Portfolio Management Trivia 101
The word portfolio was imported into english in the 1700s from the Italian word Portafoglio from porta – ‘To carry’ and foglio – ‘Leaf, sheet’. It only found its way into the world of finance in the 1930s, when all the investments and securities that an investor held were in paper form and most likely kept securely in a briefcase of some sort (or alternatively pasted on a kite as in Mary Poppins Returns!) . But it wasn’t until the 1960s that the concept of Portfolio Management was discovered and it took another decade for it to get any acceptance.
Before the 1960s, investors were basically punting on stocks, trying to determine which stock had the largest potential and was selling for cheap. No one, however, was thinking about risk. Portfolio Management revolutionised that. By calculating the riskiness associated with each type of investment, investors began to understand that Government bonds offered low returns but were extremely low risk. But stocks, on the other hand, offered high returns while also being high risk. And depending on an investor’s risk appetite and returns expectations he could choose a merry middle. So when the bears mauled the market and his stocks went south, the bonds would hold him up.
In simple terms, Portfolio investing is like betting on all the horses running the Melbourne Cup. You’re always going to win!
Here’s How we Went About Building our Portfolio
- Identification of Objectives & Constraints – This was an easy one. Of course our objective was to gain Financial Independence. We knew it would take a bit of time and we were definitely in it for the long run. Also, we weren’t afraid of any short-term volatility. On the contrary, we expected it and still continue to expect in the near future.
- Selection of Asset Mix – Because of our long term view, we decided to build a Growth Portfolio. As a rule of thumb, a growth portfolio will have 85% of the funds invested in stocks and real estate investments which are considered more risky while the remaining will be invested in less risky cash & bonds. ASIC has some great details on the different types of investment options, if you feel like getting into the weeds.
- Formulation of Portfolio Strategy – There are two types of strategies, an active one and a passive one. While both Mr. Fireball & I chose a passive one, it was beyond that that our paths diverged. The mister decided for an uninvolved passive strategy. He got himself enrolled with StockSpot as he was looking for an online investment adviser that would set up a portfolio for him without charging him a bomb in fees. I on the other hand chose to make it a more involved one and ended up opening an account with SelfWealth. I wanted to follow a more hands-on approach, while also minimising investment costs.
Pro Tip: An essential component of maximizing your returns is minimizing your investment costs. Did you know that over 30 years, an investor paying 3% in ongoing fees will lose more than half (Yes! Half!) of what their portfolio would have been worth had they not paid any fees at all.
- Security Selection – The going was easy for Mr. Fireball. He only had to choose which type of portfolio he wanted – High Growth, Growth, Balanced, Moderately Conservative or Conservative – which StockSpot had some fancy schmancy names for. But it wasn’t a difficult choice. He decided for Growth because he felt High Growth may be a bit too risky and thereafter StockSpot has been doing all the heavy lifting for him. I, on the other hand, have a more difficult time. I knew I wanted to invest only in ETFs because of the diversification that they offer, their low expense ratios and the ease of trading them like a stock. The bigger question was which markets & sectors should I invest in. After much research, I decided to take a cue from Aussie Firebug’s approach to taking exposure in the Aussie, US and Emerging Markets, which would make sure that I’m not overly reliant on one particular market. Below’s how I decided to slice up my portfolio:
- 20% in an Aussie broad-market ETF – I picked SPDR ASX 200 Fund (STW) for this, primarily because Mr. Fireball already had VAS in his StockSpot portfolio and STW was the largest sized fund at that time.
- 20% in a US focussed ETF – Even though it is not Aus domiciled, I decided on Vanguard US Total Market Shares (VTS), given its good performance in the past and extremely low management fees.
- 20% in Emerging Markets – Most Emerging Markets ETFs have higher management fees because it takes more active management for the fund and because the fund sizes are not as large. I chose IShares Asia 50 (IAA) because I wanted to get higher exposure in Asia and the fund had been around for more than 10 years.
- The remaining 20% in defensive assets like Bonds – For this I chose Vanguard Australian Fixed Interest (VAF) to not only be able to have exposure to Aussie Federal & State Bonds, but also to get some exposure to investment grade corporate issuers.
- Portfolio Revision – I’ve had to revise my portfolio a couple of times and it looks a bit different from what I started out with. And I believe I will have to continue to revise it as I go along.
- No Real Estate in the mix – I realized that we had no exposure to real estate to speak of. And given that the share market has been so volatile over the past year or so, I feared that there may not be enough to prop my portfolio up in case of any untoward incidents. So I decided to also invest in some real estate ETFs mid-way. I decided on SPDR Dow Jones Global Real Estate (DJRE). This was primarily because the Aussie real estate market was in a slump and I felt that having a more global real estate exposure would be better.
- Change in the Aussie ETF – After I bought into STW, I felt like it wasnt tracking ASX 200 as closely as the other Aussie ETFs. There were days when the market would be up and STW would be down. That struck me as very strange. But the turning point came when the other competing ETFs reduced their management fees considerably, while STW kept theirs high. And soon after they made a strange gaffe regarding Franking Credits which caused a huge sell-off. That sell-off was the last straw that broke the back of the camel. I decided to suspend further investments in STW and decided to move to IShares 200 ETF (IOZ).
- Glittery gold – I admit I gave into fear when it comes to gold. Around September 2019, when global market uncertainty and gold prices were at their top, I became afraid and decided to buy a gold ETF lest I die of FOMO. Since then, gold prices have gone up and down but I have decided to cease investing in gold and to stop giving into fear, until further notice.
Every time the share market goes significantly up or down, I’ve seen the moderating effect that my more defensive investments such as Bonds, Real Estate and to an extent Gold have on my overall portfolio. And boy do I sleep better on account of that…
Portfolio Management – Practically perfect in every way!