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Am I Too Overweight In Mutual Funds?

As investors, one of our favorite words is diversification. We are taught to diversify our portfolios to avoid exposure to any one particular investment or sector of the market and achieve balance. One of the easiest ways to achieve diversification is through purchasing mutual funds, which I did at the beginning of my investing career. However, now that I have grown as an investor and now own 30 individual stocks, I wanted to take a look back at my current mutual funds to determine if too much of my portfolio is allocated to these diversified holdings. It is time to take a look at the five mutual funds I hold and determine if ACTION needs to be taken. The Mutual Funds Currently, I own five different mutual funds . In total, the mutual funds total $16,200, or 25.5% of my total portfolio. These five funds are located in two different accounts, which impacts the accessibility of the capital if I were to decide to make a move. Roth IRA Three of the funds are located in my Roth IRA. I opened these positions during the infancy stages of my dividend growth investing career. At the time, I wanted both dividend income and diversification, so focusing on dividend paying mutual funds sounded like a great idea. So I took the capital I had and divided it evenly among the three funds listed below. ACLAX – 119.803 Shares; MV $1,994; 3.0% of Portfolio – This fund is a four star, silver rated fund on Morningstar. Some of the top ten holdings include: RSG , EMR (One of our favorites), NTRS , OXY , IMO , and CAG . The major selling points on this fund were the diversification, historical performance, strong/consistent management team, and the fact that the fund has a mid-cap focus but still pays a strong dividend. The one major downfall of this fund is the expense ratio, which is slightly over 1%. However, I knew that a fund centered on finding mid-cap funds would cost more than others due to the extra research and time needed to manage the lesser-known stocks. OIEIX – 138.551 Shares; MV $1,916; 2.9% of Portfolio – Another fours star, silver rated fund. This fund does not mess around and is focuses on large cap, value stocks. Some of the largest holdings include: JPM , XOM , JNJ , MO , AAPL , PNC , PFE , and HD . My favorite aspect about this stock is that it pays a monthly dividend. While my check usually isn’t that large on a monthly basis, as evidenced in last month’s dividend income summary, it is nice to see your position grow on a monthly basis. Isn’t that right Realty Income shareholders? MEIAX – 55.556 Shares, MV $1,952; 3.0% of Portfolio – Also a four star, silver fund. This fund has some overlap with OIEIX as some of the top holdings include: JPM , JNJ , PM , PFE , LMT , USB , and MMM (one of my favorites). However, unlike OIEIX, this fund pays a quarterly dividend and has a lower annual fee than the other two above. Since these funds are held in a personal retirement account and are not affiliated with my employer sponsored retirement account, I have the ability to trade these funds without restrictions and liquidate my positions at any moment. Employer Sponsored Roth 401(k) Accounts Like most of us that are still working for an employer, we have a 401k plan that allows us to select from a small pool of mutual funds or the company’s stock. For my company, we are allowed to select from a wide variety of Vanguard mutual funds. Vanguard funds are nice because of the extremely low expense ratios. In this account, I own two different mutual funds. VWNAX – 149.224 shares; $9,726.42; 14.9% of Portfolio. This Vanguard fund is a large-cap value fund with an expense ratio of just .27%, significantly lower than the three funds disclosed above. Some of the top ten holdings include JPM , MDT , PFE , BAC , OTCQB:MFST , WFC , PM , and PNC . If you recall, I left my current employer in March and returned later in the year. This was the mutual fund that I contributed to in my first stint at my current employer and I am no longer contributing to this mutual fund. Therefore, the only changes in value/shares owned are related to changes in market price and the receipt of dividends. Another interesting nugget about this fund is that it pays a semi-annual dividend in June and December. So it doesn’t pay frequently, but when it does, the dividend income checks have a huge impact on my monthly dividend income figures. Want proof? Check out my dividend income summary from the last time I received a payout. VINIX ­- 224 shares; $9,726.42; .8% of portfolio very similar to the last mutual fund. However, two small differences. First VINIX focuses on mirroring the S&P 500 versus investing in dividend stocks so the yield is slightly lower. Second, VINIX pays a quarterly dividend versus a semi-annual dividend. When I re-joined my old company, I thought it might be a good idea to invest in a new mutual fund to diversify my holdings. Since this position will keep growing, I didn’t want to become too overweight in one mutual fund. So now I will share the wealth in Vanguard and continue to max my contributions in this fund so I can receive the full benefit of my employer’s 401k match, which can be a very powerful tool for dividend investors. Analysis As I compiled the section above, there were a few things that jumped out at me. Here are some of the thoughts that came to my mind. There is a lot of Overlap ­- This became evident when I started listing out some of the major holdings in each fund. Outside of ACLAX, which focuses on mid-cap dividend stocks, there is a lot of overlap in holdings in the other four mutual funds. Which makes sense considering that these funds are focused on generating a dividend from large cap stocks and there are only so many stocks to select from. However, if my goal is to achieve diversification among these holdings, do I really need four different funds investing the same pool of stocks? Wouldn’t one suffice? Why am I paying Such High Expense Fees – Is it terrible that my answer is “I don’t know why?” At the time of investment, it made sense to invest in mutual funds. But I wasn’t as much of an expense hawk as I am now so I was willing to overlook the high expense ratios to achieve my goal of diversification. In this day in age, with ETFs designed to achieve the same goal as mutual funds with minimal fees, why on earth am I voluntarily paying this annual fee? A stupid/reckless mistake on my part. I understand paying a fee for a mutual fund that invests in mid or small cap stocks because these companies require more time and research to identify/trade successfully. But paying a fee to invest in a pool of highly covered large cap stocks seems ridiculous going forward. Lack of REITs in Holdings – This one kind of surprised me, especially considering I selected these funds with a dividend-focused attitude. I did not see one REIT in any of the mutual funds I own. I am sure there is some reason why and the tax rules may be too unfavorable for fund families. This was just an interesting observation to me so I wanted to share it all with you. Where do I Go From Here? Based on my analysis and observations above, I think the answer to the title of this article is yes. Holding five mutual funds, which account for over 25% of my portfolio , seems a little heavy. Especially considering that many of the mutual funds invest in the same pool of stocks and are accomplishing the same goals. Well, first things first. Let’s talk about the liquidity of these funds. Since two of my mutual funds are in an employer-sponsored plan, there isn’t much I can do outside of investing my capital in a different mutual fund. And trust me, Lanny and I have performed plenty of research on the available plans in the portfolio and we have selected two of the best. So as of now, I am not going to touch the two Vanguard funds and I will continue to invest in VINIX with each paycheck. Our employer matches 50% of all contributions, so I will continue to contribute the maximum amount each paycheck that will allow me to receive the full employer match next year. Plus, the expense ratio is very low, which is a huge positive compared to the other funds. While I can’t liquidate my two Vanguard funds, it is a completely different story for the three mutual funds in my Roth IRA. I have the freedom to trade these funds as I please. When I initially invested in these funds, I was at a different stage of my investing career and I needed the diversification. However, now that I have grown as an investor, owning 30 individual stocks, there is no need to diversify through owning independent mutual funds. The fees are too high and diversification is achieved through my employer’s plan. So after I receive my capital gain distribution in December, which always results in a nice payout, I am most likely going to sell these funds and use the ~$6,000 to invest in some powerhouse dividend stocks. Which stocks will I invest in? I’m not entirely sure yet. I’m going to special screener in the next month unique to this situation that will help me identify how I should allocate the $6,000 in capital when it becomes available. The screener will look to identify great companies with a long-term track record with a yield in excess of the yield I am receiving on these dividend-focused mutual funds. I’m not certain yet, but I believe one of the moves I am going to make is to invest half in Realty Income based on the results of my last stock analysis. Another option is to focus on one of the stocks on my “Always Buy” list or one of the high yielding stocks on our foundation stock listing. What are your thoughts on my strategy? What percentage of your portfolio are allocated to mutual funds? Do you think I am overweight? Should I consider investing in ETFs in lieu of mutual funds or dividend stocks with the capital to maintain the diversification? Do you have any recommendations for stocks that I should consider?

When To Deploy Capital

One of my clients asked me what I think is a hard question: When should I deploy capital? I’ll try to answer that here. There are three main things to consider in using cash to buy or sell assets: What is your time horizon? When will you likely need the money for spending purposes? How promising is the asset in question? What do you think it might return versus alternatives, including holding cash? How safe is the asset in question? Will it survive to the end of your time horizon under almost all circumstances, and at least preserve value while you wait? Other questions like “Should I dollar cost average, or invest the lump?” are lesser questions, because what will make the most difference in ultimate returns comes from the above three questions. Putting it another way, the results of dollar cost averaging depend on returns after you put in the last dollar of the lump, as does investing the lump sum all at once. Thinking about price momentum and mean reversion are also lesser matters, because if your time horizon is a long one, the initial results will have a modest effect on the ultimate results. Now, if you care about price momentum, you may as well ignore the rest of the piece and start trading in and out with the waves of the market – assuming you can do it. If you care about mean reversion, you can wait in cash until we get “the mother of all sell-offs” and then invest. That has its problems as well: What’s a big enough sell-off? There are a lot of bears waiting for rock-bottom valuations, but the promised bargain valuations don’t materialize, because others invest at higher prices than you would, and the prices never get as low as you would like. Ask John Hussman . Investing has to be done on a “good enough” basis. The optimal return in hindsight is never achieved. Thus, at least for value investors like me, we focus on what we can figure out: How long can I set aside this capital? Is this a promising investment at a relatively attractive price? Do I have a margin of safety buying this? Those are the same questions as the first three, just phrased differently. Now, I’m not saying that there is never a time to sit on cash, but decisions like that are typically limited to times where valuations are utterly nuts, like 1964-65, 1968, 1972, 1999-2000 – basically, parts of the go-go years and the dot-com bubble. Those situations don’t last more than a decade, and are typically much shorter. Beyond that, if you have the capital to spare, and the opportunity is safe and cheap, then deploy the capital. You’ll never get it perfect. The price may fall after you buy. Those are the breaks. If that really bothers you, then maybe do half of what you would ultimately do, but set a time limit for investment of the other half. Remember, the opposite can happen, and the price could run away from you. A better idea might show up later. If there is enough liquidity, trade into the new idea. Since perfection is not achievable, if you have something good enough, I recommend that you execute and deploy the capital. Over the long haul, given relative peace, the advantage belongs to the one who is invested. If you still wonder about this question you can read the following two articles: In the end, there is no perfect answer, so if the situation is good enough, give it your best shot. Disclosure: None.

Last Week’s Best Performer- Acadia Healthcare Company

Summary One of 20 ranked (#11th) as best-odds for wealth-building from coming-price forecasts implied by market-maker [MM] hedging on 6/17/2015. Its target upside price of 78.38 was reached (within ½%) on 6/22/2015’s close at $77.99 after a day’s high of $78.50. ACHC’s +7.7% gain in only 5 calendar days produced a huge annual rate, but was only one of 27 hypothetical positions closed on that strong market-performance day. Their average gain of +9¼% in average holding periods of 33 days from prior lists of top20 MM forecasts resulted in gains at an average annual rate of +166%. Let’s look at what specific circumstances created this bonanza. How to build wealth by active investing Passive investing doesn’t do it nearly as well. SPY is now up in price YTD 2015 at an annual rate of 4.5%. Market-Maker [MM]-guided active investing this year, has identified 1281 such closed-out positions as ACHC, 20 a day. They earned at a +31.4% rate. That’s some 2700 basis points of “alpha” better than SPY. Our “leverage” is not financial. Those results are all from straight “long” positions in stocks or ETFs, no options, futures, or margin. We have the “leverage” of perspective. The perspective of market professionals who know, minute by minute, what their big-money “institutional” portfolio manager clients are trying to buy, and to sell, in the kind of volume that can’t be done with ordinary trades. Not only which securities, but at what prices. And on which side of each block trade their firm is being called on to put the firm’s capital at risk to bring the transaction to balance. We get that perspective by knowing what is meant by the way the MMs protect themselves when they hedge their capital exposures. Their actions tell just how far the market pros think prices are likely to get pushed, both up and down. That perspective is an important leverage, but it is magnified by the way we use perspective on the other key investing resource that is required: TIME. Here is what makes active investing active. We not only buy, we sell. We sell according to plan. The plan is set at the time we buy. An explicit price target is set then, with a time limit to our patience for it to be accomplished. We are investing time alongside of our capital. If the sell target price is not reached by when the time limit arrives, the position is sold, gain or loss on the capital is taken, and both capital and time are ready, positioned for immediate reinvestment. Active investing keeps its capital working all the time, it does not try to time the overall market, nor does it make uncompetitive investments in the market, ones which would accept single-digit rates of return in fear of seeing a loss or having to accept one in order to keep capital and time working diligently. Perspective and time-discipline can keep the odds of having winning holdings positions in favor of active investors. Three wins for every loss is quite doable, and the ratio even reaches seven out of every eight. Here are the specifics of how it worked for ACHC Figure 1 pictures how the market-making community has been viewing the price prospects for Acadia Healthcare Company, Inc.(NASDAQ: ACHC ) over the past six months. Figure 1 (used with permission) The vertical lines of Figure 1 are a visual history of forward-looking expectations of coming prices for the subject stock. They are NOT a backward-in-time look at actual daily price ranges, but the heavy dot in each range is the ending market quote of the day the forecast was made. What is important in the picture is the balance of upside prospects in comparison to downside concerns. That ratio is expressed in the Range Index [RI], whose number tells what percentage of the whole range lies below the then current price. A low RI means a large upside. Today’s Range Index is used to evaluate how well prior forecasts of similar RIs for this stock have previously worked out. The size of that historic sample is given near the right-hand end of the data line below the picture. The current RI’s size in relation to all available RIs of the past 5 years is indicated in the small blue thumbnail distribution at the bottom of Figure 1. The first items in the data line are current information: The current high and low of the forecast range, and the percent change from the market quote to the top of the range, as a sell target. The Range Index is of the current forecast. Other items of data are all derived from the history of prior forecasts. They stem from applying a T ime- E fficient R isk M anagement D iscipline to hypothetical holdings initiated by the MM forecasts. That discipline requires a next-day closing price cost position be held no longer than 63 market days (3 months) unless first encountered by a market close equal to or above the sell target. The net payoffs are the cumulative average simple percent gains of all such forecast positions, including losses. Days held are average market rather than calendar days held in the sample positions. Drawdown exposure indicates the typical worst-case price experience during those holding periods. Win odds tells what percentage proportion of the sample recovered from the drawdowns to produce a gain. The cred(ibility) ratio compares the sell target prospect with the historic net payoff experiences. Figure 2 provides a longer-time perspective by drawing a once-a week look from the Figure 1 source forecasts, back over two years. Figure 2 The success of a favorable outlook comparison for ACHC on June 17 was not any rare magic of the moment. It just happened that enough reinforcing circumstances came together on that day to make the forecast and its historical precedents look better than hundreds of other investment candidate competitors. Those dimensions are highlighted in the row of data items below the principal picture of Figure 1. The balance of upside to downside price change prospects in the forecast sets the stage of similar prior forecasts. They were followed by subsequent favorable market price changes that turned out on that day to be competitive in the top20 ranking of over 2500 equity issues, both stocks and ETFs. On other days luck would have it that several additional stocks were included in the daily top20 lists, and then on June 22nd would reach their sell target objectives. Figure 3 puts the same qualifying dimensions as ACHC in Figure 1 together for the days their forecasts were prescient. Then Figure 4 lists them with their closeout results. Figure 3 (click to enlarge) Figure 4 (click to enlarge) Columns (1) to (5) in Figure 4 are the same as in Figure 3. Columns (6) to (11) show the end of day [e.o.d.] cost prices of the day after the forecast, e.o.d.prices on June 22nd, the resulting gains, calendar days the positions were held from the forecast date, and the annual rates of gain achieved. Several things are to be noted. A number of the positions are repeat forecast days for the same stock. This does not make them any less valid, since investors are posed with the recurring task of finding a “best choice” for the employment of liberated or liquidated capital “today” and these issues persisted in being valid competitors for that honor for a number of days. Note that they are not always sequential days. Further, the TERMD portfolio management discipline uses next-day prices as entry costs for each position. Here for Healthsouth Corporation (NYSE: HLS ) the price rose about +10% from $43.29 to $47.41 on the day. It was still included in the scorecard, although a rational investor judgment call might have eliminated it from the choices. As a result, its target-price closeout on the 22nd resulted in a diminished 0.4% gain and a +14% AROR. Also you may note that some of the closeout prices are slightly less than their targets. This is to recognize that investors often become concerned that positions getting close to their targets sometimes back away, losing a gain opportunity and the related time investment. So our sell rule is to take any gain that gets within ½% of the target price. But all exit prices are as e.o.d., so some are above the sell targets, like the 5/21/2015 Aetna (NYSE: AET ) position at $128 instead of $125+. Conclusion These 27 ranked position offerings are an illustration of how active investing takes advantage of the sometimes erratic movements of market prices. It is in the nature of equity markets that investors sometimes get overly depressed and overly enthusiastic. By being prepared for opportunities when they are presented, the active investor often can pick up transient gains that subsequently disappear. This set of stocks is not abnormal in the size of its price moves. They averaged +9.3% gains, and the 2015 YTD average target closeout gains are running +10%. What is unusual in this set is that their time investment has been brief, only 33 calendar days on average, producing an AROR for the set of +165%. Part of the explanation lies in these 27 positions all being successful in reaching their targets. The 2015 YTD target-reaching average (952 of them) took only 46 days to make +10% gains, for an AROR of 113%. The overall YTD average in 2015 is 57 days, including positions closed out by the time limit discipline, making the AROR a more reasonable +31%. But that is well ahead of a passive buy & hold rate of gain in SPY of +4.5%. The man said “It ain’t braggin’ if ya can do it.” We are doing it, have done it before, and have been goaded into this display by passive investment advocate SA contributors whose statements infer that active investors invariably lose money. That’s just not so. We are not in an investment beauty contest with those whose capital resources are extensive enough to allow them to live comfortably off the kinds of placid returns that passive investing typically provide. They are to be congratulated. Our aim is to let investors who are facing financial objective time deadlines that cannot be met by “conventional conservative investing practices” know that there are alternatives that are far more productive and far more risk-limited than they have been led to believe. Alternatives numerous and consistent through time which we intend to continue to record and display. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.