Diversifying your portfolio
Iwas looking at the returns of the main local indices since the end of the financial crisis in March 2009 (in hindsight we can exactly pinpoint the end, at the time we had no idea it was f inally all over). This got me thinking about a number of issues, but firstly the stats (all excluding dividends paid).
The Top40 has done around 180% as has the MidCap Index, while the Resi10 is the laggard – up only 5% over the period. The Indi25 is the clear winner, gaining some 360%, with the Fini15 up around 255%.
Aside from the Resi10, they’re all decent returns but many would look at these stats and wish they’d bought the Indi25 and nothing else. While the Indi25 has been the clear winner, the real question is what would have made you buy this index back in 2009. Ignoring hindsight bias, this question perhaps poses more of a problem. Let’s say you had bought the Indi25 back in March 2009, you have to attempt to f igure out when to sell the index and move i nto t he next winning i ndex. The reality is that there is no way the Indi25 will always be t he winning index.
The point here is that the best longterm portfolio needs to be a diversified one. So in 2009 it would have included some Indi25 stocks, as well as the other middling stocks and – dare I say – even some Resi10 stocks (the argument could be made, as I often have, that Resi10 stocks are never really long-term ‘ buy and hold’ stocks).
A diverse portfolio would have essentially returned the Top40 return of around 180% for the period, around 23% a year compounded and well ahead of inf lation, thus creating real wealth. Some t weaks (such as going l ight on Resi10 stocks) would have done even better.
The beauty of the Top40 is that it is designed to kick out losing stocks whose prices are falling, while adding the new winning stocks that are seeing share price gains. So the Top40 from 2009 looks ver y different f rom t he 2015 Top40 index.
In 2009, the Top40 index included 13 resource stocks while today it includes only si x – the replacement stocks have pret t y much a l l been industrials. As the industrials start to lose their way going forward (as will certainly happen, although when is uncertain), they will start to drop out of the Top40 and be replaced with the new winning stocks.
This self-correcting nature of the Top40 index is why I have it as one of the core exchange-traded funds (ETFs) in my portfolio, but I personally much prefer the equal weighted Top40 ETF – BBET40*.
I wil l build on t his core ETF portfolio by adding the awesome stocks that I consider to be the signif icant winners over time. This is my attempt at outperforming the generic Top40 – t his is where we have to be ver y careful about which we include. These individual stocks have mostly been industrial stocks with a few f inancial and small- or mid-cap stocks – resource stocks are not core long-term stocks due to their cyclical nature.
We could make it even simpler by using some i ndex ETFs i nstead of i ndividual stocks around t he core, adding property ETFs or any of the other three (Indi25, Fini15 or MidCap ETFs).
With t hese i ndividual stocks or ETFs that we add around the Top40 core, we increase risk, are subject to being wrong and can be hit by bad timing, so we should do so carefully and with at least 50% of our portfolio in ETFs.
Industrial stocks are likely to drop out of the Top40 and be replaced by other winning stocks.