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My model portfolio of exchange-traded funds (ETFs) lagged the market slightly in the fourth quarter. Given the risk I see in the market, I may lag again in the coming year if stocks continue to climb.
When I closed the books on Dec. 21, the portfolio showed a gain of 6.6% in the fourth quarter, just behind the 6.9% advance of S&P 500 Depositary Receipts (SPY, news, msgs), commonly called Spiders, which serve as a proxy for the market. For the year the portfolio was up 13.2%, behind the 15.6% advance for the market.
I lagged because I was very cautious during the year, especially in the third period. And if the market manages a repeat in 2007, which is very possible, I'll probably lag again. That's because I think there's just too much risk in this market, which has been rallying for four years without a significant break.
"My guess is that next year will be an OK year. We'll be mostly up 'til late spring or summer, then have a decent correction; that's the scenario I'm operating on," says Sheldon Jacobs, editor of the No-Load Fund Investor newsletter.
So I'm damping down risk in the model. I'll remain heavily committed to equities -- they account for 73% of the portfolio as it enters the new year -- but they're a bit tamer than those I held in the fourth quarter.
Here's how the portfolio looked when it finished the quarter:
| Holding | Shares | Price | Value | Weight | 3-month gain | YTD gain |
|---|---|---|---|---|---|---|
271 | 141.61 | $38,376 | 27% | 6.9% | 15.60% | |
323 | 43.38 | $14,012 | 9.8% | 7.3% | 8.10% | |
298 | 77.62 | $23,131 | 16.3% | 5.9% | 17.70% | |
83 | 101.58 | $8,431 | 5.9% | 14% | 17.20% | |
315 | 72.67 | $22,891 | 16.1% | 8% | 24.70% | |
140 | 100.6 | $14,084 | 9.9% | 1% | 4.20% | |
97 | 98.83 | $9,587 | 6.7% | 6.6% | 38.10% | |
Schwab Investors MMF | 11,822 | 1 | $11,822 | 8.3% | 1.2% | 3.80% |
$142,334 | 100% | 6.6% | 13.20% |
Source: MSN Money
(Note: I made errors in the report on this model at the end of the third quarter, including claiming a holding in iShares MSCI Emerging Market Index Fund (EEM, news, msgs), which in fact the portfolio sold at the end of the second quarter. That column has been corrected, and the information in this column reflects the corrections.)
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While I'm not expecting anything disastrous to occur in either the stock or bond markets, I do think it's prudent to ramp down on risk a bit. Specifically, I'm going to trim back my exposure to real estate and become a shade less bold among my domestic stocks. I'll use some of the proceeds to increase my foreign equity exposure a bit, and hold the balance as cash.
Playing defense
Here is how I'll implement these ideas:Big-capitalization domestic stocks have begun to catch up with red-hot small caps, and last quarter I boosted my allocation to this group. S&P 500 Spiders now account for 27% of the portfolio.
I'm going to switch a portion of that allocation, however, into a more conservative fund, PowerShares FTSE RAFI US 1000 (PRF, news, msgs). Stocks in the spider are weighted according to their market capitalization: ExxonMobil (XOM, news, msgs)accounts for 3.2% of the index, while the merely huge Wal-Mart Stores (WMT, news, msgs) gets 1.1%.
The PowerShares fund, nicknamed Footsie 1000, follows an index where stocks are given the most weight based on four fundamental factors: sales, book value, cash flows and dividends. ExxonMobil gets a slightly smaller weighting, 3.0%, and Wal-Mart gets slightly more, 1.4%.
The ultimate effect is that Footsie 1000 falls into Morningstar's value category, whereas the Spider owns more growth stocks and fits into the blend category. Value is synonymous with defensive, and that's what I'm becoming.
So I'm selling 135 shares of Spider and buy 330 shares of Footsie 1000. My commitment to big-cap stocks is the same, but risk is dialed down a little.
Small stocks are even riskier than big ones, so I'm cutting iShares Russell 2000 back to 10% of assets. I'm selling 99 shares.
One very small sale will be 26 shares of iShares Cohen & Steers Realty, which cuts this portion of the portfolio's income component to 5% of total assets. This fund is up 38.1% this year, and this is the sixth year in a row of 20%-plus returns for real estate stocks.
"Real-estate valuations were dicey in 2006, and at the beginning of 2007 we see them in pure silly season," says Christopher J. Cordaro, chief investment officer of RegentAtlantic Capital, an investment advisory firm in Chatham, N.J.
I'm going to redeploy some of this money into iShares MSCI EAFE Index, buying 78 shares to bring it up to 20% of assets.
The result of these purchases and sales is that the cash component of the portfolio has increased to $17,378, which is 12.2% of total assets. Money market funds currently are paying returns that make bonds look anemic, so I'm not increasing my 10% allocation to iShares Lehman Aggregate Bond Index.
Schwab Investors Money Market Fund, where I park my cash, is currently yielding 4.82%.
As it enters 2007, the portfolio looks like this:
| Holding | Shares | Price | Value | Weight |
|---|---|---|---|---|
| S&P 500 Spiders | 136 | 141.61 | $19,259 | 13.5% |
| PowerShares FTSE RAFI US 1000 | 313 | 57.84 | $18,097 | 12.7% |
| Nasdaq 100 Trust | 323 | 43.38 | $14,012 | 9.8% |
| iShares Russell 2000 | 199 | 77.62 | $15,446 | 10.9% |
| iShares Goldman Nat Resources | 83 | 101.58 | $8,431 | 5.9% |
| iShares MSCI EAFE | 393 | 72.67 | $28,559 | 20.1% |
| iShares Lehman Aggregate Bond | 140 | 100.6 | $14,084 | 9.9% |
| iShares C&S Realty | 71 | 98.83 | $7,017 | 4.9% |
| Schwab Investors MMF | 17,371 | 1 | $17,378 | 12.2% |
$142,283 | 100.00% |
The model portfolio ended 2006 with a gain on the year of 13.2%. Since it was launched in November 2003, it has advanced 42.3%, which is an annual average of 12.2%. In the same period, the average moderate-allocation mutual fund, which the portfolio most closely resembles, has gone up 32%, or 9.4% annually. The market, as represented by Vanguard 500 Index Fund (VFINX, news, msgs), has risen 41.6%, or 12.0% annually.
The Grinch was seen galumphing around Wall Street last week -- on Thursday alone, the Dow dropped 42.62 points -- but I don't give that any weight. Institutional investors do stupid things in December to make their portfolios look good for the annual report. January is typically a strong month and, historically, the third year of a president's term has also been good.
Happy new year.
(Note: PowerShares FTSE RAFI US 1000 (PRF, news, msgs)closed at $57.84 a share on Dec. 21, not $54.84 as reported at the time. Therefore, the new portfolio should hold 313 shares, not 330. The cash residual should be $17,371, not $17,378.)
At the time of publication, Tim Middleton didn't own any securities mentioned in this article.
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