How to Structure Your Portfolio so it Doesn't Suck

The Challenge We Face

One of the largest challenges that new (and sometimes even veteran) investors face is determining how to structure one's portfolio.

Once my work colleagues found out I was an investor, they started turning to me to advise them on how to build a portfolio. Invariably, they all want to jump on the hype train and buy high-risk stocks like AMC, PLTR, GME, and YOLO. That's fine; we all started off buying individual equities with the expectation of high growth. We are here to make money, after all. However, buying shares of individual companies leads to higher volatility and therefore frustration. 

They have never heard of an ETF.

In this post, I will discuss my view on how to best structure your portfolio to create a strong foundation under your speculation. I will also discuss my own portfolio distribution.

tl;dr: Put 50% of your portfolio into a broad indexed ETF. Put 30% into sector ETFs. Put the remaining 20% into individual stocks and options.

Establishing Your Foundation

When you build a house, you start with the foundation. The same must be true for our portfolios. A broad indexed ETF can serve as an ideal foundation on top of which you can build a more targeted portfolio. I call this portfolio structure a cake.

I remember I once had the goal of owning "100 shares of every stock on the Dow." I used those exact words, and it was a respectable goal that sounded good in high school. But it was also ignorant. There is no reason to structure a portfolio that way. 

If we start investing by choosing individual equities or options, we run the risk of either choosing positions that decrease in value, or positions that underperform the overall market. We don't want to miss out on highly-successful companies by being too precise with our stock picking. You may also overcomplicate your portfolio. In my 100-shares goal above, I could have just bought DIA and achieved the same thing.

Instead of throwing our first investment into Ford (F), we must build a foundation with a broad indexed ETF. With an ETF, you invest in a basket of stocks in a certain sector. There are ETFs for sectors as broad as "Global Equities" and as narrow as "US Cannabis." 

As humans and investors, we are just as likely to pick poorly-performing or overhyped sectors as we are to pick excellent sectors. Therefore, choosing a targeted ETF is no good. After all, is putting the majority of your portfolio into cannabis, sports gambling, and space exploration any way to build a sustainable portfolio? 

50% of your portfolio should be dropped in broad ETFs that track an index. I prefer QQQ, the ETF that tracks the NASDAQ, and I also have exposure to the S&P 500 through SPY LEAPS.

These are both US indexes. Those who want exposure to an even broader range of equities may appreciate ACWI, iShares "MSCI ACWI ETF" which tracks both emerging and developed markets. You can't get much more diverse than "Earth". Since Earth is likely to continue growing economically, it is a good bet that ACWI will increase in price.

Long ACWI or another indexed ETF with 50% of your portfolio. You can choose multiple indexed ETFs, but they should together add to 50% of your total holdings. Let this broad indexed ETF selection be the foundation of your cake that holds the rest of your portfolio together, even if we choose bad frosting.

Adding Your Frosting

You can probably make an entire portfolio out of just VTI or another broad ETF. But let's face it, investing like that is boring and you will likely experience FOMO and frustration. Further, as you gain experience, you will do a better job of identifying sectors in which you would like to invest. Let's get more precise with the next 30% of our portfolio and add some frosting to our cake.

Once we have 50% of our portfolio in broad ETFs, we have a nice foundation for our cake. With the next 30%, we will add a few sector ETFs to our portfolio, and this will be our frosting.

If there are any sectors in which you are particularly bullish, you should look to more precise sector ETFs within those sectors. Although I feel positive about the semiconductor sector, for example, I am not an industry insider. I do not know much about the industry. So if I seek to pick individual semiconductor stocks, I run the risk of selecting garbage. We need an ETF to cast a wider net.

With our frosting portion, we should select a handful of sector ETFs which we believe will perform well. Are you feeling good about the airline industry coming out of the COVID-19 lockdowns? Consider JETS, which captures most of the US and Canadian airlines. Do you feel positive about 5G? Consider FIVG, next-generation internet ETF that captures companies involved in the 5G rollout. 

If you don't know the ETF for a particular sectors, a google search for "electric cars ETF" will bring up plenty of options. GlobalX sets up many ETFs for precise sectors. Focus on volume and bid/ask spread when analyzing simila ETFs. You want high volume. Check "holdings" on yahoo.com/finance to see what stocks are in those ETFs.

Because I am bullish on the semiconductor sector, I selected the VanEck Semiconductor ETF (SMH) to capture the whole industry in one ticker. This ensures I capture the big winners, and although there will be some poorly performing stocks in that ETF, the majority of that industry will do well as long as the companies within it continue pushing their business models. If I didn't believe in it, I would choose a different sector.

I also have dividend sector ETFs that focus on monthly or quarterly payouts to serve as income. Together, all of my sector ETFs add up to about 30% of my portfolio.

There is a reason we do this with only 30% of our portfolio. What if all the sectors we invest in get hammered? Well, we have a nice foundation underneath us with 50% of our portfolio in indexed ETFs. Even if our frosting is bad, the cake is good.

Putting on the Candles

We put 50% of our portfolio into one or two broad, indexed ETFs to serve as the foundation of our cake. We got more specific with our frosting and got into some sector ETFs with the next 30% of our portfolio. Now, we have 20% of our portfolio left. It is time to add the candles.

We have established a strong foundation and targeted some bullish sectors. At this point, we can start picking some companies that we are confident in. This will provide us the thrill of investing and rooting for companies, and lets us take calculated gambles on riskier plays.

My preferred method is to invest in companies within the sector ETFs I chose in the frosting stage. This allows me to build expertise within that sector, and to double-down on particularly strong companies.

From my SMH ETF, I selected LRCX as a particularly strong pick. LRCX makes the machines and performs the research behind many of the semiconductor manufacturer's ability to produce chips. You can read about my analysis in this post. Since I felt particularly good about this company, I let it be one of my candles. If my analysis was poor, then fortunately I had the rest of the sector below it. And if the whole semiconductor sector went to shit, then hopefully the whole world doesn't go down with it and I can count on my indexed ETFs to prop it up.

From my SPHD dividend ETF, I selected AT&T (T) and Coca-Cola (KO). These are reliable stocks that are committed to their dividends, and I think they both have continuously profitable futures ahead of them. Choosing some T and KO candles lets me go deeper into these reliable companies over some of SPHD's other holdings. But again, if I am wrong, the impact to my overall portfolio will be minimal.

This is also the area in which we can take some chances on options plays. Since we are Theta Gang investors, we are already likely selling some covered calls. But with our candles, we have allowed ourselves space to take some riskier trades. This is where we pick companies like AAL, SNAP, APHA, and PLTR to buy calls or PMCCs. The implication is the same: we allow ourselves some space to take a shot at larger gains while sizing our plays well so we can fall back into the rest of our cake if our options fail.

For example, when SNAP dropped into the high $40s on news it banned Donald Trump, I thought the stock was oversold. I bought 10x OTM LEAPS with 3% of my portfolio ($13,000 at the time). It felt like a lot, but in reality, if my play went completely dead, that's only a 3% loss. And while the play is alive, I get to farm theta from selling PMCCs against the LEAPS, the premium from which I reinvest into more cake, frosting, and candles.

Maintaining Your Structure

One first-world problem we face with the cake model is that our candles may increase in value dramatically, busting our 20% candle limit. The same is possible with sector ETFs, but it is more common with individual candles since they can rapidly increase to a greater degree than ETFs can.

AAPL is an example of this. It was about 6% of my portfolio when I bought it. Now it is over 11%, even though my portfolio has also increased in size overall. Since AAPL went flying, it became a disproportionately large candle.

When you're in this position, you should not necessarily sell off some of the shares in your oversized candles to trim it back down. Doing so would incur taxes, and you may be limiting yourself if you trim down your winning positions too quickly.

Instead, go through some reflection on the position and ask yourself, would I buy this large of a position now? If you are still confident in the stock, hold that large candle. Don't give those gains back to the tax man for no reason. If you are satisfied with your gains but would not buy at the higher level, then go ahead and trim the position, pay your taxes, and turn candle into cake and frosting.

For those (like me) who dislike paying taxes, then don't sell. Instead, make future deposits into cake and frosting rather than more candles. This is the method I have been using, and although you sometimes your cake doesn't get big enough to compensate for the growing candles. That's okay. Making too good a stock pick is luxurious problem to have.