Investment Workshop 7: Time To Buy

Wanderer
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Wanderer

The Wanderer retired from his engineering job at a major Silicon Valley semiconductor company at the age of 33. He now travels the world, seeking out knowledge from other wealthy people, so that he can teach people how to become Financially Independent themselves.
Wanderer
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Hello again and welcome back to the Millennial Revolution Investment Workshop! New readers, please click here to start from the beginning.

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After a brief hiatus to sync up our buy schedule to most people’s paydays (1st and 15th), we will now be putting in our 2nd buy orders in our DCA strategy.

Now, the nice thing about DCA is that not only do you get practice putting in orders and buying ETFs, you get practice with the absolutely critical process of rebalancing your portfolio. Let me explain.

To recap, once you set up a balanced portfolio of low-cost Index ETFs like this, you decide target allocations for each of your asset classes. Over time, these allocations will drift off target, and you need to rebalance back to your original targets. This process is actually a MAJOR advantage of investing using a balanced portfolio of low-cost Index ETFs because it avoids what I like to call Single-Asset-Freakout.

I’m sure there’s a more complicated-sounding Wall Street for this, but fuck it I’m going to call it Single-Asset-Freakout.

So what is Single-Asset-Freakout? Everyone knows the old saying “Buy Low, Sell High.” That’s how you make money in the stock market, and if you think about it, it’s like “Duh, Well YEAH, that’s obvious.” But if you buy only a single asset (or single asset allocation like going 100% stocks), this doesn’t actually work that well on the ground.

Imagine you ploughed all your money, like $100k into a single stock like Apple. You get in at $10 and a year later it’s at $30. Woohoo! You just tripled your money! So you should sell, right?

“Hmmmm…but what if I’m selling too early? There’s rumours of a new product coming around the corner, so I could be missing out on some BIG money if I sell now…”

“But without Steve Jobs at the helm, that new product could be a dud, and then the stock would go DOWN. If I don’t sell now I won’t be able to lock in my gain…”

See? Not so clear about what to do, is it? And this is classic Single-Asset-Freakout. By the way, this also happens if you plough all your money into a house.

“Wow! My house doubled in value over the last 5 years! I should sell it and lock in those gains!”

“Hmm…but then I’ll just have to buy another house, which is also now super expensive, so I should stay put.”

“Hmm…but then again I heard they’re going to raise interest rates so my house could start dropping in value! I don’t want to lose money! What do I do? What do I do?”

Result: FREAKOUT.

Because when you invest your assets in a single asset, the saying “Buy Low, Sell High.” Doesn’t actually apply. It becomes more like “Buy Low, but not TOO low in case that asset is about to go to zero, and Sell High, but only if there’s a downturn coming around the corner that will eat up your gains.”

In short, if you invest in a single asset you will constantly be trying to outguess the market, and history has shown that this tends to destroy people’s wealth over time. That’s why I don’t recommend people go much above 80% equity 20% fixed income, even if they’re super aggressive.

But when you have a balanced portfolio, you just rebalance when your asset allocation starts to drift outside of your target ranges. There is no guessing involved, and no market timing. This typically happens in three scenarios.

1. Market Performance

In a rising environment like the one we’ve experienced over the past few years, equity assets will run ahead in price while fixed income assets will lag behind. This will eventually cause your equity allocation to drift higher than your target, and your fixed income allocation to drop. Even if your total portfolio value goes up, often one asset will be charging higher than the others which messes up your percentages. In this case, rebalancing will force you to sell assets that have gone up too quickly, and buy ones that are lagging. In other words, it forces you to do the exact OPPOSITE of what your instincts tell you do, which is to hang on to your winners and ditch the losers. In other words, it forces you to “Buy Low, Sell High.”

This also happens in tanking markets, like the one we saw in 2008/2009. Equities get crushed and throw your allocation out of whack, while fixed income rises in value as money seeks safety. Rebalancing in this environment means selling assets that haven’t collapsed while throwing money into plummeting equity markets. “Buy Low, Sell High.” This, by the way, feels absolutely terrifying in a market crash like the one we experienced, and is also absolutely the correct thing to do. It’s the reason we didn’t lose any money in the Great Financial Crisis.

2. Adding/Removing Cash

Cash is an asset class just like any other, so when you add or withdraw money into/from your investment account, you mess with your portfolio’s asset allocation since your target cash allocation is probably 0%. If the impact is large enough, you will likely have to rebalance.

3. Rounding Error

This happens mostly at the beginning if your portfolio building process. Because unlike mutual funds, you can’t buy fractional shares of ETFs, so at the beginning when your balance is relatively small, being only able to buy 1 share vs the 1.8 shares your target allocation demands will have cause your allocation to be off. This problem, however, naturally goes away as you add more money to the system.

Let’s Do It!

During the building process, we will mostly be affected by issues #2 or #3 above (unless the stock market starts swinging REALLY wildly, which may happen under President Trump), but the process of actually rebalancing is the same. So let’s do it! We will do this 2 separate times for our Canadian Portfolio and our American Portfolio, and I will document exactly how I make my decisions so you guys/gals can replicate it.

Canadian Portfolio

Right now on Dec 14th before the market opens, our portfolio asset allocation is this:

Asset Ticker Unit Price Units Market Value Allocation Target Allocation
Canadian Bonds VAB $25.25 8 $202.00 40.23% 40%
Canadian Index VCN $31.29 3 $93.87 18.69% 20%
US Index VUN $41.90 2 $83.80 16.69% 20%
EAFE Index XEF $26.47 3 $79.41 15.81% 16%
Emerging Markets Index XEC $22.55 1 $22.55 4.49% 4%
Cash $1 20.5 $20.50 4.08% 0%

OK, so you can see how we’re pretty close in terms of target allocation, though there are a few off-target assets (VUN being the most obvious) due to rounding errors and a little bit of leftover cash we had from the last buy. Again, this will naturally get fixed as we add more money into the system.

Now let’s add our next $500 of cash into the system and see what that does to your portfolio.

Asset Ticker Unit Price Units Market Value Allocation Target Allocation
Canadian Bonds VAB $25.25 8 $202.00 20.16% 40%
Canadian Index VCN $31.29 3 $93.87 9.37% 20%
US Index VUN $41.90 2 $83.80 8.36% 20%
EAFE Index XEF $26.47 3 $79.41 7.92% 16%
Emerging Markets Index XEC $22.55 1 $22.55 2.25% 4%
Cash $1 520.5 $520.50 51.94% 0%

OK, so now we are WAY off target, which is expected when you add cash to your account. Clearly it is time to rebalance.

To do this, we create our rebalancing table, which tells us many units of each asset we have, how many units we want to be back on target, and from there we can figure out how many assets to buy/sell. Let’s do it!

Asset Ticker Target Allocation Unit Price Current Market Value Target Market Value Current Units Target Units Difference
Canadian Bonds VAB 40.00% $25.25 $202.00 $400.85 8 15.87532673 7.9
Canadian Index VCN 20.00% $31.29 $93.87 $200.43 3 6.405433046 3.4
US Index VUN 20.00% $41.90 $83.80 $200.43 2 4.783436754 2.8
EAFE Index XEF 16.00% $26.47 $79.41 $160.34 3 6.057453721 3.1
Emerging Markets Index XEC 4.00% $22.55 $22.55 $40.09 1 1.777614191 0.8
Cash 0.00% $1 $520.50 $0.00 520.5 0 -520.5

Note: We calculate Target Market Value by simply taking our total Portfolio Value (including the new cash we jammed in) and multiplying by our Target Allocation. So in this case, I had $1002.12 in there, and for VAB my target was 40%, so my TMV is $400.85.

OK, so what is this table telling us? Well basically, we need to do this:

Asset Ticker Unit Price Action Units Proceeds
Canadian Bonds VAB $25.25 BUY 7 $176.75
Canadian Index VCN $31.29 BUY 3 $93.87
US Index VUN $41.90 BUY 3 $125.70
EAFE Index XEF $26.47 BUY 3 $79.41
Emerging Markets Index XEC $22.55 BUY 1 $22.55
Total $498.28

And I’ve said it before and I’ll say it again, make sure your total buy orders don’t exceed the actual cash you have in the account. If you go over by even a little, your cash balance will become negative which will trigger margin trading. Here, I’ve decided to round down the VAB buy from 7.9 to 7 units to avoid this. And again, over time as our portfolio gets bigger these rounding errors will have less and less effect.

So there you have it. We now have the orders we want to execute and we can now enter them into the system.

American Portfolio

Important: If you’re using TD Ameritrade as your brokerage, make sure you’re enrolled in the commission-free ETF program. It’s free to enroll but if you don’t they will charge you a trading commission.

And now we move onto our American portfolio. Here’s our current asset allocation. All figures are in USD.

Asset Ticker Unit Price Units Market Value Allocation Target Allocation
Bonds BND $80.60 2 $161.20 31.64% 40%
US Index VTI $117.53 1 $117.53 23.07% 30%
International Index VEU $45.29 3 $135.87 26.67% 30%
Cash $1 94.91 $94.91 18.63% 0%

So right away we can see our rounding error drift is a LOT more pronounced that the Canadian one, and this is mostly caused by how Goddamned expensive each unit of each ETF is. $113.72 for a single unit? Split the shares, people!

And here’s what happens when we add another $500 to the system.

Asset Ticker Unit Price Units Market Value Allocation Target Allocation
Bonds BND $80.60 2 $161.20 15.97% 40%
US Index VTI $117.53 1 $117.53 11.64% 30%
International Index VEU $45.29 3 $135.87 13.46% 30%
Cash $1 594.91 $594.91 58.93% 0%

WAY off target now, so we create our rebalancing table as before.

Asset Ticker Target Allocation Unit Price Current Market Value Target Market Value Current Units Target Units Difference
Bonds BND 40% $80.60 $161.20 $403.80 2 5.0 3.0
US Index VTI 30% $117.53 $117.53 $302.85 1 2.6 1.6
International Index VEU 30% $45.29 $135.87 $302.85 3 6.7 3.7
Cash 0% $1 $594.91 $0.00 594.91 0 -594.91

So now we come up with our orders.

Asset Ticker Unit Price Action Units Proceeds
Bonds BND $80.60 BUY 3 $241.80
US Index VTI $117.53 BUY 1 $117.53
International Index VEU $45.29 BUY 4 $181.16
Total $540.49

Again, fiddle with your buy orders and make sure you don’t buy more assets than your cash balance. Here, I’ve chosen to round down the VTI buy but round up the VEU buy to stay under our cash assets.

And that’s it! We have just done our 2nd buy, and first pseudo-rebalancing. Good job everyone!

And as always, if you have any questions let us hear in the comments below.

WORKSHOP TOOLS:


How much does it cost to participate in this investment workshop? NOTHING. Because that's how we roll. All we ask is that you sign-up using the following affiliate links to keep it free forever:


For Canadians:
Questrade

For Americans:
1) TD Ameritrade
NOTE: Due to their recent changes for their commission-free ETF program, we can NO LONGER RECOMMEND TD Ameritrade. We are currently seeking out a new brokerage to partner with and will let you know when we find one.
2) Personal Capital


Disclaimer: The views expressed is provided as a general source of information only and should not be considered to be personal investment advice or solicitation to buy or sell securities. Investors considering any investment should consult with their investment advisor to ensure that it is suitable for the investor’s circumstances and risk tolerance before making any investment decisions. The information contained in this blog was obtained from sources believe to be reliable, however, we cannot represent that it is accurate or complete.

39 thoughts on “Investment Workshop 7: Time To Buy”

  1. Interesting points regarding the inability to re-balance when above an 80/20 portfolio. To some extent it is true, but only if you hold a restricted amount of equities. Sure, it’s not very easy to re-balance if you hold 90% in one US stock ETF and 10% in a Bond ETF.

    However, if you hold different kinds of equities, like US stocks, Canadian Stocks, International Stocks, Emerging Markets etc. in your 90% equity section, then various fixed income/alternative stocks in your other 10%, like bonds, REIT’s, Gold, Preferred Shares etc. you can maintain an allocation above 80/20 quite comfortably and still be able to re-balance. Your equities won’t always move in the same direction if they are diversified, and neither will your fixed income.

    I recently moved to a 90/10 portfolio and so far re-balancing has been fine, but admittedly there hasn’t been a market crash and my portfolio isn’t very large. I think another key is that you are investing in your account frequently. If you only re-balance once a year it may become difficult to maintain the correct balance with a 90/10 portfolio.

    Also, if your portfolio is large, you can’t really rely on your additional cash investments to re-balance very easily. Assuming you have a $1,000,000 portfolio, investing $1,000 a month won’t do much in terms of being able to re-balance it during a 20% market swing haha.

    It’s actually something I’d be intrigued to delve further into since I am planning on holding a 90/10 portfolio for a long time, would be good to perform some sort of stress test on whether you can cope.

    1. True, but I’d argue when the shit hits the fan all your equities would fall at about the same rate meaning there wouldn’t be much good rebalancing would do.

      There is an argument for starting off aggressive when each cash infusion is still a relatively large percentage of your portfolio since you can “rebalance” simply with your cash buys. Once your portfolio gets bigger though, you may want to back off at that point and pivot more towards fixed income. You naturally do this anyway as your needs shift from going after capital appreciation towards needing the income, so that’s one option.

      Just know what you’re getting into if you go over 80% equity: a wild bumpy ride that will return higher over time, but when a downturn hits there will be very little you can do to cushion the fall.

    1. Yes, many times throughout the blog. We may be in our 30s but we’re also retired so having a 60/40 split makes sense because we need the fixed income. Read this answer on “How Will You Survive a Stock Market Crash?” in our FAQ: https://www.millennial-revolution.com/faq/

      If you’re not near retirement, you can pick an allocation that suits your risk profile.

    1. We’ll be evaluating robo-advisors in the future, BUT before you use them you should know how manual rebalancing works. That way you can check their work. No one will care more about your money than you do.

  2. We have a very unusual environment right now. Both stocks and bonds are close to all time highs. In previous years, when stocks fell, bonds rose to offset some losses in the equity portion. There is a chance that during then next recession both stocks and bonds will fall at the same time and bonds will not offset your equity losses. Have you thought about this possibility? I think that holding 40% in bonds, when rate are so low is very risky.

    1. I think bonds are a pretty terrible asset to be holding right now, as evidenced by the astronomical sell off that is taking place ever since Donald got elected. I was very fortunate to have sold all of my bonds just before he got elected, moving them to equity. The negative correlation between the two since has been incredible.

      Now interest rates are set to keep rising, there is only one way bonds are going and it ain’t up. If Donald follows through with his pre-election promises, we’re set for years of a declining bond market.

      There’s a reason Warren Buffet has reduced Berkshire Hathaways Bond Holdings for the past 6 years straight. As he says, they should come with a warning.

      1. Yes bonds have a long-term negative outlook but when the equity markets get whacked, money flows from risky to safe assets, dropping bond yields and increasing bond prices. That being said when things are scary enough that even bonds are considered risky, money will flee into cash/gold, etc, but we saw in the last economic downturn central banks aggressively dropping interest rates and then going into QE to keep the bond markets afloat. I have no reason to believe they won’t do that again if shit hits the fan.

      2. You’re essentially market timing. Someone who picks an asset allocation and sticks with it over time will likelier do better than someone who tries to time the market / interest rates etc.

  3. Great article! I’ve been trying to set up my portfolio to meet my target asset allocation and it’s been super complicated to try to reach my target allocation between the taxable accounts, pending IRAs contributions for both me and my husband, and me having a new job with a new 401k and an old 401K that i’m trying to rollover, since I’m trying to view everything as one big portfolio. Right now I’m in like a waiting period because the 401(k) rollover won’t mail me the check until end of this month, then I got to mail the checks I receive to my new 401(k) provider (such a freaking hassle). So I have no idea what the market value will be by end of year or mid January when all this happens. Also waiting for my sign-on bonus check with my new job so I can finish contributing to our IRAs

    I can’t wait until everything is set up and all I have to do is rebalancing every 6 months or so! I don’t have that much in my portfolio anyway so I don’t think it’ll go out of whack that much monthly or quarterly.

  4. Thanks for this workshop, it is great! Question: all these purchases are in regularly scheduled intervals based on when you make deposits (biweekly or so), instead of in large lump sums. I agree with this; trying to time the market in larger purchases 1-2 times a year generally does not work out well. But what if you also come into a lump sum? e.g. if you have an individual stock taking up a large percentage or your current portfolio, and want to sell it with the intention of using the proceeds to purchase the diversified collection of ETFs instead? After selling the stock, would you purchase the ETFs all at once, or spread it out over a few intervals?

    1. I’d spread it out over a few months. With large lump sums people tend to sit on it waiting for “the perfect buying opportunity” since they don’t want to screw up, and as a result sit for way too long paralyzed by fear. When I was in this situation, I set up a yearlong buy period and invested every month until it was all in.

  5. Have you considered not rebalancing until your percentages are off by greater than a certain percentage, like 5-10%? I recall looking through some numbers and the it wasn’t worth it to micro-manage my indices if it wasn’t already automated. That being said, if you are still in the growth phase of your portfolio (I am), you can just redirect your contributions–it is exactly like what you’re doing above, except that I would expect that most people in the ‘retirement’ phase of their career to not have a significant amount of disposable cash to rebalance with.

    Great analysis, btw.

    1. Correct. Once you’re invested, it’s generally not good to micromanage. Setting drift targets is one way to do this, but I think just an annual rebalance is fine too. That’s what I do.

  6. 50 bucks in transaction fees for purchasing shares for the Canadian profile, still as not as bad as owning a house.
    I remember the recommended of re-balancing is twice a year otherwise if you keep re balancing you will be spending hundreds in fees unless your portfolio is a 7 figure number

  7. Can you guys explain what an accredited investor is and what benefits it bestows? You would qualify as accredited investors. Has this allowed you to take advantage of any special privileges while investing as a result? Thx!

    1. Privileges? What privileges?

      The Index ETFs we’re using are heavily regulated and have to file disclosures, prospectus, etc. to make sure we know they’re actually investing in the indexes we think they are.

      Other, sketchier investments exist and are called “exempt market issues” because they’re exempt from all these reporting requirements. They don’t have to tell you what they’re investing in. And the catch these can only be sold to “Accredited Investors,” which are people with over $1M in assets. The idea is that these guys are more sophisticated and can take on riskier investments.

      In reality, though, this is how people lose their life savings. Fraudsters trick morons who want to make money but don’t understand investing to sign forms certifying they are “Accredited Investors.” They then put their money into exempt market issues that they create. Then they just steal the money while lying to them. This is what happened with First Leaside.

      http://cawidgets.morningstar.ca/ArticleTemplate/ArticleGL.aspx?id=553695

      So no, there is no privileges to being an “Accredited Investor,” other than acquiring the “right” to invest in unregulated exempt market instruments. Yay?

  8. What are your thoughts about Mark Cuban’s comments about diversification and holding long term? He suggests holding in cash and only dropping money into the stock market when there are clear ‘opportunities’ such as when certain stocks plunge or the stock market plunges. This is opposite to Warren Buffet’s view of which yours is more closely aligned.

    Is Cuban speaking from wisdom or hubris because he has enough money to afford this style of investing? Isn’t his approach a huge pitfall for Joe and Jane investor by being akin to trying to beat the market? Maybe he’s only referring to investors that choose “diverse” stocks in a portfolio rather than index investors which is ‘true’ diversity because it’s so vast (at least as far as ETFs such as VUN which span an entire market).

    https://www.youtube.com/watch?v=zTMqvHt7rmg

  9. With this manual rebalancing, are you using software to do this or did you create your own template? Love this series. Found you guys through the Mad Fientist podcast.

    1. We are calculating it manually. Get some practice doing it yourself so you understand how things work under the hood.

  10. Just a quick FYI, in the US, when trading BND, VEU and VTI through Ameritrade, make sure you’re enrolled in the commission-free program otherwise they will take commission off each trade. I learned that this morning on my first trade. There’s no fee to enroll and it’s just a click of a button but necessary to be trading them commission-free.

  11. This is a very helpful article. Thank you for the seven part series. I have a question about your selection of Index Funds in your CANADIAN Account:

    1. For the Canadian Index fund, why did you chose VCN over VCE? They both have the same MER, but VCE has a higher yield and covers a broader market of stocks. Also, over the past 5 years it has had a better return rate.

    2. For the American Index, why did you choose VUN over VFV (S&P 500)? VFV has half the MER (0.08 vs 0.16), the dividend yield is higher and based on your Canadian Index purchase it would be closer to VCN, wouldn’t it? (Essentially VCN and VFV are both “All Cap Indexes – no?).

    I am in the process of making my purchase decisions for indexes in my RRSPs / TFSAs etc and really like your strategy in this article, however I just wanted to understand your thoughts around purchasing these two indexes. I was leaning towards purchasing VCE and VFV instead of the two you chose. Ultimately the differences are quite small and won’t be a significant difference, I just wanted to make sure I wasn’t missing something.

    Thank you in advance.

    Kent

    1. VCN is total market vs VCE which is large and midcap stocks. Similarly, VUN is total market while VFV is large and midcap stocks. I chose to go with broader diversification, but you’re right at the end of the day it doesn’t make a huge difference which one you pick as long as the fees are low and they implement a passive index investing methodology.

  12. This will be such a newbie question… so forgive me. In other articles you talk about making your investments tax free… using TFSA to buy Cdn/Int equities and RRSP to buy bonds/US equities… but how does that translate to the actual act of purchasing on Questrade? Are the funds going through the workshop all cash? If so, how do you suggest maximizing tax free purchasing on this platform? I am still in the debt repayment phase of getting ready to invest… so I’m trying to learn what I can for the next steps. Thanks!

    1. In Questrade you can open up an RRSP and TFSA accounts and transfer your money into it. For the workshop, we’re not keeping the investments in RRSPs and TFSAs because our limits has been used up. However, feel free to do it in your own account.

      Keep in mind that the existing financial institution you are keeping your RRSPs in may charge you for moving money out, but Questrade may reimburse you for the fees they charge.

  13. Achieving and maintaining a certain asset mix seems to be complicated by the fact that our money is in separate accounts: RRSP, a non-registered account, and, for me, a LIRA. The relative proportions of each asset class don’t match with contribution limits in each of these accounts. What do you guys do? Reproduce your asset mix in each account, or mix and match to try to find the best fit? I assume a proliferation of funds is a pain to rebalance and makes tracking performance difficult.

  14. Very sorry. I now see you covered the issue of asset allocation in multiple accounts in the chapter on keeping investments tax-free.

    Feel free to delete my question from earlier today on this topic.

    Thanks for the fantasticly useful info, and I love the irreverent style.

    Phil

    1. We are in the process of streamlining the workshop spreadsheet and making it into a user-friendly tool. We’ll let you know when it’s ready.

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