IFB19: Portfolio Management as it Relates to Dollar Cost Averaging


portfolio management

Welcome to session 19 of the Investing for Beginners podcast. In today’s session, we are going to have a little different format than we have been doing. We are going to answer some of our reader’s questions on air. Andrew and I are going to take turns answering these questions, and this should be a lot of fun.

  • What kind of diversification do you use for your eLetter portfolio?
  • The importance of dollar-cost averaging
  • Can you find the intrinsic value of an ETF?
  • The importance of portfolio management
  • Learning is a constant, ongoing situation

The first question is from Jamison: I have just begun receiving your newsletter, so I have the May 31st and June 1st editions are the first that I have read and would like to follow along with your portfolio. That being said I am starting with $4,000 in my account, a traditional IRA. I would like to buy the latest dividend fortress that you recommended. How much or what percentage do your normally buy? Any insight would be much appreciated.

Andrew: Obviously, I can’t give any personalized advice, legally. Let’s just say if I was to put myself in Jamison’s shoes and what I would do with a kind of larger sum. The portfolio obviously follows a $150 a month, and that’s every single month, which is a dollar-cost averaging. What that means when buying a recommended stock from the eLetter is that you’re going to buy up to $150 worth of whatever stock that is. Sometimes a stock will trade at around $20, be able to pick-up six or seven shares. Sometimes the stock trades at $110 and is only able to pick-up one share. With that extra money, if I’m picking up one share of $100, then I have $50 to $45 after transaction fee, I just roll that over to the next month, so the next month I will have $200, and I can buy however the maximum amount shares I can and just keep going in that way. Obviously, you don’t get this sort of perfect position size where every position a perfect 5% or 7%, or 3% of the portfolio. That’s just the nature of the beast, and this is something that happens when you are running a real portfolio with lower amounts. In contrast to a fund manager who is managing millions or billions of dollars and then we have the average person who maybe listens to this podcast. They have different things that they need to worry about, and that is one of the ways the eLetter is structured the way it is because it helps put yourself into the shoes of actual people who are average with average incomes and putting their hard-earned money into the market.

I guess the second part of that question is when you start with a larger sum, say $4000 and do you put that all in at once, with the one recommendation or do you split it up. It is all a personal decision, the way I want to look at it and it’s again going to be different for everybody. The dollar amount doesn’t matter so much, what matters is how much are you going to be dollar-cost averaging in the future? If you are starting with $4000 and you are going to be putting $4000 a month every single month. It doesn’t make any sense to split that $4000 up because it represents one position size.

Then again if you are only doing a $150 a month as a dollar-cost averaging and you have $4000, well then you don’t want to put that all in the last recommendation because now your portfolio is going to be 95% the June recommendation. The next month your are going to have this tiny amount for the next recommendation. You want to find a nice balance, the thing I responded to Jamison as he was an eLetter subscriber. But I thought this would be a great opportunity because other people might have this kind of question and it’s a good thing to try to understand really.

What’s discussed in the investment community about portfolio management and how it applies in real life. There is a disconnect, and it’s not talked about much. On one side you have diversification, the easy answer is you just diversified to 15 to 20 positions, and you have a 5%, or somewhere between 3% to 7% position size. That’s like, you just set it and forget it, you watch that basket, and that is kind of the advice out there.

But when you are looking at reality, people who are being smart about it and practicing the fundamentals as they should. Diversification is obviously one, but dollar-cost averaging is a big one too. Again it’s one of those things like eating vegetables, you’re told you’re supposed to do it, but there is, not much mastery behind the explanation of how to navigate that. You’ll get questions like this that Jamison is asking and I forsee more questions in the future, and if I can answer them know that is very helpful.

If you’re dollar-cost averaging, the way that works is the definition of dollar-cost averaging is that you are putting the same amount of money into your account every single month. Think of it this way, the first year if your putting, let’s use the eLetter example. A $150 a month into a portfolio, over a ten month period each position is going to be worth 10% of your portfolio. However, when you get into the case where you’re maybe three years out, or five years out but that position size. Just off the top of my head, since the eLetter has been going on for two and half years. I did the calculations myself, and it ended, up being the one and a half to three percent range of the portfolio size right now.

Look at it the first ten months each position was making up 10% of the portfolio. Add a couple of years down the line, and now it’s only making up 2%,3%, or 5%. What you’re starting to see is that when you are adding diversification at the beginning. I don’t want to say in a sense it’s easier to diversify but maybe it could be looked at as it’s harder to diversify as the years go on. Because you can trick yourself that your diversified but just because you add a 2% position size. If your position size is all out of whack, then you’re not diversified in the 15 to 20 positions range that everybody likes to talk about. The billionaire fund managers like to use, guys like Warren Buffett.

What you have to understand with dollar-cost averaging and portfolio management is that there needs to be a lot of thought process into how you’re going to make the portfolio balanced over time. Sometimes that might mean that for some investors that mean adding positions multiple months. I know Dave you like to do this, you’ll save up three months worth or until you see a good opportunity and then you put money into that. It’s going to take you longer to run into this problem because you’re already saving big chunks and then putting those in.

That is another reason why I like to use the dividend fortresses so much. By selling off three to five positions all at once and moving all that money into one position, one dividend fortress that’s not going to have a trailing stop, and ideally held forever. It’s consolidating the portfolio and adding layers of proper diversification over the long term. Again every single month we are going to be adding to the portfolio, but that amount is going to be smaller and smaller.

The portfolio is going to tip in a way where instead of adding huge stones, you’re adding little pebbles to the portfolio. It needs to be balanced already.

That relates to the $4000 question because you are going to want to think strategically how you are going to split this $4000 and how it’s going to relate to your dollar-cost averaging plan moving forward. The higher your dollar-cost averaging number is going to be to the $4000 then maybe the less you want to split that $4000 up. But again if you are doing something like a $150 or $200 a month, if I were in your shoes I would probably split that $4000. Pretty substantially to the point where I can be comfortably diversified for quite some time. The best way I can think about it is as a boulder and a pebble. If your going to put $4000 all into one position but how much your adding each month is just this little pebble. Well, then you are not diversified even though you have 20 positions if you have nine pebbles and one boulder. That’s not diversified; you might want to split that $4000 into a couple of rocks so that when you add the pebbles, you can start building other rocks.

I guess in the long-wind maybe I should have said that in the beginning because it is much more easy to visualize. These are the types of things that you have to start to think about, and really if you want to be serious about managing your portfolio, this is a key aspect. Which is why again, when it comes to the eLetter and the dividend fortresses. I am selling multiple positions at once, number one that helps me take some gains off the market. I’m putting training stops in a lot of these positions so I can cover any downside and then once I am consolidating and wanting to position. There are two goals for each of my positions. I will have my trailing stop position and the dividend position. And the trailing-stop position is a just way for me to accumulate a large enough position to give me a stone, instead of a pebble.

That is really what I am doing not looking so much for a strategy like that I am looking to get a stock that is more of a discount to intrinsic value. Rather than a stock that looks like it going to increase its dividend over a long time. You want for both for both cases, but sometimes you have to put a higher preference for one or the other. That’s the reasoning behind, and it all sort of ties into this sort of portfolio management of adding dollar-cost averaging into diversification. Again, it’s all different because it’s personal. How much they are going to start with is different and how much they are going to continue with is different, even time frames are different. Some people are looking to invest for ten years; some are looking at forty, that does play a part as well.

But what I think is important is to understand that diversification doesn’t only mean having twenty different stocks but it means having that little column, if it’s Tradeking account or Ally now, whatever broker you have that column that shows you what your market value is. You need to have the basic competence to calculate a percentage and see that am I at least having ten, fifteen, or twenty stones. Instead of two boulders and eighteen pebbles. Make sure that those percentages are calculated and make sure you can sort of understand how that plays out in the future. With dollar cost averaging you can’t just place stones, you have to place a bunch of little pebbles and convert those into stones later on.

That is just the nature of dollar-cost-averaging. It is one reason why I am very intentional with the eLetter. And one reason why these dividend fortresses don’t come out every month because it is just not possible, but that’s why I try to give that guidance because it’s what I am doing myself. Because I am so focused on it and put so much attention into this, I can share that in real time with the eLetter subscribers. You can either try to understand it yourself or follow somebody along that is doing that as well. I know all the fund managers they do that to an extent. A lot of fund managers, value investors, traders, are really into position sizing but as far as combining that with dollar-cost averaging I don’t think that they have to deal with it as much as the average investor. Try to understand it at least, and hopefully, that answers Jamison’s question.

Daye Anne has a question. I recently visited with my online broker, and he asked, me why I did not purchase EFT funds instead of mutual funds. He advised me that the fees are less with ETFs that with mutual funds, which they can be. But you also have to check the bid/ask spread as well besides the other fees. So here’s my question, can you check the intrinsic value of any ETF like you can buy a stock?

Dave: In as a simple an answer, no you can’t. And the reason why you can’t check the intrinsic value on an ETF is because an ETF is made up of a basket of stocks, it can be anywhere from 10 to 1000, it just really depends on what kind of sector or factors that the ETF is trying to mimic or create a basket so you can invest in gold, without actually having to buy gold. You can buy all kinds of gold stocks that will be rolled into an ETF that would focus solely on gold, oil, or tech; it kinds of depends.

ETFs are a better vehicle to invest in that mutual funds for that very reason. With the fees you were talking about, the fees that you were talking about can be extremely high. You can have a front-loaded fee, a back-loaded fee, what I mean by those is they will charge you a fee to get into the fund or to get out of the fund, depending on what the rules are for that particular fund. In addition to that, they will charge you management fees as well as other fees throughout the course of the year.

So, if the mutual fund makes 5%, but they are skimming off 6%, based on their fee structure then you are losing money off of the account. That is why mutual funds have taken a beating the last few years because the fees are so extraordinarily high. And when you are trying to beat the market, the market is coming in around 9%.

When we are talking about the market, we are always referring to the S&P 500, that is the standard bearer that everybody compares what they say they are trying to beat something. When Andrew talks about his eLetter is beating the market he is talking about the S&P 500.

The standard return over the last 50 years is around 9%, and if the mutual fund is taking off 6%, that means you are only making 3%. And that is in a good year or an average year. That is just not going to cut it, not that you could put it in a bank but you might as well put it in a bank.

The long winded answer for what you are talking about, intrinsic value is a way of finding a specific value of a specific stock. When you try to lump them all together like if you have 50 tech stocks there is just no way you could figure out the intrinsic value of the ETF. You could go stock by stock through the ETF if you wanted to but that would get cumbersome to do. That would defeat the purpose of what you are trying to do. The ETFs, I am going, being honest with you I am not a huge follower of ETFs, so I don’t know the ins and outs of them. Maybe Andrew might have a little more insight into those than I do. I just can tell you can’t find the intrinsic value of an ETF, so I hope that helps answer your question.

Another question here from Michael: So Micheal says was curious what your thoughts were on income funds. Now I am from Canada, and I started listening to your podcast and been to your website. There is this income fund that has been talked about a lot of the guys that I work with. I am 26 and extremely new when it comes to finances. I have some cash that my bank manager pressured me to put into a mutual fund, and I don’t want it a mutual fund. Now I am so new with finances that I Google general definitions. Unfortunately, this money isn’t long-term as I plan on putting this money on a down payment on a house. But after that, I want to start investing for my future, and I look forward to your response.

Dave: So this is an interesting question. So there are several parts of this that I want to take a stab at. I guess the first thought was income funds to me are going to be very similar to ETFs, and if you are looking to invest in just a general funds, then I think, income funds or ETFs are going to be a great place to start.

Again I would steer very wide of mutual funds for the fee structure. I think you are just shooting yourself in the foot when you start going down that path. I know that there are some mutual funds that are starting to try to mimic ETFs, but why wouldn’t you just go with an ETF and be done with it. I guess that would be my thought on that part of it.

He says he’s 26 and extremely new when it comes to finances, I applaud him for what he is trying to do and I think this is going to be awesome for him in the long run. He is starting out at a great age; I wish I had started when I was 26, I would be in a lot better position for myself. The thing about the stock market is the people that have become so fabulously wealthy have done it over a very long period. They didn’t start at 26 and were able to retire when they turned 29, that just doesn’t happen. Of course, there are the few rare occasions where it happens. That is not something you want to bank on; there is a whole laundry list of people who have lost everything and more on doing things like that. Gambling on risky stocks, trying to swing for the fences so to speak.

Andrew and I are more, to put it in baseball parlance, were more singles and doubles hitters, with the occasional home run. We prefer to go for average as opposed to the swing and miss variety of investing.

Andrew: We are the gritty utility player.

Dave: Exactly. Some of my heroes and I know Andrew’s as well. They fell into that same boat as well; they were looking for the long-term and patience. I want to encourage the path that Michael is going down is going to be awesome, he wants to learn this, and it is going to come in very handy. The money he is going to put aside for his house is obviously going to come out of the house, and he is going to be able to use that to help him buy his house. I don’t know how the laws work in Canada, but so this would be something he would have to look into. But I know here in the US if you put it into an IRA, you can take that money out penalty free to use to buy a house. That is one advantage for you in one respect.

The other thing that I wanted to take a look at here, he has some cash that his bank manager made him put in a mutual fund. First of all, we need to slap the bank manager for pressuring you to do that. Never, ever do anything that somebody’s forcing you to do, as someone who worked in a bank for a while. I’ve dealt with that in the past, and that is never acceptable, the fact that he did that to you is just disgusting. It’s your money, and you should put it where you want to put it, it’s your choice, and you need to get that money out of the mutual fund and deposit where ever you want to put it. Provided there are no fees for doing that. Frankly, your bank manager should cover those because if he is the one that made you do that, then he should foot that bill.

Being new in finances, there is nothing wrong with that, were all new. I still have to Google stuff; there are things when I am reading or writing articles that I am not sure on or I might have to go back to my textbooks from college and look things up. It’s a constant learning, and you should never feel bad about that. I was listening some transcripts of the recent Berkshire Hathaway meetings from a few weeks ago. They talked about Warren Buffett and Charlie Munger being perpetual learning machines, and keep in mind these guys are in the 90s in Charlie Munger’s case and close to 90 in Warren Buffett’s case. The fact that they are still learning even when they are as accomplished and successful as they are is incredible and humbling as well.

The other part of this I would say as you start to put money away to buy the house, one of the things that you are going to find is that you may find that the money that you are making on this may help you make more money to help buy your house. I would encourage you to get that money in that income fund, or the ETF that could help you to start investing and just start being patient. Keep listening to our podcast, read the blogs that Andrew and I both write, there are lots of great resources out there to help you learn, Michael. You’ve come to right place and where here to help you, so if you have any other questions in the future, don’t ever hesitate to ask us, that’s why were here. We want to help people learn how to do this, and we understand that it can be a scary, overwhelming experience to try to do. But if you just start building brick by brick, like Andrew likes to say, or building on your foundation. Just build up your knowledge you’re going to be impressed by how quickly you’re going to learn this information.

Andrew: Yeah, I would just say to the piggyback on what Dave said. It’s really important to be learning and start investing for the future as you would be doing. I would just caution putting money into any investment that you are going to put on a down payment. If you admitted that it’s not going to be long-term, I would be wary of putting that into the market at all because a bear market could happen at any time. Going into some income fund could be a nice way to start, and it’s a great way to get your feet wet and to start on the journey. In the long scheme of things something like money on a down payment on a house compared to all the potential money you’ll be putting into the market in the future is going to be minimal, compared to the grand scheme of things. I would be careful about putting money in if it’s going to keep it in the market for a long time.

portfolio management

A great question here from Amy. I thought I would share the biggest frustration I’ve encountered while beginning to invest. I am 18 and just finished my first year of university, and I live in Canada. I just started to become interested in investing and began listening to your podcast a few weeks ago. I haven’t invested yet because I find it difficult to get good advice on investing in the Canadian stock market. I am unsure if I should stick with the only the Toronto stock exchange or should I dip into the New York Stock Exchange as well? I found your book very helpful and truly appreciate it being in a beginner format for young people like myself. Keep doing what you are doing.

Andrew: It depends on I am not a tax expert, there is the implication from the US side trying to invest in the Toronto stock exchange. I am assuming it goes the other way too, all I will say as far as that goes. I have gotten feedback from an eLetter subscriber who said that because of the crossover between the borders and I think this depends on which broker you choose. One of the brokers was not able to establish a DRIP program for a couple of the smaller market cap stocks because they’re too small. Personally, I’ve never had any problem putting a DRIP in any US NYSE or Nasdaq. For whatever reason, that wasn’t able to happen in a couple of positions that were recommended in the eLetter.

That does play a part; taxes will obviously play a part to. I don’t know what the retirement accounts are like there, something like a Roth IRA or a regular IRA here in the US takes away the negative effects of long-term capital gains tax and short-term capital gains tax as well. If Canadians retirement accounts do the same thing that could be something that is beneficial but you want, to see if that applies to US stocks as well.

I think what the biggest thing is is to understand the strategy behind it. And pretty much everything that Dave and I talk about on the podcast about understanding how to get at least a basic sense of what a companies annual report means, what they’re financial data means, and what kind of mindset you need to have to succeed in the market. I think that’s of a much greater importance than figuring out what stocks you should buy; it’s the why, the how and not so much the what. I see no problem with if somebody sees that okay, the Canadian stock market, I live here in Canada and there are more opportunities in the Toronto stock exchange or maybe I am being taxed too heavily on the NYSE. I see no problem with somebody taking those principles and strategies and applying them to their stock market in their country and seeing success from that. I think that can very well happen and I just caution giving a straight up answer, just invest in the US because it works for me, doesn’t mean it will work for you.

I think just stick with it, keep listening to the podcast and try to get the big strategy things down and apply that to your investing actions and investing buys and sells that you end up doing. Regardless of whether you end up in the Toronto stock exchange or the NYSE, I think you can find success either way as long as you focus on the fundamentals, dollar-cost averaging, diversification, long-term holding periods, and buying stocks at a discount to intrinsic value. If any of those concepts or as a whole just seem too overwhelming then maybe you would be better off just investing in an ETF.

I think as a young person there is so much opportunity, and it depends on how much you want to dig into the nitty gritty, but obviously, I believe in, it because I am living it. And I believe there is plenty of opportunities and at 18, that extra almost decade of compounding interest that really can accumulate is even further substantial than anything I could accumulate. Maybe just try to remember me one time you want to pick me up on your private jet.

Moving on to the last set of questions. These are a set of questions from a mutual reader of Andrew and me’s blogs, and he asked some great questions. What we are going to do is talk a little bit about Andrew’s service. I am a huge fan of Andrew’s work, and I think it’s a very helpful tool. I know that Andre obviously uses his tool and I find it very useful. We thought we would go over these questions on the air because they kind of hit some of the things that we talk about and I thought they would be beneficial to others.

I have been receiving your emails and have heard a couple of the podcasts you are doing with Dave Ahern. For context, I am a retiree age 62. Having lost a job in a “disrupted” industry a couple of years ago. I have taken over management of my retirement funds, and I am looking to “actively” invest about half of them. I would like to generate about 8 to 12% a year utilizing a variety of strategies. I have been reading Ben Reynolds newsletter, and on the stock, the side has gone over to mainly dividend stocks for the reasons you have discussed in your podcasts.

Is your spreadsheet evergreen? I.e., not likely to change or be updated since it relies on common business metrics.

Andrew: Yes, it is evergreen. There is a general overview of things that are going to be consistent. Things like assets, debt,cash, revenue, earnings, that is always going to be a fundamental part of business metrics. That is always going to really be the core foundation of the spreadsheet. I have updated it in the past, and I will most likely update it in the future. There is always little discrepancies and little intricacies behind the numbers and it can evolve.

I mean Warren Buffett evolved his approach from a very cigar-butt method to something more of buying a wonderful business at a fair price instead of a fair business at a wonderful price. Those things can evolve, and sometimes little situations need to be accounted for like one of the things I saw the other day was a negative cash at the end of the year. I have been researching companies spanning all the way back to the 1930s.

Would I gain experience in evaluating company fundamentals as disclosed in reporting?

Andrew: Yes, a 100%. You learn by doing, and they say when it comes to learning there is a study that has a percentage that states. There is a percentage of how much information is retained by the human brain. It maybe something above 50%, if your teaching and its something less than that and if you are doing and watching it on video it’s less, listening to it on audio is less and then reading it is even less. I think a big way I am personally able to find mastery from plugging numbers in myself and starting to see that how it all fits together. And once you do a few of these you start to see that this business is pretty bad compared to this group of businesses over there. Why are people putting money into this terrible business? And you start to see the world of the stock market differently. I don’t think you gain that type of mastery unless you are doing it yourself.

Could any stock/company be assessed with this spreadsheet? Would it work with MLPs and REITs?

Andrew: Yes, any stock or company that files a 10-k with the SEC. Technically you can do it with international stocks as well as long as they’re providing the same financial metrics that companies here in the States are. And that’s main revenue, earnings, dividends, and things like liabilities, assets, shareholder’s equity and then cash at the end of the year. As long as you have that information you can use the spreadsheet to analyze your heart away.

If there were ever an update of the spreadsheet, would there be a charge for that?

Andrew: No.

Is it possible for company data to be imported in an automated fashion? I would expect it to be manual, find the information on the annual and plug it in.

Andrew: Yeah, I don’t have an automated feature as of now. It’s all manual.

Is the entire portfolio to date available upon subscription, including closed positions.

Andrew: Yes, he is talking about the eLetter portfolio and yes, you, get a complete archive of the back issues of every issue. It’s been two and half years know and the monthly issues that have been sent out. So you can see which stocks were bought when they were bought, and which ones were sold.

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