# Please critique/give me feedback on this index portfolio - Part II



## Donkey (May 26, 2009)

How about this for a plan for my wife (29) and I (33) for our self-funded retirements? Our only current investments are about $110,000 in mutual funds held through our RRSP's and TFSA's.


*1. With our current $110,000, purchase through TDW:*

*a.* 

35% XIU - MER 0.17
5% XCS - MER 0.55
25% XSP - MER 0.24
5% XSU - MER 0.35
25% XIN - MER 0.49
5% CBQ - MER 0.60 (or use CWO? - MER 0.65)

Combined MER 0.32 I think?

OR

*b.* 

40% XIU - MER 0.17
30% XSP - MER 0.24
25% XIN - MER 0.49
5% CBQ - MER 0.60 (or use CWO? - MER 0.65)

Combined MER 0.29 I think?


*2. For our ongoing monthly contributions of $2,200 purchase:*

40% TD eCI - MER 0.31
30% TD eUSI - MER 0.33
30% TD eII - MER 0.48

Combined MER 0.367 I think?


*3. Transfer money from TD efunds to ETF's and rebalance once yearly plus top up our TFSA's.*


Does this seem a reasonable approach to diversification and minimum fees for maximum growth given our long time horizon and high tolerance for volatility?

I'm not clear on how the 90 day penalty works for withdrawing from the TD efunds and how this might impact my plan. Any clarification?

Also, I understand Claymore has a PAC system now. If I were to incorporate purchases of CBQ into my monthly contributions, how should I then adjust the relative percentages between it and the TD efunds listed above?

We have close to 100% equity in our house, and we're exploring real estate investment options such as MIC's, REIT's and revenue properties in order to diversify beyond the plan above.

Any specific or general comments?

Thanks very much!!


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## Sampson (Apr 3, 2009)

Looks good to me.

1. I'd prefer 1a due to the small cap exposure.
2. Good idea - your ongoing contributions will not shift your allocations too significantly.
3. Since you are building up your savings quickly $2.2k/month, I would consider rebalancing more frequently. After 5-6 months, that'll be $11-13k that you can move into the ETFs in $2000-$3000 amounts (or $4-$6K if you really want to keep expenses low).

Seems like you're on a great path. No matter what your risk tolerance and time horizon I would suggest you have some allocations to bonds or cash. This last year has really highlighted the benefit. If you were all in the market you had no chance to deploy when the market was down. Maybe look to a small (10%) bond/cash allocation.

Would it be proper to address you as Mr. ***


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## Squash500 (May 16, 2009)

Donkey said:


> How about this for a plan for my wife (29) and I (33) for our self-funded retirements? Our only current investments are about $110,000 in mutual funds held through our RRSP's and TFSA's.
> 
> 
> *1. With our current $110,000, purchase through TDW:*
> ...


 Your potential portfolios looks good. However IMHO you need at least 30% fixed income in your portfolio. 100% equities is way too risky no matter what your time horizon is.

IMHO a good fixed income etf is the XBB.


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## Rickson9 (Apr 9, 2009)

I would dump all of it into one U.S. or Canadian index and leave it at that. 

100% equities is fine for my wife and I, but we're abnormal in that we don't like diversification and prefer portfolio concentration so keep that in mind when reading this.

We've dumped virtually all of our 2008 RRSP contribution, 2009 TFSA and 2008/2009 non-registered cash into 3 stocks; 2 of them that we've had from before and 1 new one that we've never had.

Rabid portfolio concentration has treated us (very) well for the last decade and 2009 looks to be another good year.

"An irrisistable footnote: in 1971, pension fund managers invested a record 122% of net funds available in equities - at full prices they couldn't buy enough of them. In 1974, after the bottom had fallen out, they committed a then record low of 21% to stocks."
- Warren Buffett, 1978 Chairman's Letter to Shareholders


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## Donkey (May 26, 2009)

Thanks for the replies!

Sampson - I think my wife would agree with that nickname!

Squash500 - I'm really uncertain about what to do with the fixed income. We really are capable of handling the increased volatility without panicking if a higher % equities might give us a greater return. Are there other arguments for including fixed income?

Rickson9 - I'm still early in my investment education/experience but I'm learning a bit about value investing and concentration. I don't really have the time right now to devote to doing it properly however. If using index investing, what is your argument for sticking with one index vs attempting a spread such as i've proposed?

Thanks again all.


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## Germack (Apr 4, 2009)

I agree with Squash500. Your portfolio should always contain some fixed income. (e.g. 30%)

I do not really like the approach Rickson9 is using. In my opinion diversification is very important to reduce risk. Buying only three stocks is very risky and neither does it increase your potential return.


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## Rickson9 (Apr 9, 2009)

Donkey said:


> Rickson9 - I'm still early in my investment education/experience but I'm learning a bit about value investing and concentration. I don't really have the time right now to devote to doing it properly however. If using index investing, what is your argument for sticking with one index vs attempting a spread such as i've proposed?


There is no benefit spreading your money around multiple index funds.


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## Donkey (May 26, 2009)

Rickson9 could you elaborate please?

thanks.


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## Rickson9 (Apr 9, 2009)

Donkey said:


> Rickson9 could you elaborate please?
> 
> thanks.


There is no benefit. I don't know how else to say it. You won't get a better return. You won't pay less in fees. You will recieve more useless statements in the mail. You will not receive any benefit.


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## ethos1 (Apr 4, 2009)

Rickson9 said:


> There is no benefit. I don't know how else to say it. You won't get a better return. You won't pay less in fees. You will recieve more useless statements in the mail. You will not receive any benefit.


Rickson, that sounds about right

For a long hold, instead of holding three individual stocks (which you have posted elsewhere) why not put all of the money into one of SPY, DIA or QQQQ?


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## Germack (Apr 4, 2009)

Rickson9 said:


> There is no benefit. I don't know how else to say it. You won't get a better return. You won't pay less in fees. You will recieve more useless statements in the mail. You will not receive any benefit.


So you are saying the Capital Asset Pricing Model (CAPM) and Modern Portfolio Theory (MPT) are wrong? Both models recommend to hold a well diversified portfolio to reduce risk. Canada is a very small market, heavily weighted in banks and commodities. Therefore, I believe Canadians would strongly benefit from international portfolio diversification.


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## Rickson9 (Apr 9, 2009)

Germack said:


> So you are saying the Capital Asset Pricing Model (CAPM) and Modern Portfolio Theory (MPT) are wrong? Both models recommend to hold a well diversified portfolio to reduce risk. Canada is a very small market, heavily weighted in banks and commodities. Therefore, I believe Canadians would strongly benefit from international portfolio diversification.


CAPM and MPT are not accurate at all. 

99% of individuals believe in CAPM and MPT, which is why the 1% who do not, will continue to do well as investors.

http://blogs.wsj.com/marketbeat/2009/05/02/buffett-and-munger-stay-away-from-complex-math-theories/

http://www.travismorien.com/FAQ/portfolios/mptcriticism.htm

My wife and I have avoided CAPM and MPT to our benefit.


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## mogul777 (Jun 2, 2009)

The idea of diversification is to lower risk not to increase returns. The argument against it is that if you have conviction buys then why not go full in and not waste time and money buying a whole pile of stocks closer to the bottom of your buy list? Obviously option two is a high risk/high reward scenario and not suitable for some investors.


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## Germack (Apr 4, 2009)

On average diversification decreases risks and increases returns.

Ricksons9, I know it worked out for you but maybe you just got lucky. I can try to cross a busy highway blindfolded. Just because I made it to the other side does not make it a good idea.


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## Rickson9 (Apr 9, 2009)

Germack said:


> On average diversification decreases risks and increases returns.


Diversification does not decrease risk. If you know a company well it increases the risk to avoid it and buy everything else for diversification's sake. Diversification doesn't decrease risk - it is designed to compensate for lack of knowledge. Don't know what to buy? Buy everything.

Diversification definately does not increase returns.

The fact is, if diversification were sold as a hedge against ignorance instead of "decreasing risk", it wouldn't sell as many mutual funds.



Germack said:


> Ricksons9, I know it worked out for you but maybe you just got lucky. I can try to cross a busy highway blindfolded. Just because I made it to the other side does not make it a good idea.


Following diversification is definately like crossing a highway blindfolded. The results speak for themselves - nobody diversifies to the otherside to become wealthy.

It would be foolish of me to believe that I am the first and only person to become "lucky" by practicing value investing portfolio concentration. Generations of individuals from Ben Graham, John Maynard Keynes, Walter Schloss, Warren Buffett, Bill Ruane, Philip Fisher, Joel Greenblatt, Marty Whitman and many others have been far far "lucker" than I.

Individuals who diversify should hope that things work out, but they shouldn't expect it.

I should heed my own advice - the more people who believe in diversification (CAPM, MPT) the better it is for me. I should avoid speaking too loudly lest people actually listen. However, I strongly believe that individuals are born to believe in value investing portfolio concentration; that it can't be taught so I think I'm fairly safe.


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## humble_pie (Jun 7, 2009)

a problem i have with ETFs is that they cannot yield more than the relevant index. A way to overcome this is to own the ETF and sell options against it. As in sell OTM calls, an ultra-conservative strategy. And sell OTM puts, a riskier stategy that one can hedge by a) selling far-OTM strike prices and b) selling fewer puts than calls. The combination of these 3, long equity + short call + short put, is called a strangle.

in practice, i look for equities, whether stocks or ETFs, that trade in a long-term band. The option sales are poised at the extremities of the band. As time passes, these become an income stream that usually is taxed at favourable capital gains rates. In general i expect an annual yield of 10% or better merely from the dividend/option sales combo.

the investor needs highly liquid ETFs, as only these will have liquid option markets. The granddaddy in canada is XIU, but in my experience the montreal market makers/specialists - never generous on their spreads in the first place - are ultra-draconian on the ETFs. You'd think they used to be wardens in the lubyanka in the soviet era.

for several months now i've been buying transport, a few mining & ag, a few highly selected financial stox. Recently buying telcos for their high dividends, remote likelihood of bankruptcy, yield can easily be over 10% when combined with above-mentioned option strangle as an alternative conservative income-producing investment, now that fixed rates are close to nil.

for a USD telco i'll probably end up with ishares' IYZ ETF (dow telcos) plus option strangle. There are other USD telco ETFs but they're not liquid enough to support active options markets.

but what's for fun, donkey? a 100% ETF portfolio is short on fun, even if it's long on righteousness. Somewhere near you - where you live, where you work, where your family works - is a nifty little company with a quirky, human story. Buying a few shares will spice up those tombstone hieroglyphics.


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## Potato (Apr 3, 2009)

Rickson9 said:


> Diversification does not decrease risk. If you know a company well it increases the risk to avoid it and buy everything else for diversification's sake. Diversification doesn't decrease risk - it is designed to compensate for lack of knowledge. Don't know what to buy? Buy everything.
> 
> The fact is, if diversification were sold as a hedge against ignorance instead of "decreasing risk", it wouldn't sell as many mutual funds.


Diversification does decrease risk. I get Buffet's arguments about concentration and how much harder you research what you buy and how much more comfortable you must be with that with portfolio concentration, but you still need some minimum level of diversification as a hedge against ignorance, or being wrong. Because you can always be wrong (or you can be right, but a random act can change the circumstances and take it all away from you anyway), so you should never have more than you can afford to lose in any single company. 

For example, you could find a nice little company that has more cash on the balance sheet than they're currently trading for, with a decent business to boot. You see that their massive cash reserves are safely invested in "AAA paper" so you back up the truck. Then one day the news talks about the "collapse of the ABCP market" and you find out most of that "cash" stockpile has vanished... Or the CFO could be cooking the books... Or some wacko political group could organize a boycott of the whole company because some manager at a single branch said something mildly offensive that was taken out of context...

For me, I wouldn't be comfortable with more than 20% of my savings in any one company, no matter how much I liked it, which means that I'd diversify into at least 5 different companies (and in practice, more like 15-20). Granted, that's not the same level of diversification as index investing, but it will reduce risk.



> It would be foolish of me to believe that I am the first and only person to become "lucky" by practicing value investing portfolio concentration. Generations of individuals from *Ben Graham*, John Maynard Keynes, *Walter Schloss*, Warren Buffett, Bill Ruane, Philip Fisher, Joel Greenblatt, Marty Whitman and many others have been far far "lucker" than I.


Ben Graham?? He was big into diversification from what I remember, both in his portfolio and his love life! Schloss likewise owned hundreds of "cigar butts" at a time. 

Value investing != portfolio concentration. According to a value investor the _best_ way to reduce risk is to have a margin of safety, to stay within your circle of competence, to be exceptionally comfortable with what you're buying... but the value investors don't dismiss the value of diversification to also help reduce risk and protect them from imperfect knowledge.


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## Rickson9 (Apr 9, 2009)

Potato said:


> For me, I wouldn't be comfortable with more than 20% of my savings in any one company, no matter how much I liked it, which means that I'd diversify into at least 5 different companies (and in practice, more like 15-20). Granted, that's not the same level of diversification as index investing, but it will reduce risk.


5 different companies is similar to our own and I wouldn't consider that a diversified portfolio.



Potato said:


> Ben Graham?? He was big into diversification from what I remember, both in his portfolio and his love life! Schloss likewise owned hundreds of "cigar butts" at a time.


This is true. My mistake. Peter Lynch also diversified, however there is little choice once you run a billion dollars in a mutual fund.



Potato said:


> Value investing != portfolio concentration. According to a value investor the _best_ way to reduce risk is to have a margin of safety, to stay within your circle of competence, to be exceptionally comfortable with what you're buying... but the value investors don't dismiss the value of diversification to also help reduce risk and protect them from imperfect knowledge.


I never said that value investing = portfolio concentration so I'm not sure what the first sentance means. I did say, however that value investing with portfolio concentration is not believed by 99% of individuals; and also that it cannot be taught. The majority practice rabid diversification and experience mediocre results. This is the case and will always be the case.

"I was suffering from my chronic delusion that one good share is safer than ten bad ones, and I am always forgetting that hardly anyone else shares this particular delusion." - John Maynard Keynes

"I have owned one stock since 1969, two since 1988 and one I started buying in 1986 or so. That's my portfolio. Six stocks. I once owned 17, but that was way too much." - Philip Fisher

"The strategy we've adopted precludes our following standard diversification dogma. Many pundits would therefore say the strategy must be riskier than that employed by more conventional investors. We disagree. We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort-level he must feel with its economic characteristics before buying into it." - Warren Buffett

To me (and of course I can only speak for myself) diversification offers no benefit and is a huge negative to performance. Of course, the proof will always be in the pudding, so I hope those who diversify do well over the next 40 years. We can compare our results then.

PS: If investing in 15 different companies is "diversified" then investing in half a dozen index funds must be "overdiversified".


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