The current market direction that can be extracted from various indices -- the S&P500, NYSE, NASDAQ and S&P small cap 600-- is clear (see previous article). What is a little surprising is that the small cap index has moved ahead of the first three and this against common beliefs that large capitalization will (again) outperform the small caps. Going by the numbers, i.e. what the market tells you it is doing, has so much more value than listening to commentators or investment gurus.

Are small caps leading? I was hoping you would ask and even search for the response… If you did you found that the small cap index is not in the lead! The REITs have so far in 2007 performed even better. I like to use ICF (another ETF) as a proxy although there are many others. ICF yielded YTD 12.1% or three times the S&P small cap index.

Let us take all of this and construct a portfolio that will be passively managed --meaning transactions will only be made to avoid significant losses, there will be no chasing of better opportunities—with the objective of matching or exceeding a benchmark… with the least amount of effort -- call it the “anti-thesis O’Neil” investment approach--

What benchmark shall we pick? Let’s use the MSCI World stock index – which was covered in Ken Fisher’s book -- although given what follows we could have picked others.
Instead of employing the weights of the MSCI World Index (which only represents 23 developed countries in the world) our portfolio will use the market information in this and the previous article. In other words we are not going to speculate as to what stock markets will outperform; we are going to go by what the markets are currently telling us. Thus we are letting the market decide what to invest in.

Let’s assume we start with a capital of $50K (although we could do the same with any amount) and allocate equal dollar amounts to just four holdings. This is crucial because we do not want to over diversify, nor be overly exposed to just one part of the world. My picks based on what I provided earlier are ICF, IJR, ILF and EPP (all ETFs which are traded daily and hence easy to get in and out off).

To figure how much to buy from each we take $50K divided by 4 and then by the price of each of these ETFs. For example, for ICF compute $50K/4/112.45 to get 111 shares. For IJR compute $50K/4/$68.53 (the close price) to end with 182 shares. The same should be applied for the other two holdings. Share amounts are rounded since with ETFs one cannot buy fractions of shares –

Thus the $50K is allocated as follows: 111 shares of ICF, 182 shares of IJR, 69 shares of ILF and 95 shares of EPP. Note that this still provides us with 50% allocation to the US markets, 25% to Latin American markets and 25% to the Pacific region excluding Japan. If we were to simulate the return of that portfolio assuming we had started it on 01/02/07 the YTD would be 6.8%, not bad given that the MSCI World index is at about 3.9% and the S&P at 2.2% as off the close of yesterday.

Will this allocation hold up? Will it be able to gain enough on the MSCI World index so has to end the year with a return that is comparable -- if we invested this portfolio yesterday, we were already 6.8% behind matching the index for the year--?. The more important question is: do you feel confident enough to take $50K and invest it in the market today along these lines?

A lot of investors enjoy watching the markets but never achieve great results... because they never put their money down. It’s hard to learn to invest if one is not willing to take a risk. This portfolio will be monitored throughout the year, so stay tuned…

732 words 2.4 minutes @ 300w/m