Ever since I started engaging finance and investing in 2011, I’ve been tearing through the sea of literature on the subject. The evolutionary steps that have come along with the years went something like this: ignorant>low cost index funds>individual stocks>fundamental concepts of value investing. While I think I’ve learned a lot in the preceding 4 years, I still feel like an impostor. While I have some confidence in the knowledge, wisdom, and experience I have gleaned, I still question if I really know what I’m doing. In order to discover whether I know what I’m doing or not, I need to test my hypothesis. And that’s where Judgement Day 2020 comes in: this is the deadline I’ve set for myself to gauge how our portfolio has performed on a total return basis in 5 years time.
Stress Test The Shit Out of It
One of the greatest lesson’s I’ve learned is from Charlie Munger, which is to stress test the hell out of your best ideas and discard it if isn’t working or faulty. I’ve immensely, and continue to, enjoy the area of security analysis. I admit, this is an area I find as fascinating as a nerd finds the intricacies of Dungeons and Dragons fascinating. Most people would bore themselves to tears reading annual reports and learning accounting. I for one love it.
But just because I love something, does not automatically and necessarily mean I am good at it. For example, I love hockey, but that does not mean I am very good – in the sense professional level good – at it. In order to figure out if I’m at all good at what I love, I need to put it to the test. And if it ends up being that I am no good at it, I need to discard the exercise and go with what is most logical and rational.
What’s Been Going On
This as been the timeline of what’s been going on financially since 2011:
- 2011 – Finish College / Looking for Work
- 2012 – Student Loan Repayment
- 2013 – Student Loan Repayment
- 2014 – Finishing up Student Loan Repayment / Transitioning to Investing
- 2015 – Investments into Portfolio
As we finish up 2015, the investments in our portfolio has swelled considerably from effectively zero back in 2014. I won’t necessarily say how much, but I did hint at it roughly back in this post.
Core Ideas & Concepts
From everything I’ve learned, what has made most sense to me in terms of investing revolves around two fundamental ideas: value investing and purchasing the greatest amount of net earnings at the best price. To say it simply: I want to buy the most real, net earnings at the most favorable price. That means not overpaying for a company’s earnings stream.
I combine this with another fundamental idea: knowing your circle of competence. I’ve essentially stuck to a handful of billion dollar plus market cap, publicly traded companies. I know in theory that there are better bargains in the small and micro caps, but that’s an area I have no knowledge of. I’ll stick to the large and mega-caps while I’m learning. It lets me sleep at night.
Along with the core concepts of value investing and sticking to a circle of competence, I know based on my personality that I possess the temperament to handle volatility. I’m truly not bothered by it. But I can understand why many people are. I know I won’t be having any kind of amygdala hijack type of response because I know that the space between stimulus and reaction when it comes to the markets is large. To be blunt, I’m not fazed when holdings drop 30% in value.
So what is the hypothesis? Based on all I’ve learned, by choosing the investments I have chosen, I expect to either:
a) keep pace with or surpass a total US market index based on total returns
b) experience a compound average growth rate of 10% or higher
Yes, lofty goals. But if one is going to put in this much time and effort, the point is to at minimum match an index like the S&P 500, or else what was the point? You could have just dumped your money into an index, gotten a better return, and studied investing and finance to boot for fun.
Based on the two conditions, I will be satisfied with either or. You may have different criteria, but these are mine at the moment.
Now, investing is a decades long process. To experience the wonders of compounding, you need decades. While I am willing to see the decades out, I also need a slightly more short term check in. From what I’ve read, 5 years seems to be a general rule of thumb to gauge a portfolio’s performance. That is, if in 5 years time your investments haven’t performed to the expectations you had for them going in, your hypothesis for selecting them were probably wrong as the results should have shown up by now.
I’ve been purchasing the investments exclusively in US holdings in the TFSA and RRSP – US equivalents being the ROTH IRA and 401(k).
In an alternate universe, if I had decided to forgo security analysis and the selection of individual stocks, I would have just bought Vanguard’s Total US Market Index Fund – VTI.
So what I’ve done to gauge performance is to gather up all the purchases that went into creating the current portfolio, and constructed an alternate reality portfolio where I purchased VTI instead of whatever stocks I bought. So on each date I purchased a stock, the alternate reality portfolio registers a purchase in VTI at that specific day’s average price (as listed on Vanguard’s website).
Currency conversions have been cancelled out for both the real portfolio and hypothetical portfolio as the dual-listed arbitrage trade I conduct to convert Canadian dollars to US dollars effectively makes the exchange fee nil. However, I have added up all the trading fees that have gone into constructing the real portfolio and added an equivalent amount of VTI to the alternate reality portfolio as one of the discount brokerages I use has no trading fees for purchasing ETFs. This added about 1.6 more shares to the total VTI held in the alternate reality portfolio.
My hypothesis is that my portfolio should either pace or surpass this alternate reality portfolio or experience a compound average growth rate of 10% or higher by December 2020.
As of today, almost exactly one year in, this is where the real and alternate reality portfolios sit:
I don’t really like to talk about any of the individual stocks I choose for investment, even though they are large and mega-cap companies. Why? First, I’m not completely sure my knowledge and analysis of my picks are adequate enough to pronounce any kind of recommendations to buy or sell. Second, I would be mortified if someone read something about an analysis of what I was buying and then bought it themselves, but then didn’t possess the knowledge and temperament to withstand the volatility and sold out at a loss. And finally, I truly think if you are going to be selecting individual companies, you better know how to read the financial statements and have done your own due diligence – I don’t want to be responsible for anyone’s successes or failures of constructing investment portfolios with real, cold hard cash. I feel enough pressure with my own money: I don’t want to be taking on responsibility of a complete stranger’s financial well being.
With that said, I’ll give you a peek into the broad sector’s the portfolio is made up of and the percentages allocated to each sector, based on book value:
I know conglomerate isn’t a sector but it’s a unique category encompassing many different sectors so I broke it out on its own.
For now, this is the most comfortable I feel sharing insights into the portfolio.
In conclusion, by 2020, if the portfolio has not met the 2 expectations I’ve outlined above, I will seriously contemplate just moving everything to a total world market index fund, like Vanguard’s VT, and just forget about it. It’s a strange measurement window though, as I’ve bought these assets with the mindset of holding them for our entire lives. These assets, outside some outlier events, will never be sold. I want them to sit there and compound decade after decade.
The decision to switch to a set and forget index fund will depend on how badly the portfolio lags the expectations. But if it is bad enough, , I will very seriously consider shutting it down and just indexing going forward.
And if this is what ends up happening, I’ll be fine with that. I would put my ego aside and go about structuring our financials lives in the most logical and rational way possible. In the end, there is nothing wrong with compounding at the market’s rate of return. Especially if it’s through a no effort, no time spent way of investing like automatically putting aside a regular monthly amount to dollar cost average over decades.
*[edit: December 9, 2015] Inner Scorecard mentioned in the comments below about a dollar cost averaging scenario for the hypothetical VTI portfolio. I completely forgot to take this into account: if I had been indexing from the start, I would have been dollar cost averaging a fixed amount at the beginning of each month. So I went and created a new row to include an alternate reality VTI portfolio based on a DCA scenario.
Interestingly, if I had been dollar cost averaging into VTI, I would have 11 more shares, higher total dividends collected, and as of this moment, a positive 1.83% total return thus far:
I’ll run both hypothetical VTI portfolios going forward.
**[edit: December 10, 2015] A reader requested a sample of how I did up my comparison portfolio like shown above so I’ve made a template for you to use and customize how you want on Google Sheets here.
I’ve added 11 comments to explain things – you’re smart, I’m sure you’ll figure it out. Some of the cells are color coordinated to show where it connects in the spreadsheet.
Also, in order to make edits, you need to go to File>Make a Copy and that will create a copy of the sheet onto your Google Drive and you can change it to your heart’s desire.
Remember, this is just a template: you don’t have to use VTI. You can use whatever you want as a comparison. You just need to add in whatever values yourself. Again, this is the link to the template.