Passive vs. Active Investing – The “No-rules” Account vs. A Disciplined ETF Strategy

Passive vs. Active Investing

The “No-rules” Account vs. A Disciplined ETF Strategy

Over the past 15 years or so of working and saving here in Canada, we have built up our retirement accounts.  Starting with a few basic equity-based mutual funds, and later opening self-directed brokerage accounts we began buying individual stocks in addition to the funds. As ETFs become more popular, we added some of those.  About 10 years ago, I became interested in options, and began trading them, usually in the form of covered-call strategies to increase income on stocks I already owned.  Sometimes I would “gamble” with naked puts and calls – a potentially more risky strategy.

As 2016 began I made the decision that it was time to simplify our retirement holdings. Both retirement accounts had become a hodge-podge of miscellaneous mutual funds, individual stocks, ETFs, and options, with no real strategy for diversification across asset classes, sectors of the economy, or geography.

The Current Situation and Simplification Strategy

We have 2 main retirement accounts, one is in my name, and one in my wife’s. Both are of similar total value, with my account, let’s call it Account #1, worth ~$150,000 (CAD), and the other account worth ~$165,000.  Thus, any under or over-performance should be quite apparent as the strategies play out over the coming months and years.

The simplification strategies are as follows:

Account #1 – the “Active” account (approximate value $150,000 CAD)

Investment Mandate: This will remain the actively managed account without too many rules.  It’s essentially a free-for-all in this account.  It can hold Individual stocks.  ETFs, Naked call and put options, covered options, and cash.  There are no set minimums or diversification limits.  I will attempt to maintain some diversification across industries, but there are no hard and fast rules.  Stay loose!  There is potential for excess returns in this account, but there are also many perils.  The ability for psychological biases to creep in and create losses is greater in this account given its wide berth.

Holdings: The securities (as of early May 2016) held in the Active account included:

Canadian Securities trading on the TSX or Venture exchanges:

  • 800 shares CAMECO (CCO.to)
    • Short 800 CAMECO CALL OPTIONS 2016JUN17 17.00
  • 778 shares KP TISSUE (KPT.to)
  • 958 shares TRANSALTA (TA.to)
  • 6000 shares VITREOUS GLASS ( VCI.v)
  • 100 (naked) Put Options PENN WEST PETROLEUM 2016SEP16 2.00

U.S. Securities trading in New York or NASDAQ:

  • 200 shares POWERSHARES NASDAQ ETF (QQQ)
    • Short 200 call options POWERSHARES 2016JUN17 114.00
  • 400 shares WELLS FARGO (WFC)
    • Short 400 call options WELLS FARGO 2016JUL15 50.00
  • 400 shares WHITEWAVE FOODS CO (WWAV)
    • Short 400 call options WHITEWAVE FOODS CO 2016MAY20 42.50
  • 400 shares PAYPAL HOLDINGS (PYPL)
    • Short 400 call options PAYPAL HOLDINGS 2016APR29 42.00

 

RRSP #2 – the “Passive” account (approximate value $165,000 CAD)

This is the account that will have much more structure. It will hold index-based ETFs only.  There will be a target asset mix by geography with regular rebalancing back to the targets.  Covered call writing will be employed to enhance income and reduce volatility of returns.

The target ETF mix follows:

Market                 ETF                                  Target weight

Canadian             XIU (S&P TSX60)               20%

U.S.                        SPY (S&P500)                     40%

International      EFA (EAFE index)              30%

Emerging             EEM                                       10%

 

All previous positions in RRSP #2 were sold in the account my Mid-April 2016. The resulting cash was used to purchase the ETF at the weights described above.

A note on target weights: Why 20% Canadian, 40% U.S., 30% Europe/Asia/Far East, and 10% emerging?  The exact proportions are less important than picking a reasonable diversified mix and sticking to that mix.  Should the U.S. be 50% instead of 40%?  Maybe it should be 30%?  It really doesn’t matter.  The more important question is that there are rules in place and the rules will be followed, eliminating emotion from the equation.

Why these specific ETFs? They are all low cost, popular, and liquid.  They all have options trading on the underlying ETFs, and the options are liquid as well.

Writing covered calls on these ETFs is allowed in this account. The idea is to increase income in the account while reducing volatility and providing some downside protection.  The following guidelines for covered call writing will be followed.

  • Strike prices are to be a minimum 5% above the current ETF price on the day the options are sold. This allows reasonable capital appreciation.
  • Expiry date to be a 1-6 months out.
  • Option premiums received for each sale will provide a minimum 1% of the total value of the underlying position.

 

Rebalancing

Rebalancing back to target weights will occur in Q1 of each year, probably in January.   I considered more frequent rebalancing, such as quarterly, but decided against it for two reasons.  First, transactions costs would be higher with more frequent trading, and second, I like the idea of letting the winners run for longer than just a few months.  For example, if International markets are outperforming other markets, this allows the outperformance to continue for a while before selling off some of the winnings and buying more of the “losers”.  Trends tend to continue for more than a few months at a time, and letting them play out over the course of a full year prior to rebalancing provides the opportunity for excess returns.

 

Future Updates

I will write periodic (quarterly?) updates on the performance of the two accounts. Which one do you think will outperform over time?  Which investing strategy do you follow in your own accounts: Active? Passive? Something in between?  Post you comments below!

Thank you for reading “Why work forever?”

 

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s