Where Are We With Respect To The ITA Risk Reduction Model?

Photograph by John Fitzgerald

Photograph by John Fitzgerald

With several “ITARR” portfolios coming up for review, what is the condition of the critical ETFs we use to populate our portfolios.  The critical ETFs are: VTI, VNQ, RWX, IWN, VEU, VEA, VWO, DBC, PCY, etc.  To examine these ETFs and others that may be used by investors, go to this site and request the ETF, index fund, or stock of interest.  VTI is the example shown in the link.

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A Third Investing Path: Mosaic Investing

Photograph by John Fitzgerald

Photograph by John Fitzgerald

We hear and read about active and passive investing, and which style is most beneficial to the majority of investors.  There is a third path which is a combination of both the active and passive styles and I call it Mosaic Investing.  Mosaic Investing, as I use the term, is where one constructs the majority of the portfolio around index vehicles such as non-managed index ETFs, and then adds a few individual stocks to the core of ETFs as a way to lower the overall portfolio correlation.  While adding individual stocks would not seem to lower portfolio correlation, with careful selection and some additional analysis it is possible to find stocks that will bring added diversification to the portfolio.

This third investing style is not frequently mentioned in academic literature.  The Gauss, Newton, and Curie portfolios are examples where I add a few stocks to the core of ETFs.  At one time a few stocks were part of the Schrodinger as individual stocks were donated to that portfolio.  Those stocks were sold and reinvested in ETFs so that portfolio is totally indexed and is passively “managed.”  None of the eleven portfolios tracked here at ITA Wealth Management are what I would classify as actively managed portfolios.  Fortunately for index investors we have lots of individual investors who are convinced by “art, science, and intellect” they will be able to outperform the market.  Active management flies in the face of research and numerous studies that lead to the opposite conclusion.  We need those investors to buy and sell stocks so there is a market operating under the ETF umbrella.

Mosaic investors fit somewhere along the broad continuum of all investing styles, depending on what percentage the individual stocks make up the total portfolio.  I rarely exceed 15% of the total portfolio.   A Mosaic investor may construct a portfolio around a core of index funds with a particular asset allocation tilt.  Some investors will build their portfolio around sectors rather than asset classes. To this core of index investments, the Mosaic investor may sprinkle in a few individual stocks. The Mosaic investor thinks they can added value or alpha to the portfolio through policy tilt, rebalancing policy, and astute stock selection. However, the Mosaic investor does not feel competent to select stocks in all asset classes or in all international markets, and emerging markets. To build a well-diversified portfolio requires heavy use of index funds or index ETFs.  An all stock portfolio will not work for the Mosaic investor.

Since there is a variety of active decisions made by the Mosaic investor, most writers slot the Mosaic investor into the active management category. I prefer to split off the Mosaic investor from the active investor as the Mosaic investor relies heavily on index vehicles to form the core of the portfolio. An extreme passive oriented Mosaic investor will design a portfolio plan and implement that plan by populating the portfolio with index funds or index ETFs. Once the plan is in place, little is done except to keep the asset classes in balance through a rebalancing strategy. This approach varies little from the investor who buys 20 to 30 individual stocks and then rarely sells them.

Which of the above three investing styles, active, passive, or Mosaic is best? That is not an easy question to answer.  ITA Wealth Management is a blog showing the benefits of the Mosaic investing style, while tracking several portfolios that are passively “managed.”  There is no one right answer for everyone.