A Portfolio Construction Policy

Photograph: Main Gate to University of Glasgow, Scotland

As an educational investment blog, ITA Wealth Management is all about portfolio construction, management, and monitoring.  In this post I will focus on the beginning steps of portfolio construction.  Portfolio construction is the process of assembling security holdings using a Strategic Asset Allocation blueprint.  We will walk through that process in this critical blog entry.  It is not unusual for an investor to put together a hodgepodge of individual stocks and call it a portfolio.  This is not what I call an intelligent approach to portfolio construction.  What are the steps one uses to weave a portfolio?

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1.  Step one is to determine the percentage breakdown between equities (stocks) and bonds.  The ratio will vary from 90% to 30% equities with 10% to 70% in bonds.  This is not to say there might be rare instances when one holds 100% in either equities or bonds.  The Equity/Bond ratio is very individual as are most of the steps to building a portfolio.  A common Equity/Bond ratio is 60/40.  Most portfolios I track have ratios that vary from 70/30 to 90/10 with a strong tilt toward equities.  Tilting toward equities to this degree indicates rather aggressive portfolios.  Retired investors with no pension and modest social security income will want to move to a higher percentage in bonds or at least income generating investment vehicles.

2.  Step two is not as difficult as step one.  What investment vehicles should one use for equities and bonds?  In my opinion, serious investors will use non-managed index mutual funds or non-managed Exchange Traded Funds (ETFs).  Flee actively managed mutual funds and be very careful when it comes to using individual stocks.  While I am not opposed to buying individual securities, I don't think it is wise to use them as core portfolio holdings.  The odds of meeting investment goals are too low when portfolios are built around individual stocks.  We are still examining "Fundamental ETFs" and I will not go into that subject as I don't want to cloud the more important aspects of following a portfolio plan toward construction.  My investment vehicles of choice are index ETFs and Platinum members see this strategy implemented daily.

3.  Step 3 is lay out what asset classes to use to build the portfolio.  At a minimum, investors should use ETFs to cover U.S. Equities, Developed International Markets, Emerging Markets, Bonds, and REITs.  I consider these to be the five basic asset classes.  Larger portfolios will include International REITs, and some will add Commodities.  I have yet to branch out into International Bonds.  That asset class is certainly a possibility.  It is assumed that all portfolios will include Cash, so lets add that as a major asset class even though the percentage held in Cash will be small if we are following a policy of full investment.

Those are the basic steps to I follow when launching a portfolio such as the Kenilworth.  The Kenilworth is our newest portfolio and investors new to asset allocation will want to watch that portfolio as it continues to grow into the various asset classes.

Portfolio Activity

Photograph: Cafe in Dublin, Ireland

Einstein Portfolio Changes

Shares of VOE were sold from the Einstein Portfolio in an effort to bring the Mid-Cap Value asset class into balance.  As you can see from the Dashboard worksheet below, this asset class is still over target, even with the Threshold set at 30%. 

Normally, if one were adding significant amounts to the portfolio each month, any asset class over target is of little concern as asset oriented investor will purchase shares in the under target asset classes each month.  As one can see in the screen shot below, two asset classes are lingering below target. Limit orders are in place to rectify the imbalance, and now that we have cash available for the VOE sale, an effort will be made to bring all asset classes into balance.

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