Once again, the SmallTrades Portfolio failed to outperform the Standards & Poor 500 TR Index ('benchmark'). In 2019, I will replace five exchange-traded funds (ETFs) with a single ETF.
The SmallTrades Portfolio is actively managed within a tax-protected Roth IRA. No cash has been added or removed from the account since the time of inception in 2007. Figure 1 describes the portfolio and its investment strategy:
The following strategies are used to earn capital gains:
- The passive strategy is to collect dividends and capital gains from exchange-traded index funds (ETFs). Each ETF is ‘passively’ managed to match the performance of a market index rather than ‘actively’ managed to outperform or underperform a market index.
- The swing strategy is to buy the stock at a low price (‘bargain’) and sell it at a high price, however long the price-swing happens to occur.
- The growth strategy is to purchase a reasonably priced stock and hold it until the company stops growing over several-to-many years. The stock price should increase with the company’s profit.
- The drip strategy is to buy a reasonably priced stock to collect dividends and reinvest them in additional shares of stock. The beneficial effect of ‘drip’ increases as the stock survives several market cycles.
Figure 2 shows the changes in value for every $1 invested in the Portfolio (solid blue line) and Benchmark (dashed blue line) after 12/31/2007. The market value of the benchmark was consistently higher than that of the portfolio.
In 2013, I replaced the Portfolio‘s mutual funds with ETFs that match the performance of 4 market sectors based on a model portfolio of global stocks, U.S. real estate investment trusts (REITs), U.S. bonds, and gold bullion. I rebalanced the ETFs as needed and continued to actively manage a group of stocks. Figure 3 shows annual fluctuations of the stock values (solid red line) and ETF values (dashed red line) as if $1 were invested in each group on 12/31/2013.
The benchmark (solid blue line) underperformed the stocks and outperformed the ETFs until 2018, when the benchmark surpassed both groups of investments (Fig. 3).
Several events in 2018 worked against the portfolio.
- The U.S. stock market lost its collective annual earnings in the last quarter of 2018. Most stocks declined in value.
- Stop-loss trading orders triggered steep losses from 5 stocks in the portfolio. Four were high-risk investments in small companies that failed to generate returns. One investment was a large company with steadily declining earnings.
- The 4-sector model portfolio predicted that the portfolio’s ETFs would collectively grow by nearly 9% every year, but instead they grew at half that rate, 4.4% annually. The databases for the model portfolio were outdated (limited to the time period of 1997-2011) and have not been updated.
The new SmallTrades Portfolio will hold one index fund, the Schwab U.S. Large-Cap ETF (i.e., SCHX), and a group of stocks. The SCHX is designed and tested to match the performance of the benchmark (more information in Model Portfolios, updated). The stocks will initially comprise 20% of the portfolio’s market value and they will be actively managed to outperform the SCHX. Consequently, the portfolio’s growth should outperform the benchmark’s growth.
Copyright © 2019 Douglas R. Knight