Thursday, June 10, 2010

Portfolio 6 Update

In my May 8 post, Implementing Portfolio 5: A Current Example, I discussed a plan for a particular investor to migrate from a simple portfolio to a more complex portfolio (more asset classes). This is an update on the execution of that plan (you may want to scan the May 8 post before reading this post). Since the allocation is slightly different than Portfolio 5, I’m renaming this portfolio Portfolio 6. If you need a refresher on stock asset classes (e.g., large-cap, small-cap, growth, blend, value, international, etc.), please read my January 2010 post, Asset Allocation: Part 2.

Keep in mind that this is a fairly complex portfolio, and that the investor is taking a very active approach to building the portfolio. This approach probably is not suitable for most investors, but is being presented for those who might be interested in dealing with the additional complexity. The most important point is that the investor has made decisions on how to proceed, and is taking action to execute her plan.

The investor decided to include REITs in her asset allocation, so for the US stock allocation (60% of stocks), we set a target allocation of 12.5% (of the US stock allocation) for each of the four new US stock asset classes. Since the investor already owned the Vanguard Total Stock Market Index fund, no new fund was required for the Large Blend asset class. The target allocation among US stock asset classes is shown below (the ETF or index fund used for each asset class is in parentheses):

  • Large Blend: 50% (Vanguard Total Stock Market Index fund – already owned)
  • Large Value: 12.5% (Vanguard Value ETF)
  • Small Blend: 12.5% (Vanguard Small-Cap ETF)
  • Small Value: 12.5% (Vanguard Small-Cap Value ETF)
  • REIT: 12.5% (Vanguard REIT ETF)

For the international stock allocation (40% of stocks), the investor decided on the following target sub-allocation:

  • Developed Markets: 65% (Vanguard Total International Stock Index fund)
  • Emerging Markets: 20% (Vanguard Total International Stock Index fund)
  • International Small-Cap: 15% (Vanguard FTSE All-World ex-US Small-Cap ETF)

Since the investor already owned the Vanguard Total International Stock Index fund, no new fund was initially required for the Developed Markets or Emerging Markets asset classes (Vanguard Total International has about 75% Developed Markets and 25% Emerging Markets). In the future, Developed Markets or Emerging Markets ETFs may be required to adjust the balance.

Roth IRA

We opened the Roth IRA Vanguard Brokerage account as planned. Since the investor already had a Roth IRA mutual fund account at Vanguard, it only took a few minutes to open the brokerage account online. The investor made an initial 2010 contribution of $2,000 to the Roth IRA money market fund, and we started purchasing shares of the five ETFs (listed above in the bulleted lists). The investor decided to gradually build her positions in the new asset classes, and to buy shares more aggressively if the market declined.

After buying a few shares each of the five ETFs, limit orders were entered to buy more shares if share prices declined -- 1 additional share of each ETF for each 1% decline in share price, down to –5%. It turns out that this was just before the start of the recent correction, so these orders were quickly filled. Additional shares were purchased as prices declined further. We have been setting limit orders 2%-3% below the current share prices, and thanks to the correction, have continued to buy shares at lower prices.

Additional contributions were made to the money market fund to enable additional purchases. A total of $4,000 has been contributed to the IRA so far (out of $5,000 allowed for 2010), and about $3,500 of that has been used so far to purchase the ETFs. The investor is about half way to the target allocations for the new asset classes. Further market declines would be welcomed as opportunities to buy more shares at lower prices.


In mid-May, the investor began making contributions to her 401(k) plan through payroll deductions. Contributions are made to a stable value fund (similar to a money market fund), with the intention of informally value averaging into the S&P 500 index fund (large blend).

As mentioned in the May 8 post, in the 401(k), the S&P 500 index fund is the only low-cost index fund that fits well with the desired asset allocation. However, since the current allocation to large blend is already above target, our strategy is to sell some of the Vanguard Total Stock Market Index fund (also large blend) in the Roth IRA on market advances -- roughly offsetting purchases of the S&P 500 index fund in the 401(k), and providing more cash for additional ETF purchases in the Roth IRA. This is essentially transferring part of the large blend asset class position from the Roth IRA (where good funds for the other asset classes are available) to the 401(k) (where only the one good fund is available).

So far, $550 of the S&P 500 index fund has been bought in the 401(k), and $550 of the Total Stock Market Index fund has been sold in the Roth IRA.


The tactics used here are not necessarily the most rational, and would not be appropriate for many investors due to the effort involved. Theoretically, the most rational approach would be to immediately establish the target asset allocations, invest all available money now, and invest additional money as it became available. For example we would immediately sell enough of the Total Stock Market Index fund in the Roth IRA, and buy enough of the ETFs to get the asset allocation to target levels. Then, additional 401(k) contributions would be made directly to the S&P 500 Index fund, and we would periodically re-balance the portfolio to target allocations.

One benefit of the approach used here is psychological: it is training the young investor to embrace market declines as opportunities to buy more shares at lower prices. We just happen to have lucked out and started this process shortly before a market correction. If the market begins a sustained move higher, the investor will continue to add to her positions, but at a slower pace (consistent with the value averaging strategy).


  1. Ok, so when should the investor think about getting REITs? I thought you said this wasn't the smartest choice...

  2. I would recommend considering REITs when your portfolio is big enough so that you can invest 10-15% of your stock allocation in a REIT fund. This means that there has to be a REIT index fund or ETF with a minimum investment that is less than 15% of your stock allocation, and if it's an ETF there should be a very low or no commission to buy it.

    In your case there was no REIT option that met these criteria when we designed your portfolio. Since then, Vanguard has stopped charging commissions to trade its ETFs, and they have a REIT ETF, so there's now a good REIT choice for small investors. It may be possible to work this into your portfolio if you want to do so.