The Ultimate Buy and Hold Portfolio

[Gigi]

My current portfolio is based on "The Ultimate Buy-and-Hold Strategy" written by Paul Merriman. A sample portfolio can be found here.

I'm using the ETF all equity porfolio:
10% S&P Depository Receipts (SPDR) S&P 500 (SPY)
10% Vanguard Value VIPERs (VTV)
10% I-Shares Russell Microcap Index (IWC)
10% Vanguard Small Cap Value VIPERs (VBR)
10% Vanguard REITs Index ETF (VNQ)
10% I-Shares MCSI EAFE (EFA)
10% I-Shares MSCI EAFE Value Index (EFV)
20% WisdomTree Int'l Small Cap Div Fund (DLS)
10% Vanguard Emerging Markets VIPERs (VWO)

There is a similar post regarding this here.

This is in a taxable account at Zecco. Because of the zero transaction cost, I can rebalance as often as I would like. For now I am only rebalance by adding funds. For example, REIT has been down lately so I added shares to it so it makes up 10% of my portfolio. I did not have to sell any gains to rebalance my portfolio because I have additional funds that I can invest.


Questions:
1) At one point (when I don't have enough cashflow to rebalance by only adding positions), I would need to sell gains to rebalance my portfolio to keep the risk-adjusted return high. How important is this rebalancing process considering I will have to pay taxes on my capital gains?

2) As Barron mentioned , you can lower volatility through hedging. Can this be applied given the portfolio I have, and if so, what is the easiest way about doing it?

Any other suggestions or input is appreciated.

[maxtower]

You'll probably get enough in dividends to help with the purchase only rebalancing, so that you can avoid taxes.

[TheMetetron]

[ QUOTE ]
You'll probably get enough in dividends to help with the purchase only rebalancing, so that you can avoid taxes.

[/ QUOTE ]

Yes set dividends to not reinvest and just divert them where necessary. Be sure to check regularly or you will end up leaving them sitting without earning interest.

Don't sell to rebalance, the taxes aren't worth it.

[DcifrThs]

well, for starters, save for REITs, the portfolio is entirely equity based.

in risk space, that puts about 91 or so % in equities.

the overall sharpe ratio of this portfolio is probably around .3 at absolute best. it can probably be around .35-.4 with hedging.

global markets are now more connected than ever so business cycles can be expected to be highly correlated. as a result, monetary policy has become highly correlated. the amount of diversification you gain from spreading equity allocations around the globe have been reduced drastically from historical levels.

your portfolio will do great in high growth, low inflation environments. the REIT allocation will add some value in low growth low inflation environments and high inflation low growth environments but only a very small amt of value b/c the risk share of that allocation is only about 9% (<10% relative to other allocations). further, it can probably be expected to be around 60% or higher correlated with the rest of your portfolio.

GIVEN all that, however, the portfolio isn't horrible from a practical sense.

i'd research what leveraged fixed income funds they have available. you have no allocation to fixed income and there is alot there that would improve your portfolio's efficiency & the leverage wouldn't sacrifice any (or not enough ) returns (to make alocation to them worthwhile).

so now you have 40% allocated to int'l funds.

the first step is determining how much exposure you have to currencies and which ones.

if the EAFE value index has the same proportions as the EAFE index, then i think those are all developed countries. if the allocation DOESN'T say "ex-us" i think that means that the US is included (but i'm not sure about this). if so then you don't have to hedge as much as you think and you don't get as much int'l diversificaiton as you thought (though as i've mentioned it isn't worth as much as you've thought either).

so you first determine what your allocations are to various exchange rates.

lets assume it is as follows (which it won't be but i'll take you step by step through this example):

20% GBP
20% JPY

the next step is determining what the volatility & correlation between the yen & pound are.

lets say it is 15% for the Yen and 20% for the pound and they are both 50% correlated to each other (may be different but i'll show this for simplicity).

in this case, the volatility from int'l FX exposure comes to 15.21% volatility (it would be 17.5% if you assumed 100% correlations).

since that allocation is only 40% of the notional value, you factor that in and come up with (in this case since the allocations are equal) 6.08% notional volatility.

so whatever the Amt you have in your portfolio, assuming all else is true, you take 6.08% of that and you have to hedge it accordingly. since transaction costs & marginal gains of hedging are inversely correlated. you only need to hedge 1/2 of that notional amt.

in this case, since the int'l FX proportions are 50/50 GBP & JPY and the vol's are 20%/15%, you have to hedge 57% of the 6.08%/2*Notinoal portfolio in GBP and 43% of 6.08%/2 in JPY.

this is available in the forward market through interactivebrokers.com i believe.

thats how you figure out what you need to hedge.

the spreadsheet gets way more complex, but doable for the entire int'l allocation.

these hedges should reduce the volatility you have allocated (as an add on exposure) to your int'l equities.

hope this helps.

Barron

[Gigi]

Thanks for the detailed reply. This is all very interesting and I have a lot of learning to do. Wish it was at simple as buying one fund.

[DcifrThs]

[ QUOTE ]
Thanks for the detailed reply. This is all very interesting and I have a lot of learning to do. Wish it was at simple as buying one fund.

[/ QUOTE ]

well those who do work will make more (and with compounding a ton more) than those who don't do the work.

i left out the risk calcs going from allocations to risk %s given correlations as those are not overly complex but hard to write out in html posting like this.

hope it helps though.
Barron

[Nomad84]

[ QUOTE ]
[ QUOTE ]
Thanks for the detailed reply. This is all very interesting and I have a lot of learning to do. Wish it was at simple as buying one fund.

[/ QUOTE ]

well those who do work will make more (and with compounding a ton more) than those who don't do the work.

i left out the risk calcs going from allocations to risk %s given correlations as those are not overly complex but hard to write out in html posting like this.

hope it helps though.
Barron

[/ QUOTE ]

The risk formulas can be found here.

I believe that website has enough info/equations to get you started.

[Jeff W]

[ QUOTE ]
if the EAFE value index has the same proportions as the EAFE index, then i think those are all developed countries. if the allocation DOESN'T say "ex-us" i think that means that the US is included (but i'm not sure about this).

[/ QUOTE ]

North America is not included in EAFE. EAFE stands for Europe, Australasia, Far East IIRC.

[Jeff W]

SPY and EFA are crappy. Link to ETF comparison for various asset classes.