Small Trades Journal

Portfolio Visualizer is a highly rated online tool for designing investments (ref. 1). I used it to backtest the model portfolios listed in the following chart:

Legend: The top row shows the trading symbols of six index funds selected to build the model portfolios in rows 2-5.  The portfolios were backtested from December 2018 to January 2010.  $1.00 was initially invested in each portfolio and allowed to grow in value to the final balances shown in the righthand column.  The performance benchmark is Standard&Poors 500 TR Index in row 6.

Four-sector models in rows 2-4 represented diversified investments in stocks (VT, VTI), real estate investment trusts (VNQ), investment grade U.S. bonds (AGG), and gold bullion (GLD).  Several observations:

• Four-sector models outperformed the bond market as determined by comparing their balances to the $1.32 that would result from investing only in AGG.
• Portfolio performance was affected by the percentages of the index funds. The final balance of  four-sector models increased with the total percentage of stocks (VT, VTI) and real estate (VNQ) investments. 
• Four-sector models underperformed the benchmark.

The one-sector model in row 5 held diversified investments in U.S. stocks. SCHX is a proxy for U.S. large-cap stocks and VTI is a proxy for all U.S. stocks. Among models, only the final balance of this model surpassed that of the benchmark in row 6.

Applications

Four-sector models are ideal portfolios for making short term investments of 1-5 year time periods. The goal of four-sector models is to improve safety by reducing the downside risk of investing in one sector.

The one-sector model of diversified U.S. stocks is ideal for making long term investments of 10 or more years.

Plan

Last year’s SmallTrades Portfolio, in 2018, was a four-sector portfolio that underperformed the benchmark.  In 2019, the new SmallTrades Portfolio will hold a group of actively managed stocks plus the passively managed Schwab U.S. Large-Cap ETF (SCHX). The initial allocation will be 20% stocks and 80% SCHX.

Thesis: SCHX is designed and tested to match the performance of the benchmark. Successful management of the stocks will raise the portfolio’s total performance above that of the benchmark.

References

1. Vikram Chandrasekhar, 2016.  What is the best tool to backtest a portfolio online?

Math

The total return of a portfolio is estimated by the following formula:

R_T = aR_A + bR_B+ cR_C + dR_D

For example, what is the estimated total return for the following portfolio?;  

25% VT + 25% VNQ + 25% AGG + 25% GLD

• a, b, c, and d = 0.25.
• R_A = 7.19%, R_B = 10.21%, R_C = 3.13%, and R_D = 1.37%.
• R_T = 0.25*7.19% + 0.25*10.21%+ 0.25*3.13% + 0.25*1.37% = 1.80% + 2.55% + 0.78% + 0.34% = 5.47%

By comparison, the Portfolio Visualizer  reported R_T = 5.93% with a final balance of $1.68.  

Copyright © 2019 Douglas R. Knight 

This entry was posted on Wednesday, January 23rd, 2019 at 12:35 pm and is filed under do-it-yourself investing, exchange-traded fund (ETF), Portfolio, Stocks. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.