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Portfolios have a lot of moving parts. Each asset and liability in your wealth portfolio makes a contribution to your portfolio risk and expected return. The top-level asset allocation decision is the percentage invested in cash, bonds and stocks.

 

The wealth portfolio dashboard  above the balance sheet for John R. Saw indicates that he is close to his benchmark on bonds, but is significantly overweight cash and underweight stocks relative to his custom benchmark. Clicking on the differences icon in the dashboard gives the exact dollar difference amounts relative to his custom benchmark.

But which stocks or stock funds should he buy with the excess cash? Click on the information dropdown menu in the dashboard; select Stock Details and scroll to the right.

 

 

John’s portfolio is underweight U.S. stocks a bit, but more so in international (Non-US) stocks. Now we can see that the stock portfolio composition is underweight more in large capitalization stocks than mid and small cap stocks. Growth stocks are also more underweight than value stocks in the portfolio. Scrolling more to the right is the stock sector breakdown.

Only John’s brokerage and IRA accounts have stocks. In order to see the individual contributors to the stock portfolio, he needs to get into account mode by either clicking on one of these accounts or the ACCOUNTS icon.  Click on both accounts to see their assets and stock details. Scrolling further to the right provides the stock sector details.

The Vanguard Tax-Managed mutual fund in the brokerage account has very little international and small cap exposures. The Vanguard Value ETF in John’s IRA is responsible for the relative value overweight for the entire portfolio and has very little small cap exposure. Both Vanguard stock funds in the IRA have little international exposure.   Now that we know the stock portfolio’s deviations from the benchmark, let’s examine how to bring it back in line.

 

Portfolio Revision

The wealth portfolio dashboard indicates that John is underweight stock and the composition of his stock portfolio is relatively underweight international stocks, small cap stocks and growth stocks.  That means he can’t just invest more cash in his current stock portfolio to get to his benchmark weights in cash and stocks.  John can explore the possible alternatives before making any trades, by clicking on the NEW REVISION icon located just below the dashboard.  The source of cash to increase the stock portfolio is in John’s checking account. Click on this account.

Note that all accounts in revision mode will have a new first 5 columns under the Revision Section that can be edited. Columns 10, 11, and 12 with headings Quantity, Value and Allocation are the current security positions for reference. In this case, however, money is leaving this account to another. Using the Account Actions dropdown menu, select Move Cash. Entering the amount of overweight in cash, $ 32,343.71, and use the dropdown menu to select the brokerage account where the cash is to be moved. Then, clicking on Move will transfer the cash.

Now the checking account revision section shows the dollar amount leaving the account and the remaining value while the brokerage account shows the cash $ 32,343.71 transferred is available as Non-allocated Funds.

 

 

In the revision section of the Vanguard Brokerage account, the asset allocation within the account to stocks in this account has changed from 100% to 64.3098% as the remaining 35.69% is in non-allocated funds (cash). However, moving cash from one account to another, does not change the wealth portfolio cash allocation. Note that the current and revised allocations in the wealth portfolio dashboard (at the top) remain unchanged.

John needs international stock exposure. Since the dividend yield is relatively high on total international funds, it should be purchased in his IRA with tax deferment. Use the dropdown Account Actions menu, select Add New Investment, type in Vanguard Total International Stock and select the ETF version. This investment is now a line item in the IRA account, but with 0% current and 0% revised allocations. Note that all the values and allocations in the Revised and Current sections are the same until John makes revisions.

Mr. Saw no longer wants the value overweight so we can sell it all. Easiest way is to edit either the Value or Allocation in the Revision Section and put in a 0.  Now the dollar value change is $ -18,839.04 and there is a positive $ 18,839.04 in Non-allocated Funds.  Since John needs another $ 7,000 to get close to the Non-US underweight of $ 25,707.79, he can sell $ 7,000 of Vanguard Total Stock Market ETF by entering  -7,000 in the Dollar column. Then he can purchase $25,839.04 of Vanguard Total International Market ETF from Non-allocated Funds.  See the sales and purchases below. Note that John made his sell decisions before his purchases so that there would be sufficient cash available for the purchases.

Now John can see in the wealth portfolio dashboard that he is close enough to his benchmark on Non-US and Emerging Market stocks. 

Now the cash in his brokerage account needs to be allocated to stocks in conjunction with getting the Large, Mid and Small Cap stocks aligned. Use the Account Actions dropdown menu and select Add New Investment to retrieve the Vanguard Total Stock Market ETF and Vanguard Small Cap ETF into the account.

If the primary goal is to match the benchmark, then John could sell all of the tax-managed fund combined with the cash moved over from the brokerage account and invest all in the total stock market fund.

Because the total stock market fund is in his benchmark, these trades would get John closest to his capitalization weights.

The reason John was in the tax-managed fund was to have a higher after-tax return for a little less diversification. Furthermore, selling the entire tax-managed fund will result in an immediate capital gains tax. Alternatively, using more of the tax-managed fund and the small-cap fund may provide a better tradeoff between diversification and after-tax expected return. For example, $ 8,000 in the small cap fund with its relatively low dividend yield (presumably higher expected capital gain) and the remainder of Non-allocated Funds in the tax-managed fund has a relatively small underweight in large-cap and small-cap relative to the benchmark.   

 

 

 

All funds have overlap between the capitalization categories. Large-cap and small-cap funds each have mid-cap exposure. Furthermore, the differences in the stock sectors are also small with this strategy.

 

 

John’s bond portfolio is fully contained in his traditional IRA where all coupon income is tax-deferred.

 

 

The primary bond portfolio is comprised of the Vanguard Short-Term and Intermediate-Term Treasury ETFs which are 100% AAA rated. Relative to the benchmark that has corporate bonds, John’s bond portfolio appears to be overweight AAA bonds and underweight the rest of investment grade bonds (AA, A, BBB).

 

 

This makes sense for John’s view of the market. It is a tactical allocation strategy when he views the compensation for taking on default risk in corporate bonds as insufficient. It is also a hedge against a flight-to-quality situation when stock prices fall dramatically from negative news or large increases in uncertainty. In this scenario, corporate bonds will also fall as the bad news about the equity of the companies that issue bonds require a discount to buyers for the increased default risk. Another large component of the bond benchmark is Agency mortgage-backed securities (MBS). A flight-to-quality situation that has Treasury bond prices bid up and yields down will increase prepayment risk in Agency MBS, and hence, reduce its price.  Although flight-to-quality scenarios are infrequent, a Treasury hedge is nice when you need it the most. The wealth portfolio dashboard clearly shows the overweight in Government and Government Related Bonds as well as the underweights in Agency MBS and Corporate Bonds.

 

 

The term-structure of John’s bond portfolio has an intended overweight in short-term bonds and an underweight in long-term bonds. This is a tactical shift to shorter maturities with less interest rate risk than the benchmark.  A positioning that is consistent with a view that unanticipated increases in interest rates is too risky for the amount of incremental compensation for longer maturity Treasuries (a relatively flat yield curve).

 

 

Note that it is useful to work with the components of the benchmark to modify your exposures relative to your benchmark consistent with your personal situation and views of market conditions.  Furthermore, understand that using Ripsaw to work out a strategy does not mean exact to the penny or dollar. When you go to make the trades with your financial institution, you can sell entire holdings, but will buy a whole number of shares in an ETF. Prices may change between the time you set up a strategy and execute it. Your objective is to get reasonably close.

 

Use the Revision Actions dropdown menu to select Save As. Give the new revision a name (i.e., John R. Saw 1/28/2019), click on Save and the Summary for Revision will popup. If you wish to take a break and transact with your financial institution(s) later, you can reload the saved file from the Load Revision dropdown menu and get the Revision Summary from the Revision Actions dropdown menu.