  For example, after reading a book like the above, you realize that your present advisor is charging way too much to manage your assets.  Or, you may be rolling over a 401(k).  In these instances. you may need to sell existing Funds, have tax questions, etc.  These can be tricky situations, and you may want to get some hourly consulting just to make sure you are not making some basic mistakes.

The second case would be where you inherit cash or want to get a maturing CD invested in stocks. This is much simpler; you need just focus on the buy side.

In some instances, where an individual has never transacted in the stock market, I recommend starting with a target date fund or life strategy fund.  These funds already do all of the allocation for you - you have one Fund to buy.  You just need to figure out the number of shares to buy and how to buy them.

Here, as an example, is the Vanguard "Moderate Growth Fund" allocation:

Underlying funds as of 07/31/2014
Rank Fund name Percentage
1 Vanguard Total Stock Market Index Fund Investor Shares 41.6%
2 Vanguard Total Bond Market II Index Fund Investor Shares** 32.4%
3 Vanguard Total International Stock Index Fund Investor Shares 17.9%
4 Vanguard Total International Bond Index Fund 8.1%
Total 100.0%
**Information on this fund can be found on Vanguard's Institutional Investors site.

As you can see, this is basically a 60% stocks/40% bonds allocation.

Suppose you have $100,000 and you are ready to take the leap and buy shares.  First off, you need the ticker symbol.  This Fund has a ticker symbol of VSMGX.  This ticker symbol can be input into the quote box on any financial site and the price ascertained.  As this is written, the price is $24.11.  Divide $100,000 by 24.11, and you find the number of shares to buy at approximately 4,000.

Once you log on to Vanguard or whatever broker you are using, you need to find the "Trade" button or, in Vanguard's case, the "Buy & Sell" button.  Next, on Vanguard, click "Buy Vanguard Funds" and it is straightforward from there.

In carrying out a transaction like this, I would likely do the buy in a few transactions - maybe 500 shares at a time.  If you are doing this for the first time, you may even want to start with 50 shares just to make sure the computer doesn't blow up when you hit the "buy" button ;)

I would also look at the bid-ask spread.  If it is wide, I would maybe put in a limit order.

When you first start, it is good practice to go slow.  I use Schwab primarily and have a routine I go through.  I run my eyeballs to the top and see available funds to invest.  I look to the left to make sure I am on the right account.  On the review page, I read the footnotes, etc.  I then go to "order status" to see that the trade was executed.  This is important because it is easy not to push the "buy" button on the review page and, therefore, not actually put in the trade.

An interesting point is that this simple process has historically outperformed 70% and more higher priced actively trading professional managers who seek to beat the market!

Once you are confident with the process, you can easily graduate to buying the individual Funds.  To replicate VSMGX requires only 4 Funds, the ticker symbols of which can easily be found on the Vanguard site.

Or you may prefer to jazz it up a bit with some of the Funds listed by Sherman Spencer.  Which will do better?  Only those with a crystal ball can tell!

Disclosure:  This post is for educational purposes.  Individuals should do their own research and/or consult a professional before making financial decisions.  My clients and I own some of the Funds mentioned.



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