Since the end of 2016 is almost here, I wanted to see if there are any gaps in my investment portfolio used to produce passive income. If I did find some gaps, then I want to close them out to have a better balanced portfolio. I did some research and found that there are a few ways to find gaps in your portfolio.
Vanguard Portfolio Watch
If you have a Vanguard account and have all your investments in Vanguard, then Vanguard provides a tool called Vanguard Portfolio Watch. This tool will give you recommendations like the following:
- OK: Your investments in foreign stocks add diversification to your portfolio.
- CAUTION: The proportions of large-, mid-, and small-capitalization stocks in your portfolio differ from those of the market.OK: Your portfolio is tax-efficient.
- CAUTION: Your portfolio emphasizes value stocks which puts you at risk of under-performing the market when growth stocks perform well.
- CONSIDER: Holding more foreign bonds can potentially increase the level of diversification in your portfolio. Allocating up to 20% to 50% of your bond portfolio to foreign bonds is a reasonable amount to capture the diversification benefits.
- CAUTION: Sectors indicated with a red arrow vary substantially from the benchmark weightings.
You can use the above analysis results to identify gaps in your portfolio and then invest accordingly. If you want to just see the effect of adding a new investment to your portfolio, you can use a tool called Portfolio Tester….also provided free by Vanguard.
Personal Capital Investment Watch
Personal Capital is a wonderful free tool that anybody can use for tracking their investments, spending and a whole bunch more.
- The one feature I really like is that it breaks down all the funds in your portfolio into the following categories, JUST by taking the names of the different funds like VDIGX, VTCLX, etc. For example,
- Large cap, mid cap, small cap split
- Cash and bonds split
- Alternatives (real estate, etc)
- US and International split
- Personal capital pointed out a weakness in my portfolio diversification w.r.t. lack of investment in Alternative Investments like Real estate, hedge funds, commodities, etc. Hence I started looking at how to add a real estate dimension to my portfolio.
- I wrote about how I found this portfolio gap here.
This tool has something called Investment watch and that is what I use often to see the composition of my portfolio. Take a peek at it and see if it is useful.
Whether you have none of the previous two ways OR you have it and still want to still find portfolio gaps, Correlation Analysis is a super-wonderful way to do it.
- Two mutual funds (or stocks or any of the asset classes) are correlated means that the investments behave similar to each other i.e. they both reach the same way in the same market cycles…both go up OR both go down. Lets use the following tool to find correlation co-efficient (Asset Correlation Tool)
- Example 1:
- Correlation coefficient of VDIGX and VDAIX is 0.98 (98%)
- This means that VDIGX and VDAIX behave 98% similarly
- Example 2:
- Correlation coefficient of VDIGX and VTMGX (International) is 0.77 (77%)
- This means that VDIGX and VTMGX behave 77% similarly
- Example 1:
- Two mutual funds are not-correlated means that the investments behave differently in diff ways i.e. both react differently in the same market cycle….if one fund goes up, then one goes down. Lets use the following tool to find correlation co-efficient (Asset Correlation Tool)
- Example 1:
- Correlation coefficient of VDIGX and VCADX (CA MUNIs) is -0.13
- This means that VDIGX and VCADX behave totally opposite to each other i.e. they have negative correlation.
- Example 1:
A portfolio is a balanced one if it has assets in it that are correlated in different ways i.e. all the assets should not behave the same way. If we are in a bull market, some assets should go up and some may go down….if we are in a bear market, the same should hold true. If you think this does not make sense, go watch this awesome video titled Asset Allocation: Building a Better Balanced Portfolio The video is a long one but worth the time…and quite entertaining too 🙂
Tool for Correlation Analysis
A wonderful and free tool (no login required) for Correlation Analysis of your portfolio is a tool called Correlation Tracker. I chose the option where I type in all my portfolio values and I get a recommendation of different SPDR funds/etfs that correlate positively (same behavior) and correlate negatively (different behavior).
- I punched in all my mutual funds that generate passive income for me. They are: VCADX, VWIUX, VTMFX, VWELX, VDIGX, VDAIX, VHDYX and VTMFX.
- Funds that correlate positively:
- SPDR Select Sector Fund – Industrial XLI Correlation = 0.882
- SPDR Select Sector Fund – Consumer Discretionary XLY Correlation = 0.874
- SPDR Select Sector Fund – Technology XLK Correlation = 0.805
- Funds that correlate negatively:
- SPDR Select Sector Fund – Utilities XLU Correlation = 0.311
The last one (XLU) surprised me. The main reason I own so many different Vanguard funds is to diversify risk by acquiring different asset classes and within each asset class, have multiple managers competing for my money. But, a correlation coefficient of 0.311 for XLU indicates to me that my portfolio has a gap with utilities.
Verifying what the Correlation Tool said ….
To verify the gap of utilities in my portfolio, I tool 4 of the stock Vanguard funds I own (VDIGX, VDAIX, VHDYX, VWELX and VTMGX) and plugged them into Vanguard’s fund compare web page: Vanguard Fund Compare.
Fund VDIGX VDAIX VHDYX VWELX VTMGX
Utilities 0.00% 2.81% 8.01% 4.23% 3.10%
The above is a clear clear vindication that the percentage of utility stocks in my passive income portfolio is low. The maximum is 8% but that fund does not have the most money. So, the correlation analysis tool correctly predicted a gap of investment dollars in Utilities in my portfolio.
Granted, utilities is not the most sexy of the stock picks, but it is a rock solid foundation on which passive income streams of many other people are built upon. And more importantly, it balances out my portfolio by adding an asset that correlates less with all my existing mutual funds.
I found one Vanguard utilities mutual fund (VUIAX) but minimum is $100K 🙂 No way that I have that kind of money. But there is a corresponding ETF called VPU. I just invested one share in this ETF….hopefully, I can save some more money and add a few more shares to my portfolio. I am happy to have added an asset that has only 30% correlation (0.311) with my existing funds. Wish me luck for some awesome passive income for years to come via this new asset vehicle called Vanguard Utilities ETF (VPU).
5 thoughts on “Finding portfolio gaps for a balanced portfolio”
Good luck with your utilities ETF 🙂 It does seem like this is more signs of robo advising. Is it any good? I’m not sure, but for people totally oblivious then it’s awesome.
Thanks for dropping by Tristan. Yes…robo advising is all the rage nowadays and it definitely serves a purpose. In my mind, there are two key points.
Everybody has a level of outsourcing. For example, I do not do analyze and buy individual stocks….I buy mutual funds where I have outsourced stock picking to a fund manager. I have no time to do the analysis. Of course, the fund manager takes a cut. Robo advising is a higher level of outsourcing where you not only not pick the stocks, you let a robo-manager pick the (same) mutual funds/etfs also. Of course, not only does the mutual fund manager take a cut like before, but the robo-manager service also takes a cut. What I am getting at is that for each level of outsourcing, one gets some freedom at a cost. And that is where I think low-cost robo-advisors are here to stay…there will always be people ready to pat that cost for some freedom. Read this article by Mr. Money Mustache: http://www.mrmoneymustache.com/betterment-vs-vanguard/
The biggest difference in say monthly passive income comes not from choosing individual stocks or mutual funds OR robo-advisors. It comes from cold-hard-cash 🙂 If you put $10,000 dollars into individual stocks or low cost mutual funds or low-cost robo advisors, my opinion is that the gain difference is not going to be that much. Compare that with putting $100,000….so, what I have come to realize is that as the money you have working for you increases, the importance of the vehicle reduces….as Jack Bogle or Warren Buffet say, just pick a total market index fund and keep investing and this in itself should serve you well.
So, mix some good principles like low cost mutual funds, tax efficiency, tax-loss-harvesting, etc with cold-hard-cash, and watch the passive income stream grow!!
Thanks for the very nice analysis and response 🙂 You’re right, however you do it, as long as you’re investing, it’s all good in the end 🙂
Looks like you have some great toolsto analyse the portfolio. Do they also work for Europeans? Ordo I need a login?
Question: why not buy xlu?
Thanks for dropping by! Sorry about the delay…was out of town on work and picked up a nasty flu on the way back…just getting back up to speed.
Do the tools work for Europeans? Can’t remember being asked for location/nationality….so, it should work.
Why not XLU? Good question. XLU has higher current yields and more potential for earnings growth. I was tempted for sure but there were a couple reasons I passed on it. Biggest reason was that XLU is highly concentrated…appx 30 holdings and top 10 holdings account for 60%. VPU has appx 80 holdings and top 10 holdings account for appx 50%. Second reason was that XLU had only 30 stocks or so….VPU has appx 80, including large, mid and small caps. So, better diversification and hence lower risk. A tiny third reason was that all my funds are in Vanguard…so, adding another was more convenient..but the first two reasons were the drivers for my decision.
LikeLiked by 1 person