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).