The Two Most Important Aspects of Portfolio Construction
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Most people think that security selection and dividend analysis is the most important thing when it comes to building a portfolio. However, research has proven that security selection is only a small piece of the larger puzzle. In the book The Only Three Questions That Count
The article is best summed up in the following statements:
What investors should be doing when panic is in the air is tuning out the market’s day-to-day distractions and focusing on multidecade goals. That means sticking to two basics: deciding what asset categories to own and finding ways to own them cheaply. [Emphasis mine]
That is good advice. My experience has shown that asset allocation is crucial in helping to manage my portfolio’s risk. Over the long term, my expectation is that my carefully chosen asset allocation will provide me better returns than the securities I hold. That means my balance of equities to bonds will provide me with similar returns as an all-stock portfolio, but with much less volatility. Please do not get me wrong, proper dividend analysis is crucial to making sure I don’t blow my brains out on any one selection. However, with enough stocks in enough sectors and with enough fixed income assets I will be much better protected to whether a downturn like the one we have been experiencing.
In addition, fees are equally important. My biggest beef with the rest of the Forbes article is that they suggest mutual funds and do not list the management expense ratios of the funds. They provide some sort of cost per $100, but I think that is a way to hide the real cost of the fund. In addition, they also list load funds which are a complete ripoff – there is a sales charge for the privilage of buying the funds. If you want to avoid individual dividend analysis and security selection, then choose low cost index funds and avoid the mutual funds, especially the ones that pay a sales charge to commissioned sales people.
So, when you are deciding on your portfolio strategy don’t jump right into the fun stuff of analyzing and choosing dividend growth stocks. Instead, step back and determine your asset allocation first and then determine the low cost ways to fill out that target allocation. Over the next 20 years, it will all pay off.
10 Comments on this post
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chiefie said:
i’ve been trying to resolve a question regarding asset allocation… perhaps you can help – if assets are in an rrsp… do you count the market value in the portfolio, or the estimated AFTER TAX value, as if it was cashed?
for example, if my all bonds are in an rrsp, current value 100k, 35% tax bracket… do i count on 100k bonds, or 65k bonds in my asset allocation?
thxJune 16th, 2008 at 11:07 am -
The Dividend Guy said:
Hi Chiefie – in my opinion, you need to look at the current value of any asset in your portfolio, regardless of taxes. I think about it in terms of risk – in your example you have $100,000 in bonds that are at risk.
Does that help?
TDG
June 16th, 2008 at 9:17 pm -
Bob said:
I agree keep the fees low and have some diversification in your portfolio.
With direct stock purchase plans I have built up over 279 shares in the following companies (BAC, CVS, DBD, GE, K, LBY, PEP, PFE, WMT, and XOM) while all of these might not have been great picks it sure is diversified. My per share cost is only .34 at this time and getting smaller with each purchase since some of the companies I invest in pay the fees for additional purchases. While in the last 8 months the portfolio is down $156 the calculated yearly dividend payout is at $284.31.I encourage anyone interested in direct stock plans to visit my web site where I have over 150 companies listed that offer DSPP.
Just opened the mail and got another .771571 shares in PFE with my DRIP account (fees paid ZERO.)
June 16th, 2008 at 11:52 pm -
Chad @ Sentient Money said:
Obviously, I agree with you on fees, that point is unassailable.
I do not in anyway agree with you or any of the so called “experts” on asset allocation. If an 80/20 stock/bond portfolio averages .5 to 1% less than 100% stock portfolio, but the 100% stock portfolio has more volatility it doesn’t matter. Why would you care about volatility unless you were 5-7 or so years from retirement or in retirement? If you aren’t planning on touching your money for at least 5-7 years or more, the total return is more important than volatility. Volatility is only important when you have to consider potential withdraws.
June 18th, 2008 at 10:18 am -
chiefie said:
Thanks for your reply TDG (re: RRSP allocation).
I see your point, though I’m still not convinced. My thinking is – there’s 100k bonds in the registered account, but I only “own” 65k, the balance belongs to the government. For asset allocation purposes, I feel I’m risking only 65k.
Is this logic wrong?June 19th, 2008 at 5:27 am -
Dade said:
I wanted to comment and thank the author, good stuff
March 14th, 2009 at 11:18 pm
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