Investment Resolutions for 2012


2012 Resolutions

As we are about to turn the page into 2012, it is worthwhile establishing or reexamining our investment goals.  We want to be able to keep these resolutions and many on the list are not new to readers of ITA Wealth Management.  So let's begin.

1.  Lay out an investment plan if you have not already done so.  Most readers of ITA already have a plan in place.  Now stick to it.

2.  Pay off credit card debt.  This seems to be the current trend.  Keep at it.  This one likely should be number on on the list.

3.  Establish a savings plan.  Follow the Golden Rule of Investing.

4.  Make the decision whether you want to manage your own money or pay a fee based advisor.  The cost of an ITA Platinum membership is far less than the cost of a professional advisor.

5.  Seriously consider whether you are better off using index vehicles or picking individual stocks.  Do some serious research on this topic.  Read Richard Ferri's book, "The Power of Passive Investing" if you have the slightest question.

6.  Read several of our Top Ten Investment books before launching your investment plan.  Begin your investment education.

7.  Turn off CNBC and other financial advertising services.  They do not have your best investing interests in their thinking.

8.  Think through your asset allocation plan.  Keep it simple as you learn.  You might even begin with the four asset class portfolio.  The ETFs are: VTI, VEU, VWO, and TIP.

9.  Learn how to monitor your portfolio.  We recommend taking the time to learn how to use the TLH spreadsheet.  There is a lot to learn.

10. Be patient.  Invest for the long run.

Asset Allocation Plan for ITA-RR

Below is the asset allocation plan for the new risk reduction portfolio.  Names suggested thus are Dirac and ITA-RR.  This portfolio would be appropriate for investors age 35 to 50 as the allocation to bonds is a tad over 30%. This allocation, combined with the 10% commodity allocation holds the projected volatility under 15%.

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Asset Allocation: Breaking It Down

Launching a new portfolio requires a portfolio policy or an asset allocation plan.  There is a significant body of research on the importance of this decision.  However, some of the latest research by Ibbotson and Associates show this decision to be less important than it was thought to be twenty years ago.  Here are some of the steps I go through in thinking through what it means to construct a portfolio.  The first decision I make is to do this myself rather than turn it over to a professional manager.

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Searching for the Holy Grail of Investing

The following blog was posted about 1.5 years ago and it is still timely here at the end of 2011.  I made a few minor changes in the post below. 

Kenneth French continues to update this research and it is still valid.  If readers ever wonder why we tilt our asset allocations they way we do, the reason is based on the following research.

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Launching a New Portfolio and Initializing ITA Index

Platinum readers know about the funding of the new ITA-RR portfolio. Since tomorrow is the last business day of the month (December) I will take a careful look at the price points for VTI, IWN, VEU, VWO, VNQ, RWX, and IGE and compare them with their respective 195-Day EMAs.  If nothing were to change tomorrow, on January 3, 2012, I will take out a full position in VTI, IWN, and VNQ.  VEU, VWO, RWX, and IGE will be neglected for another month.

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ITA Index: How to Initialize

The ITA Index is a customized benchmark found within the TLH Spreadsheet.  It makes little sense to compare portfolio performance of most portfolios with the very popular S&P 500 benchmark (VFINX) as most portfolios include asset classes other than large-cap stocks.  ITA portfolios, for example, include developed international markets (VEU), emerging markets (VWO), bonds (BND, HYG, JNK, TLT, IEF, etc.), domestic REITs (VNQ), commodities (DBC, SLV, GLD, IGE, DJP, etc.), international REITs (RWX) and a few other asset classes.  If one is going to appropriately benchmark a diversified portfolio, the usual benchmarks are inappropriate.  That is where the ITA Index comes into play.

The following Dashboard Worksheet was extracted from the Einstein Portfolio.  I'm using it as an example since each of the 17 asset classes we use in our portfolios includes a percentage requirement in the Strategic Asset Allocation plan.  Here are the benchmarks I using in the ITA Index or customized benchmark.

VTSMX is the benchmark for the "Big Nine" asset classes.  These nine asset classes include large, mid, and small cap asset classes as well as value, blend, and growth.  Those are the nine U.S. Equity asset classes found in the upper left-hand corner of the following Dashboard.

Not covered by the VTSMX benchmark are: Bonds & Income, International Equities, Domestic REITs, Emerging Markets, Commodities, International REITs, and International Bonds.  VGTSX includes both developed and emerging markets so it will cover those two asset classes.  For the remaining asset classes, I use individual index ETFs as the benchmarks.  For bonds, I use BND.  The last four asset classes, REITs, Commodities, International REITs, and International Bonds are represented by VNQ, DBC, RWX, and EMB respectively.  In most cases, I use TIP as my cash representative.

The mathematics of the ITA Index can be found in the equation you see at the very top of the following screen shot.  Since 38% of the portfolio is allocated to U.S. Equities, we multiply 0.38 x Cell C5 which is the IRR for the VTSMX index fund.  The next calculation is the one percent (1%) allocated to cash.  Our cash ETF is TIP as I hold that ETF in all portfolios and it is a fair, but not perfect, representation.  Note that 0.01 is multiplied by Cell C34.  In similar fashion, the percentage allocated to each asset class is multiplied by the IRR performance of the ETF that represents that particular asset class.

While this is not a perfect customized benchmark, it is far more representative of the performance of a portfolio when measured with respect to an array of asset classes vs. measuring the performance of the portfolio against either the VTSMX or VFINX.  Readers may ask, why are the portfolio IRR performance numbers always compared against the VTSMX when the various portfolios are reviewed?  The simple answer is that in most portfolios I do not have sufficient data to use the ITA Index.  I need three years of data to come up with a minimum of accuracy.  I am getting close to being able to switch from the VTSMX benchmark to the ITA Index benchmark.  I'll continue to use the VTSMX as it provides a valid comparison with how well a well-diversified portfolio is performing with respect to the U.S. market.

Calculating the ITA Index may seem a little complicated.  As I recall, I have a Camtasia audio/video clip that will help TLH Spreadsheet users see how one walks through this calculation.  If there is still confusion, I will provide individual help if you drop a comment in the appropriate box.  I much prefer questions in the comment box so everyone can read my replies..

Newton Portfolio Review

Thirty shares of VO were added to the Newton yesterday, bringing the Mid-Cap Blend asset class closer to balance.  I am slowly pulling this portfolio back into balance.  Emerging Markets (VWO) is the asset class that needs primary attention.  Plenty of cash is available in the Newton, making it much easier to bring asset classes below target back up to their targeted percentages.

Platinum membership is available for $5.00 per month.

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Risk Reduction Portfolio: A Potential Asset Allocation Plan

Bob Warasila, author of the "New Normal" portfolio, sent me an asset allocation plan that is worth sharing with Platinum members.  This Risk Reduction Portfolio differs slightly from one I recently posted over on Seeking Alpha in that this portfolio has a small exposure to precious metals and it also includes on stock.  In the following three screen shots readers will find the Quantext Portfolio Planner (QPP) analysis, the "Delta Factor" projections, and a Correlation Matrix for this portfolio.

This blog entry is not available for publication on other web sites.

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Kepler Portfolio Update: 27 December 2011

Twenty-five shares of VWO were added to the Kepler Portfolio last week.  This addition brought the Emerging Market asset class within the 25% target limit, but still left the portfolio 118 shares below the targeted percentage.  Platinum members will note the Dashboard or Strategic Asset Allocation (SAA) plan below.  If I make changes over the next few weeks it will result in shifting shares of Mid-Cap Blend to Small-Cap Value.  This would mean selling a few shares of VO and purchasing more IWN.  This move has two advantages.  We increase our exposure to the value side of the investing spectrum and the dividend yield is increased about one percentage point.

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Portfolio Rebalancing: Essential or Overrated

Portfolio rebalancing is as old as asset allocation and it is one of the cardinal rules of portfolio management.  It is an action or discipline used by money managers to keep the percentages of the various asset class within stated target limits.  Rebalancing policies assure the investor that the portfolio continues to be well diversified.  If one never rebalances the market will determine the asset allocation plan for the portfolio.

The portfolio manager or investor has two basic choices when it comes to portfolio rebalancing.  They can rebalance on a calender year or according to some contingency plan.  William Bernstein recommends rebalancing every one or two years.  Error on the side of infrequency.  ITA followers will note I use a contingency rebalancing plan that is built around target limits.  These target limits are generally set at 20%, 25%, or even as high as 30%.  The reason these percentages are as high as they are is based on an 18-year study of eight basic asset classes.  How does this rebalancing plan work if one uses target limits?

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