ETF Choices

These are the ETFs that I am going to focus on for now.

	Ticker	Family	Name
1	EFA	ishares	MSCI EAFE Index Fund
2	EWJ	ishares	MSCI Japan Index Fund
3	GLD	statestreet	SPDR Gold Shares
4	IEF	ishares	Barclays 7-10 Year Treasury Bond Fund
5	IWB	ishares	Russell 1000 Index Fund
6	IWM	ishares	Russell 2000 Index Fund
7	RWX	statestreet	SPDR Dow Jones International Real Estate ETF
8	TLT	ishares	Barclays 20+ Year Treasury Bond Fund
9	VNQ	vanguard	REIT ETF
10	VWO	vanguard	MSCI Emerging Markets ETF
11	SLV	ishares	Silver Trust

The US stocks segment is split into large cap stocks based on the Russell 1000 index (IWB) and small to medium cap stocks based on the Russell 2000 (IWM) index.

Foreign stocks are split into Europe, Asia and Far East (EFA), Japan (EWJ), and emerging markets (VWO).

Bonds are split into mid-term bonds (IEF) and longer term bonds (TLT). Later I will consider whether to use short term bonds (SHY), or a money market account to hold cash.

Real estate is split into US REITs (VNQ) and international REITs (RWX).

Commodities are split into physical gold (GLD) and physical silver (SLV). I'll have more to say later about alternatives, for example exchange traded notes that track a commodities based index, such as DBC.

My Reasoning For Choosing These ETFs

Each of the equity and bond ETFs are based on broad indexes, which provides diversification within that asset type. The exception being GLD and SLV, which concentrate on gold bullion and silver bullion. Each ETF covers a different portion of the economy and hopefully react differently and at different times to changing economic conditions. Therby giving me a second layer of diversification, ie across asset types.

I'll dig deeper into the math of why this is beneficial next time.

Disclaimer

I own EFA, VWO, GLD, SLV, RWX, VNQ, IEF, SHY at this time, and could buy and sell at any time.

Introduction

To paraphrase an ironic curse: May you invest in interesting times.

This has indeed been true over the past ten years. An investment in a S&P500 index fund ten years ago has returned a total of 50% over the past ten years (including dividends), which works out to 6.2% annually. Not only that, but you suffered through a decline in value from the peak in October 2007 to the bottom in March 2009 of over 50%. Only now would your investment have fully recovered back to that peak.

For those who have a lifetime of earnings ahead of themselves, constant and disciplined periodic savings over many years may overcome the severities of the market. However for those of us much closer to retirement, capital preservation becomes an overriding concern.

Consequently, my investment goals now include:

• the need for greater diversification, beyond just a mix of stocks and bonds, into other types of assets;
• diversification within each of those asset types;
• the need to know when to overweight or underweight a particular asset, or to stay out of it entirely;
• a way to reduce the maximum loss of the portfolio;
• and maybe a way to squeeze out a couple of extra percentage points in the annual return.

That's not asking too much, is it?

Fortunately, what has become known as tactical asset allocation and the widespread use of exchange traded funds would seem to meet that need.

Over the rest of the winter, I will use this blog to discuss how I built such a portfolio. Keep in mind that this is just one investment strategy, and one approach. Learn from it if you wish.

Basically, I use exchange traded funds (ETF's), which are highly liquid, passively indexed, well diversified with respect to themselves. Limit the choices to a broad selection that covers many asset types. Select those that have performed the best amongst that small subset. Rebalance periodically. Adjust the size of the positions as to control volatility of the portfolio. I will also consider putting in a floor of some kind under each investment to control losses.

There are many choices at each step, avenues to research and experiment with, and decisions to be made. I will start by discussing the following questions in the next few posts:

• What is an ETF?
• Who are the largest providers?
• What assets are available in an ETF?
• Which assets should I invest in? Compare this to the institutions, endowments, and target date mutual funds.
• Of so many similar sounding ETF's, which ones to use?
• Risks of ETF's – there are some, believe it or not
• Biases – Hindsight and other animals
• Start with a simple equal weighted portfolio of say, 5 or 10 ETF's and see how that would have performed over the past ten years.

Preface

Intended Audience

Hopefully anyone can find something to take away from this discussion. I start from the simplest portfolios and add more sophisticated layers while building upon more advanced concepts. You may choose to incorporate any level that is compatible with your level of risk, understanding of the concepts, and how much time you choose to devote to managing your portfolios.

How is this different from other similar approaches

Tactical asset allocation has been a significant development over the past several years, although many aspects related to creating such a portfolio has been researched over the past twenty to thirty years.

The focus is strictly on building well-diversified portfolios of exchange traded funds. Starting with a variety of ETF’s that cover most asset types, I gradually add more sophisticated layers. Some easy to implement, and others maybe not so easy. I will explain each layer as I add them.

Some of the layers I investigate, may be found in the academic literature, under the such concepts as endowments, institutional management, sector rotation, global asset allocation, momentum trading, as well as Capital Asset Pricing Model, the efficient frontier, and mean-variance strategies.

In addition, I will track a real money portfolio at here at this website: mostlyquant.com. I have staked my retirement savings on these ideas discussed on this website.

Necessary Caveats

Let’s get the usual disclaimer out of the way.

As with any investment, there are risks. Any investment may fall in price at any time, seemingly for unfathomable reasons. Anything contained within must not be construed as individual advice. Only you can determine the appropriateness of any particular investment or strategy.

I may buy, sell, hold any security mentioned within, at any time.

Who am I

I have a BS in Math from University of Illinois at Urbana-Champaign, and a MBA from University of Illinois at Chicago. I’ve been a programmer, a systems analyst, a bookstore owner, and a lifelong investor.

I have been around long enough to watch the 1987 crash from the visitor gallery above the Mercantile Exchange floor; convert busted Savings and Loan institutions into a larger bank in the late 80’s; sold off stocks leading into the tech bubble in the late 90’s; and sat anxiously by as the housing bubble burst most recently, and three rounds of quantitative easing so far have kept that last shoe from dropping.

Securing a comfortable retirement should not depend upon getting lucky a few times in your life. Tactical asset allocation is a way to tweak a passive indexing approach while at the same time hopefully limiting the downside risks that has become such a part of life lately, and maybe adding a couple of percentage points extra return on top of a buy and hold strategy.

That is the goal. I hope to share what I have learned, and the decisions I have made to enhance a tactical asset allocation strategy.