Introduction

What is Investing?

Investing Involves Risk

What Can I Invest In?

The Stock Market - Explained

Passive Portfolio Step 1: Pick a Strategy

Passive Portfolio Step 2: Allocate Assets

Passive Portfolio Step 3: Select Securities

Passive Portfolio Step 4: Monitor & Rebalance

Investing in Real Estate

Alternative Asset Classes

Taxes

Active Investing

Throughout this book I've emphasized that passive investing is the best path forward for most investors and that active investing is best left to industry professionals. This recommendation is strongly supported by research that shows actively managed funds, after adjusting for their higher fees, don't beat the passive approach.

Nevertheless, active investing is appealing for investors who are drawn to the allure of above-market returns.

Circumstances recently led me to consider experimenting with an active portfolio, where I have full control over asset selection, and my broker won't charge me transaction costs for buying individual securities.

I thought it would be instructive to document the process for those who are interested. Before I proceed with that, I recommend that if you do feel inclined to active investing, whether you're doing it as a form of intellectual stimulation, or socially as part of a club, or for any other purpose, you should commit no more than 5 to 10% of your overall nest egg to active investing. 

With that caveat in mind, let's dive into my thought process. First, consider the advantages and disadvantages to forming my own portfolio.

Advantages:

  • No annual management fees
  • No trading commissions payable (my broker allows commission-free trading)
  • Freedom to form any portfolio I want
  • Freedom to alter portfolio composition at any time

Disadvantages:

  • I must choose the individual investments on my own
  • I don't have time for in-depth analysis of hundreds of stocks
  • I will have to make some active decisions down the road, including the decision that is psychologically most difficult for investors--when to sell!

Next, let's consider my specific circumstances.

 

The circumstances

The stock market has been on a tear over a decade, and many stocks look expensive, for example, using standard measures such as price-to-earnings ratios, reflecting how much an investor needs to pay to "buy" or gain access to one dollar of earnings by the company.

Given this, where can I find value?

One segment of stocks that has lagged in recent years are the "value," firms, so-called as they are believed to be undervalued. In contrast, most of the recent market returns have been driven by "growth" stocks, led by the FAANG stocks: Facebook, Amazon, Apple, Netflix, and Google. 

Another segment that has lagged are dividend paying stocks, which are companies that generate a lot of cash but don't grow very quickly. I am in a relatively high tax bracket, and I generally max-out all my tax-deferred account contributions. (BTW, most of my investments are in the form of indexed ETFs--I do practice what I preach). The upshot is that the active investment I'm considering will have to take place in a regular brokerage account, which means gains will be taxed each year. Given my circumstances, dividend income is taxed at much lower rates than my regular income. This led me to conclude that I should pursue an active, dividend-income generating portfolio.

The S&P 500 average dividend yield has ranged from about 1.5% to 1.6%. I'd like to outperform that percentage in my portfolio. 

Conveniently, I came to this conclusion at the end of 2020, and I formed the portfolio on the first trading day of the year, January 4, 2021.

 

How Did I Select Stocks for My Portfolio?

My approach was not scientific, but it did follow some logic. I searched the usual year-end articles for dividend-paying stock recommendations. This led to a list of about 40 candidates. I then examined each in turn, fairly quickly, retaining companies that are generally household names with long-term records of solid dividend payments. I excluded fossil fuel energy companies and utilities, as well as one tobacco company. I also rejected most financial institutions, on the grounds that I already have some exposure to those through other investments in the Financial Select Sector SPDR Fund, XLF. (XLF has a fairly low annual management fee of 0.13%).

 

Here is the resulting portfolio, which I purchased on the afternoon of January 4, 2021:

 

Quantity Ticker Purchase Price Amount Spent ($)
8 JPM $125.72 1,005.72
10 HAS $91.58 915.78
12 MRK $80.15 961.78
8 DLR $135.63 1,085.03
17 VZ $58.55 995.31
16 O $60.38 966.08
36 BGS $27.20 979.2
8 PG $136.76 1,094.06
7 KMB $133.31 933.2
7 CCI $155.54 1,088.78
34 T $29.22 993.31
17 MDLZ $57.69 980.71
23 CSCO $43.75 1,006.14
11 DFS $89.78 987.58
34 IRM $28.81 979.46
7 PEP $142.73 999.08
6 JNJ $154.68 928.08
10 ABBV $104.64 1,046.40
21 GEF $47.06 988.26
6 TGT $176.15 1,056.87
       
    Total Spent 19,990.83

 

Fortuitously, the market dropped significantly that morning, which meant my costs were about 1 to 2 percent lower than the previous closing prices. 

From the amounts I spent on each investment, you can see that I opted for an equally-weighted portfolio with about $1,000 in each stock and a total investment of around $20,000.

This portfolio contains 20 stocks, selected across several industriesm, aimed at providing some natural diversification. In coming weeks I may add some more stocks, although I likely won't go beyond a total of 30. Research shows that most diversification benefits are realized once we reach 25 to 30 stocks in a portfolio, so there likely won't be much benefit to going beyond that number.  

In coming months I'll report on this portfolio's progress. In particular, I'm looking forward to examining total returns, taking into account dividends.


32

05/01/2021 06:13 PM

Out of interest, why the exclusion of utilities? I'm guessing you excluded tobacco and fossil fuel companies for ESG reasons, but would like to have that confirmed. Thanks!

Yuval Bar-Or

19/01/2021 02:06 PM

Hi Eleanor, My apologies for taking so long to respond. I've been focused on preparing a new online course. I excluded utilities/fossil companies for two reasons. The first is, as you guessed, on ESG grounds. For those of you who are unfamiliar, ESG stands for Environmental, Social and Governance. Collectively, these are perspectives which have been largely ignored for about 50 years, during which corporations have focused almost exclusively on financial profits, at the expense of people and the environment. I felt it important to recognize environmental issues in my investing decision. The second reason is somewhat technical. Many companies that pay high dividends are energy/utility companies. If I hadn't decided to filter them out my portfolio would have ended up being an energy fund. I wanted broader exposure for the purpose of diversification.