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SDec 23, 2003

Changing The Mea Culpa Portfolio: Going ETF

Scott Burns
It's confession time again.

For several years I've ended the year with a report on what I did with a small investment account. The original idea was to invest in a portfolio of individual stocks and hold them long enough to make me a proverbial 'malefactor of great wealth.'

Well, it's not so easy.

I ended last year with the conclusion that investing in individual stocks was for the birds--- the account had, more or less, done as well as the S&P 500 index but took a lot more effort. As a result, last year ended with 40 percent cash, 60 percent equities.   The equity money was divided between two remaining individual stocks, Bristol Myers and Schwab, plus shares of the Russell 2000 Value Index iShares (IWN) and Russell 1000 Value Index iShares (IWD). I had purchased the exchange traded fund shares to reduce volatility. I planned to sell both Bristol Myers and Schwab during the year.

I did. I hung on to the Schwab shares until Schwab announced it was going to discontinue its contribution to the employee 401(k) plan. I know that was a tough decision for them, but I don't think it sets a good example and I don't want to make my return on the backs of Schwab employees. Schwab is off my "Most Admired" company list.

It was similar with Bristol Myers. If any company would benefit from the 15 percent tax rate on dividends, I had thought, it would be Bristol Myers and its 4.6 percent yield.

Wrong.

I sold the shares (with a nice gain from the 1993 purchase) when it was clear lower taxes weren't going to move the stock.

The sale proceeds, along with any other cash, were invested in Vanguard Total Market Index. So I've had a good year--- the Russell 2000 Value Index shares were up 39 percent for the year as of December 10th and the other shares had done somewhat better than the S&P 500 which had, in turn, done better than 72 percent of its competing managed equity funds. I'm ending the year with shares of Vanguard Total Market Index, iShares Russell 1000 Index (note that I've sold the 1000 value index shares), and iShares Russell 2000 Value index. So I'm 100 percent invested in domestic equities, with a slight over weighting of smaller stocks.

I'm full time couch potato.

Well, kind of.

In September I described how I had opened a brokerage window in my Fidelity 401(k) account and how I had used a combination of Fidelity Spartan Index Funds and Exchange Traded Funds to reduce expenses.   (Trading thru a 401(k): Tuesday, September 30, 2003:  http://www.dallasnews.com/business/scottburns/columns/2003/stories/100103dnbusIQburns.8c1be.html )   The idea was to get out of the portfolio manager selection game. I wanted to commit, 100 percent, to raw asset allocation--- and to do it across all my accounts.

Here are the results:

•  Fixed Income. A bit less than 20 percent (17) is committed to cash and TIPS (Treasury Inflation Protected Securities) by way of the Fidelity fund that invests in same. Like 2003, I expect 2004 won't be a good year for fixed income investing. TIPS are likely the best choice because the return will ratchet up with the official inflation rate.

•  Domestic Equities. A bit less than 40 percent (38) is committed to domestic equities in a variety of index funds: Fidelity and Vanguard Total Market, Russell 1000 shares and iShares S&P 500 index shares, along with the Russell 2000 Value index holding. Why so many? Different account sizes dictate slightly different purchases.

•  Foreign Equities. A bit over 20 percent (21) is committed to foreign equities. Most of this is in Fidelity Spartan International Index fund, which clones the broad MSCI EAFE index. A portion is in Scudder New Asia fund (SAF), a closed end fund. It sells at a discount to net asset value and serves to enlarge the commitment to Pacific Rim investments. The Asian investments in the MSCI EAFE index are dominated by the size of the Japanese stock market. Foreign equities did much better than domestic stocks this year but are, I think, only an even bet for 2004.

•  REITs. A small collection of Real Estate Investment Trusts (about 7 percent of assets): Equity Residential (EQR), Plum Creek Timber (ticker: PCL), and Apartment Investment and Management (AIV). Plum Creek is unusual. It invests in timber properties and wood is another commodity likely to provide inflation protection. Equity Residential is the largest apartment owner in the country. Apartment Investment and Management is a large apartment owner attempting a turnaround. Apartments have been overbuilt but they provide relatively low cost housing. Long term, I think many of the boomers will discover that their biggest asset is their home equity. They will sell and increase the demand for apartments. Near term, REITS are likely to be a source of income, not capital gains.

•  Oil. A small collection of major oil companies (about 8 percent of assets): Exxon Mobil (XOM), BP (BP), Royal Dutch (RD), and Petrochina (PTR). The analysis here was simple: find companies that have the largest oil and gas reserves. Buy them in different parts of the world. With the stellar exception of Petrochina, oil companies haven't done very well in 2003. Global energy production and distribution, however, are stretched to the max. If there are ugly surprises in 2004, I think they will come from the energy sector.

•  Gold. Another small collection (about 9 percent of assets), this time selected by buying the three largest domestic companies: Newmont Mining (NEM), Barrick Gold (ABX), and Placer Dome (PDG). I'm not a gold bug. This is the first time since the late 70's that I've invested in gold. The bipartisan spending crew in Washington, however, requires insurance against paper money.

•  Finally, I own one individual stock (about 1.5 percent of assets). It is Barclays ADRs (BCS). The London bank sells at a P/E of 14 and a yield of 3.6 percent. While their Barclays Global subsidiary contributes only a small amount to company earnings, this group is likely to dominate the rapidly growing Exchange Traded Fund market. ETFs are the mutual funds of this century.

You can slice this portfolio quite a few ways. Added in the traditional manner, it is 17 percent fixed income, 7 percent REITs, and 76 percent equities--- a fairly aggressive portfolio. It could also be added another way: 60 percent equities and 40 percent fixed income or dollar substitutes like TIPS, real estate, timber, oil, and gold. However you slice it, it is very diversified, promises low portfolio turnover, and has an average "expense ratio" of about 20 basis points.

That gives me a running start of at least 1 percent a year over professional managers.  

Filed Under: Income Investing