Now that the bull market is over and we are facing the possibility of further market declines, what is the prudent thing to do? Rather than react to this fear driven market, consider how you are going to manage your portfolio over the next 20 to 25 years. For a starting point, assume you have a $100,000 portfolio. Scale this up or down based on your financial situation. With a portfolio this size and larger, I recommend breaking it down into several parts. The reasons will soon become evident.
Why break a portfolio into parts? Long-time readers of ITA Wealth Management have seen different investing models wax and wane over the years. By breaking a large portfolio into parts, one is diversifying and diversification seems to be one of the few “free lunches” in the investing food court.
Assume one breaks the $100,000 portfolio into five different parts. It could be four or six, but let us move forward with five different investing models. By using different models, we are diversifying right out of the starting blocks.
Model #1 is our passive portfolio. Consider this your Buy-Hold-Rebalance portfolio or an account similar to the Schrodinger. Since the other four models are likely to hold a higher percentage in equities, I suggest a stock/bond ratio to range between 30/70 and 60/40. Lower exposure to equities if you are retired. Keep in mind that plenty of exposure to equities will be available in Models 2 through 5.
One major disadvantage of this passive model is that there is little one can do to protect capital in a down market. That is why I lean toward the conservative side such as 40% in stocks and 60% in bonds. Protection of capital is another reason for portfolio diversification as explained in the following investing models.
Invest the second $20,000 of the $100,000 portfolio using the Dual Momentum (DM) model. A few months ago I was nearly ready to give up on the DM model. Then the Cordid-19 virus showed up and this model recommended moving from equities (VTI) into the TLT treasury bond. The timing was nearly perfect. Three portfolios here at ITA follow this model. The Galileo is one example. I just checked and the Galileo is outperforming the S&P 500 by nearly a factor of six (6) when the starting date is 4/30/2017, or when I first began using the Investment Account Manager portfolio tracking software. And that does not include 3/12/20 information for the S&P 500.
The next three models are not quite so clear cut as the first two. Some investors might wish to concentrate on models 1 and 2 and be satisfied.
Model #3 moves into the inner working so the Kipling spreadsheet. For this model, I recommend setting the investing system to LRPC and then making a decision whether or not to turn on the Target Filter. Were we to use six different models, for one LRPC portfolio I would switch on the Target Filter and for the other portfolio I would turn it off. Since we are in a volatile market, for this model I suggest turning on the Target Filter.
The most difficult decision required of an investor with this model, is – what ETF arrows to use to populate the investment quiver? A start is to use the ETFs identified in the Rutherford portfolio. Another option is to use all or a portion of the ETFs found in the Schrodinger portfolio.
Model #4 also comes out of the Kipling and it is the BHS investing option. With this model, turn on the Target Filter, particularly when the market is roiling. The combination of the BHS model with the Target Filter set to Yes provides the fastest responding portfolio. These settings are in contrast to Model #1 where we have no way to protect capital. In a later post I’ll go into more detail, but most ITA readers are well aware of how the combination works.
Model #5 identifies itself as in this BHS model we turn the Target Filter off. The only difference between #4 and #5 is the position of the Target Filter. Should the owner of these portfolio want further diversification, select a different investment quiver.
To protect capital, and something I failed to do when we took a recent road trip, is to set Stop Orders or Trailing Stop Loss Orders (TSLOs) using volatility recommendations built into the Kipling spreadsheet.
There you have my recommendations as to how to diversify a large portfolio into smaller parts. By working with smaller amounts of money, it is also easier to fill orders. While there is some evidence that end-of-month portfolio rebalancing has performance advantages, one can spread out the portfolio reviews to make life a little easier.