Developing a Portfolio Protocol

The Workshop community is discussing the details of how to set up and manage a mechanical portfolio. Eventually, the discussion will result in a protocol that lays out the way the Workshop Portfolio will be purchased, renewed, and managed. �The original blend of strategies proposed last week has been refined, and the dangers of underfunding and overdiversifying are duly noted.

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By Ann Coleman (TMF AnnC)
December 7, 2000

This is Be Kind to Editors week, so today's report will run in two parts. Those of you reading this in the Workshop area can find tomorrow's version in the Foolish Four area.

The Foolish Workshop community has been discussing every aspect of the real-money Workshop Portfolio that we will be starting in January. The process has been a wonderful learning experience -- for me, at least. Not only do we have a pretty good consensus of which strategies to use but almost every aspect of running a mechanical portfolio, from start date to rebalancing, has been discussed and for many issues a "best practices" consensus is emerging.

Exciting stuff! Maybe not quite as exciting as statistical testimony in various Tallahassee courtrooms... (just kidding). Today, I want to summarize where that discussion is. If you object to any of the decisions reached, or have questions about them, or other issues you would like to see discussed, the thread starts here.

What is slowly emerging from this process is a protocol that we will follow when setting up and managing the portfolio. We will write it down before the first stock is purchased and follow it as best we can. I doubt that we can anticipate every contingency, but we are making every effort to decide in advance exactly how we will proceed. I don't know about you, but every time I make a plan and try to follow it, something comes along that I didn't anticipate. So we will reserve the right to make adjustments if that happens. But generally we will commit to following the protocol as mechanically and unemotionally as possible through the first year. Next December we will see what we have learned and reevaluate the rules.

Today and tomorrow I will summarize the discussion thus far and report on the decisions reached. Many thanks to Elan Caspi for pulling together the various ideas that are scattered through the board and for his role in moderating the discussion. Moe Chernick has also been helping with this project. He's on vacation right now, but we expect to see him back soon to help us refine the final protocol.

The working model portfolio proposed on November 29 was:

Based on suggestions from the community and testing, the original six-strategy portfolio has evolved into:
All strategies hold three stocks. The Foolish Four will also be part of the portfolio. (Guess how many stocks it will hold?) We will reduce the amount invested in each Foolish Four stock so that the strategy as a whole carries the same weight as the other strategies. For example, if we invest $1000 per stock in each three-stock strategy, we will invest $750 in each Foolish Four stock.

Key EPS was substituted for Key100 because it provided more diversity. I rather hated to see it go because Key 100 has been wonderful for the last couple of years. But this is unemotional investing. Switching to the KeyEPS shifts the strategy to larger-cap companies that may balance the small caps picked by some of the other strategies. (Or it may not matter.)

Plowback was changed into a semiannual largely because it seemed like a good idea to have a semiannual strategy. OK, that may not have been the most logical approach, but the change didn't affect the way the portfolio blend would have worked in the past (even when trading costs were considered), and it does give us some symmetry. The RS-13 monthly was replaced with the PEG-13 monthly for a number of reasons, among them, that the PEG-13 monthly is one of best-performing screens ever discovered. Then PEG-26 was dropped since it didn't seem necessary to have two PEG screens.

Reducing the portfolio from six Workshop strategies to five was suggested by many, many readers. It's simpler, reduces trading costs, and is more like something that an individual investor would set up. Of course, when the Foolish Four is included we are still at six.

There was some discussion of the ways in which this portfolio doesn't reflect what an individual investor would do. Many thought we definitely have too many strategies and that starting with just $1000 per stock is too little. I agree. Commissions will probably constitute a higher percentage of this portfolio than we advise others to accept. Essentially, we are trading some percentage of our potential return off against the educational value of following more strategies, and keeping the amount per stock low has more education potential for smaller investors. (I just hope the education isn't too expensive!)

We will be using the Brown & Company brokerage, which offers $5 Internet trading. Two Fools suggested we check out one of the new online brokers that offer free (Financial Cafe) or virtually free (Interactive Brokers) trading, but the consensus was that they might be just a bit too good to be true. We will wait and see. (Also, Interactive Brokers is not set up for IRAs yet.)

Workshop Portfolio trades will be announced on Friday afternoons. The exact mechanism for that is still being worked out here at Fool HQ, but we will need to be sure that all portfolio trades are announced in advance. If we announce on Friday, the trade will take place the following Monday, probably not at the opening -- Mondays tend to open rather wildly.

That's enough for now. Tomorrow we will get into some of the nitty-gritty of how to rebalance within and among strategies, what to do when a stock is selected by more than one screen, and the exact start date. We will also talk about some minor issues raised and suggestions and criticism received.

If you are considering starting a mechanical portfolio, reading this thread, all 200 or so posts, is one of the best educations you can give yourself. One thing, please: If you have basic questions about terms or techniques, first follow the thread through all the way to see if you can pick up clues, then ask your question by starting a new thread rather than posting in the main thread. It's long enough as is! (You start a new thread by clicking Post New instead of Post Reply.)

Fool on and prosper!