11/11/08

$100 a Month ETF Portfolio

Since I wrote some suggestions for beginning investors and started a couple of model portfolios (here and here--note that the dividend stock portfolio is non-diversified), I received several requests for a portfolio that starts out with smaller sums of money. So here's an ETF portfolio to this end.

The allocation I chose is a moderately risky one, is meant for the long term, and is certainly not the best fit for everyone (see my suggestions for more on this). The goal of this portfolio, as with the others, is to show how one's wealth can grow by developing an investing plan and sticking to it. This and the other ETF portfolio are also meant to show how contributing small sums on a regular basis will eventually lead to large gains. There are various risks involved. If you choose to follow any of these (and others') sample portfolios, bear in mind that the risk you take is your own. Please do your own research and/or consult an investment professional.

With that out of the way, here is the eventual intended allocation:

37% US stocks (VTI)
14% International stocks (VEU)
5% Real Estate (VNQ)
7% Commodities (DBC)
18% Total Bond Index (BND)
19% Intermediate Term Treasuries (IEF)

The average expense ratio is around 0.2%.

The portfolio will work as follows. It will use a broker like Sharebuilder, which charges $4 a trade when you buy fractional shares. As I like to limit my commissions to 1% of my trades, purchases will be made in the portfolio when the cash balance reaches $404 ($400 to invest and $4 for the commission). Every month (on the 11th or thereabout), $101 will be added to the cash portion of the portfolio. This is the monthly amount we put away for investing. When it reaches $404 (every four months) it will be invested. Starting out, I'm assuming we have already saved $404.

Purchase prices will be determined as of market close the previous day. For example, if the purchase is made on a Tuesday, the ETF's closing price on Monday will be used. Given the $4 commission expense, the portfolio starts out with a 1% loss. Commission expenses will be calculated into the purchase price. For example, the first $404 was spent on BND, which closed at 74.60 yesterday (11/10/08). Four hundred dollars was spent buying 5.3619 shares. Factoring in the $4 commission, our actual purchase price is $75.35 per share.

Initially, purchases will be made alphabetically (BND, then DBC, then IEF, etc). Subsequently, investments will be made into the ETF that is farthest from its target weighting. If all positions are at their target weighting, I will again proceed alphabetically.

Dividends will be automatically reinvested (commission free) as they come in. Payout dates will be used for receipt of the dividends and they will be reinvested at the closing price on that day. For sake of ease, cash will not earn interest. Were this a real life portfolio, I'd keep the cash in an online savings account, such as at ING Direct or HSBC Direct, unless the broker's money market sweep had a better yield.

All portfolio updates will be posted here. The portfolio will be tracked in the spreadsheet below, and for easier viewing here.



Note that a similar portfolio composed of no transaction fee index mutual funds might provide a greater long term return because of less fees. The ETF portfolio has two sets of fees: broker commissions and the ETFs' expense ratios. No transaction fee mutual funds generally have higher expense ratios than similar ETFs, but purchasing them does not involve commission expenses. One reason this portfolio uses ETFs is that most low fee index mutual funds require relatively high initial investments (e.g., Vanguard requires $3,000 for its funds).

Another reason is that the ETF portfolio might actually be cheaper in the long run. As the portfolio's value grows, commission expenses will be an ever smaller percentage of the portfolio's value. At some point, depending on how much the portfolio is worth, the sum of broker expenses and ETF expenses may become less than the mutual fund expenses.

One way to minimize expenses in an ETF portfolio is to increase the amount per trade. That is, as it is currently set up, the portfolio has a 1% commission expense. (As the portfolio gets larger over time, commission expenses as a percentage of the portfolio's total value will become smaller and smaller.) Were we to buy $800 worth of shares per trade (say every eight months), that expense would drop to 0.5%. An additional way to lower an ETF portfolio's expenses would be to find a lower priced broker. As of writing, Zecco offers 10 free trades a month (but no fractional share purchases) when your account is valued at $2,500 or over. SogoTrade charges $3 a trade.