Portfolio Retrospection

As a long term investor, it is important to revisit and perform a portfolio retrospection from time to time. Normally investors tend to do this at the end of the year, but as long as you do it regularly (without overmonitoring/obsessing over it), its all good. Our needs, risk/reward profile etc change constantly as we mature and gain more experience as investors. What was once believed and held true can change in a matter of days or weeks. When the markets are going up and everyone is making money, it is easy to lose track and keep emotions in check. Or worse, apathy creeps in. But during market crashes, corrections and bear markets we realize that we should’ve been more careful and regret with some of our decisions.

Portfolio Retrospection

August saw some increased volatility in the stock market and the S&P 500 index dropped 10%. While this kind of correction from time to time is healthy for the overall market, it is important to be self-aware and reflect on the emotions/experiences. Year-to-date, the market is still trading pretty flat with the S&P 500 down just 2%.

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Building An ETF Portfolio

Regular readers of this blog are aware that we recently sold my wife’s expensive mutual fund holdings a couple of weeks ago. This has been long time coming and we finally got the funds transferred to a discount brokerage. Now comes the part of picking the ETFs. This article captures the exercise of building an ETF portfolio. Hope it helps you in your decision if you decide to go the route of passive investing.

The overall strategy remains as I mentioned earlier: my wife’s portfolio will use index funds via ETFs to invest in the broad markets using some rules of thumb in mind as discussed below. My portfolio will continue investing in more focused dividend growth stocks.

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Recent Sell – Mutual Fund

After being a goal for long time, we finally sold majority of my wife’s expensive mutual fund holding. The fund in question is Scotia Canadian Balanced Fund, which had an expense ratio of 2.04%. That number is nothing to sneeze at and the expenses pile up over time. More details on this below. Going forward, we will be balancing our portfolios better integrated so that we align closer to our combined goals.

Why Sell?

  • Expensive fund: The fund is extremely expensive at over 2%. Two percent is a large amount of money for what is simply an index tracking fund. To put things into perspective, for every $10,000 invested, that results in $200 per year. Over the course of next 30 years, that is $6,000. Now multiply that by every $10,000 invested in the fund and you will notice how the expenses can get out of hand!
  • Lack of diversification: Another important factor in selling this fund is the lack of diversification. The fund is invested completely in the Canadian market (55% in stocks and 45% in bonds). While the stock/bond diversification is good, we are exposed too highly to one country (Canada) and any recession or economic hardship hitting Canada will result in serious under-performance and loss of our hard earned money.

Investment Strategy

We will be using the cash from this sale to invest in index funds via ETFs. ETFs are a lot more inexpensive (its not uncommon to find a fund tracking S&P/TSX for 0.05%) and we will also be picking more than one or two funds to achieve some diversification in exposure to both stocks and bonds. We are also planning on keeping things simple so that my wife can maintain the portfolio going forward. Overall, the plan is to maintain a simple diversified index fund based portfolio in my wife’s account while I invest in individual stocks of blue chip companies.

In the coming days, I will be posting details of which funds we will be picking for the investment in this account. Stay tuned!

Top 10 Lowest Correlation Dividend Aristocrat Pairs

The following is a post from Ben Reynolds, who blogs at Sure Dividend
Those who have invested in Dividend Aristocrat stocks have done well in recent years.  Over the last decade, the Dividend Aristocrat Index outperformed the S&P500 by 2.88 percentage points per year.  Deciding which Dividend Aristocrat stocks to invest in goes beyond examining stocks individually.  Viewing investment decisions from a portfolio level helps investors to make better selections.



The current Dividend Aristocrat stocks cover a wide variety of businesses.  Businesses whose returns are dependent on different factors increase diversification better than businesses that are in the same field.  The more closely related a stocks returns are to another stock, the higher the correlation.  Stocks that moved exactly the same way every day would have a correlation of 1.  Similarly, stocks that moved exactly opposite each other every day would have a correlation of -1.  A correlation of 0 implies the stocks returns are not related at all; they come from different factors.

Dividend Aristocrats & Correlation

There are currently 54 Dividend Aristocrats.  Of these, 53 have price data going back 10 years or more.  AbbVie is the only Dividend Aristocrat that does not have a long price history due to its recent spinoff from Abbott Laboratories.  The average correlation coefficient of the 1,484 pairs of Dividend Aristocrat stocks with 10+ years of price history is high at .81. While the average is high, there are several stocks that exhibit very low correlation to one another.  The 10 lowest correlation pairs of Dividend Aristocrats are:
  1. .12 – McDonald’s & Medtronic
  2. .18 – Family Dollar & Medtronic
  3. .19 – Cintas & Nucor
  4. .21 – Consolidated Edison & Medtronic
  5. .24 – Leggett & Platt Co., & Nucor
  6. .25 – HCP, Inc. & Medtronic
  7. .27 – Family Dollar & Nucor
  8. .27 – Coca-Cola & Medtronic
  9. .29 – Nucor & Medtronic
  10. .30 – Sigma-Aldrich & Medtronic
There are several companies that recur repeatedly on the lowest correlated pairs list above.  Medtronic & Nucor in particularly come up over and over.  Medtronic has an average correlation to other Dividend Aristocrats of just .49.  Similarly, Nucor has an average correlation of .49 to other Dividend Aristocrats over the last 10 years.


Quality & Correlation

The correlation coefficient is a useful tool in determining what businesses to add to your portfolio.  The lower the correlation between a stock and your total portfolio, the higher the diversification gains will be.  Diversification is not the goal of investing.  I believe investing for long time periods in high quality businesses that have a history of rewarding shareholders through dividend payments will result in solid investment returns.  It is more important to find high quality businesses than it is to find businesses that are uncorrelated with one another. High quality businesses have strong competitive advantages that allow the business to grow earnings and dividends consistently and continuously.  These businesses are likely to have strong operational performance even during recessions. Given the choice between a portfolio of high quality businesses that are highly correlated to each other, and a portfolio of uncorrelated businesses that did not have competitive advantages, I would chose the high quality portfolio every time.  Once you have identified high quality businesses, then examine how well the business fits into your overall portfolio.


Where to Find High Quality Businesses

An Excellent place to find high quality businesses is the Dividend Aristocrats index.  A business that has paid increasing dividends for 25+ years either has or at one point had a strong competitive advantage.  I use quantitative rules backed by academic research such as The 8 Rules of Dividend Investing to further determine what businesses are likely to make sound investments over the next several years.



Minimizing correlation between your stocks will reduce portfolio standard deviation.  Standard deviation is not risk in itself; it is merely a proxy for risk.  With that being said, stocks with low volatility bounce around less, making it easier to sleep at night.  Even better, low volatility stocks have historically outperformed the market. A portfolio of high quality dividend stocks that seeks to reduce the correlation between each holding will likely provide capital and income appreciation in addition to the safety and peace of mind that comes with knowing you hold high quality businesses in a portfolio designed to reduce volatility.
About the Author:  Ben Reynolds runs the Sure Dividend which focuses on high quality dividend growth stocks suitable for long-term investing

The Importance of Diversification: Part 1

Talk to any investor or financial advisor, and the rule of thumb to protect your assets is: diversification. This is part 1 of a two-part series (part 2 available here) where I discuss the importance of diversification. In this post, we look at the importance of diversification in investments. There are various complex mathematical models to determine risks in investments, which are outside the scope of this article and blog. For a simplistic viewpoint of risk assessment from a diversification viewpoint, consider the following chart (Image source: Nasdaq) comparing the Portfolio RiskGrade and the Number of Stocks.
Risk Grade vs. Number of Stocks
Risk can be either Unique or Systemic. As most investors know, investing in a company comes with a risk of the company either going under or just losing value, which results in the investor losing part or whole of his/her capital. This is called Unique risk. While investors can preserve their capital and investment by picking better companies, it is almost impossible to find a good investment without any inherent risk; as the old adge goes “Without risk, there is no reward”. As illustrated in the graph above, studies have shown that risk can be mitigated by investing in as little as 12 companies, and close to elimination with approximately 50 companies.
Systemic risk may arise from common driving factors such as broad economic factors (for e.g., recessions), war, natural disasters etc. The broad markets move when such events occur. Note that even with a  globally diversified portfolio of stocks, there is still a risk-grade of 100 in the graph above. This is the systemic risk.

My ThoughtsWhen I consider diversification for my investments, I consider it on three different levels: diversification based on asset class; diversification by sector of the economy; and geographical diversification. Another old adage that investors should remember: “Never put all eggs in one basket”.

  1. Asset class diversification is important for investors as relying on one asset class such as stocks, bonds, real estate or commodities exposes risk immensely. Stock market crashes of the yesteryears remind us how investor’s fortunes were gained and lost.
  2. Sector allocation: Investors should try to mitigate risk by investing in all sectors of the economy. I current own 20 individual stocks and 5 funds, which provides me with pretty good diversification. However, I still do not consider my portfolio completely balanced as it is lacking in certain sectors of the economy and it is an ongoing project on getting that balance right. Once I get it to a state I want it in, I will be cycling through my holdings and investing additional capital in the relatively undervalued stock/fund.
  3. Geographical diversification: The type of diversification often overlooked by investors is the geographical diversification. A lot of investors believe in the mantra “invest in what you know”. This, I find is a double edged sword. Yes, it is good to invest in companies that you know well if you are familiar with the business model and know how the company actually runs and turns profits and if the company has good future prospects. However, it is important to not depend only on your local businesses, but invest globally – esp now that we have all the tools available at our fingertips making trades available and affordable. This way, any local disturbances such as recessions, wars, natural disasters will not take a toll on your investments and the risk is mitigated.
Our Portfolio
Our portfolio diversification as of Jun 2014

As things stand, our portfolio is not so bad on the sector-wise asset allocation, but geographical diversification is very skewed to our home country (Canada). This big skew occurred after my wife and I merged our portfolios and all of her investments were focused on the Canadian markets. As part of my 2014 goals, we intend to rebalance our portfolios with better diversification.

What’s Your Number?

I can think of a few finance bloggers who consider 40-50 stocks to be a number that makes them feel that their portfolio is well diversified. Dividend Mantra posted on this topic a couple of months ago where he makes the case for his portfolio to contain 50 stocks to achieve enough diversification. What are your thoughts? Do you have a number in mind? How many companies would you want to own before considering your investment portfolio diversified?Full Disclosure: My full list of holdings is available here.