Portfolio Report Card: A $512,000 One-Trick Pony

Portfolio Report Card: A $512,000 One-Trick Pony

Diversification means different things to different people. In some cultures, diversification means having large families to diversify so that when mom and dad get old, there will be plenty of children and grandchildren to care for them in their old age. For the individual investor, diversification boils down to spreading your risk across a variety of major asset classes. Can owning just one stock or mutual fund inside your portfolio get the job done?

My latest Portfolio Report Card is for Chris, a successful 47-year old entrepreneur who retired 12-years ago after selling his novelty shop.

AUDIO:Listen to Ron DeLegge @ The Index Investing Show

After years of having his money mismanaged by brokers, Chris fired them. He now manages his $512,000 investment portfolio all by himself and he owns just one mutual fund; the Franklin Income Fund class-A shares (Nasdaq:FKNIX).

Before I give Chris his final Portfolio Report Card, let’s examine his investment account together.

On diversification, Chris’ one-trick pony portfolio of FKINX misses asset exposure to major categories like commodities, REITs (NYSEARCA:RWO), and TIPS (NYSEARCA:GTIP). Thankfully, FKINX does have exposure to other key assets like U.S. (NYSEARCA:SCHB) and international stocks (NYSEARCA:EFA), bonds (NYSEARCA:CWB), and cash. Nevertheless, Chris’ current investment strategy is weak on diversification.

What about the actual cost of Chris’ portfolio?

Unfortunately, too many income investors are focused on the wrong ball and Chris is no different. In an email to me, he said, “I use FKINX’s dividend as income which gives me around $2,240 per month.” He’s so fixated on his monthly payments, he sees nothing else.

On the surface, many observers would quickly point out that FKINX carries a 30-day SEC yield of 3.16% – which is higher than the S&P 500’s yield (NYSEARCA:VOO). But that’s only part of the story. Look at how much of that income or dividend is being eaten by FKINX’s expenses.

FKINX Chart

The fund’s annual expense ratio is 0.62%. Put another way, FKINX consumes almost 20% of its yield, which is clearly way out the ballpark in what an investor should be sharing with fund managers. Also, FKINX has inhospitable load of 2.25% (breakpoints for Chris’ $512k account) which is still a high entry fee for future money he decides to add.

All investors should take deliberate steps to minimize taxes. That means smart asset location and tax-loss harvesting when warranted. It also means not investing in mutual funds that needlessly increase your tax liabilities when better choices are available elsewhere. Here too, Chris can improve.

FKINX has a tax cost ratio of 2.21%, meaning shareholders over the past year have paid around 2% of their assets to taxes. From an asset location angle, Chris can do a better job by strategically using a combination of tax-deferred and taxable brokerage accounts to cut his tax liabilities.

What about performance?

From 7/17/13 to 7/17/14, FKINX gained 14.66% vs. a 12.18% gain of blended benchmark of index ETFs with the same general mix of 33% US stocks, 13% non-US stocks, 34% bonds, 13% convertible bonds, and 7% in cash.

Chris’ final Portfolio Report Card is a “C.”

While FKINX is classified as a “conservative income fund” Chris’ biggest risk is a lack of diversification. This is true from an asset allocation and asset location perspective. He’s got his nest egg concentrated in one nest.

Also, if Chris does a better job of minimizing his investment costs, it should substantially increase his portfolio’s income.

Ultimately, his current portfolio strategy relies completely on the very difficult long-term challenge of Franklin’s fund managers to outperform the market. It’s the kind of bet and act of faith that Chris might win, but the odds are stacked against him.

Ron DeLegge’s Portfolio Report Card challenge stands: If your investment portfolio scores an “A”, you’ll get paid $100. Ron grades family trust accounts, 401(k) rollovers, 457 plans, 403(b), UGMA accounts, and anything posing as an “investment.”

Follow us on Twitter @ ETFguide

Suggested Reads:


7 comments on “Portfolio Report Card: A $512,000 One-Trick Pony
  1. KraneD says:

    Nice analysis Ron. I’m learning a lot from these portfolio exams that you’re doing.

  2. BillS says:

    How does $512K of FKINX generate income of $2,240 per month?

    • Ronald Delegge says:

      Hi BillS,

      FKINX has a historical distribution yield of 4.79% but based upon Chris’ monthly withdrawal rate ($2,240) he’s yanking out more than his yield (around 5.1% annualized). Put another way, he’s dipping into his principal.

      Also, I used FKINX’s SEC yield vs. the distribution yield in this article because the former closely approximates the yield an investor would receive in a year assuming that each bond in the portfolio is held until maturity. This measure also assumes reinvestment of all income, and it accounts for fees and expenses.

      Not only is the SEC yield a requirement, but it provides a more accurate result than the distribution yield, and it is more consistent on a month-to-month basis. The SEC yield is therefore the best method for making an apples-to-apples comparison of the future yield you can expect when evaluating two or more mutual funds or ETFs. In contrast, the distribution yield is backward-looking, and not necessarily representative of the yield an investor will get in the future.

      • Jay says:

        How can you possibly consider the SEC yield a more accurate calculation of comparing mutual funds. First, you cant put all mutual funds on the same field. The yield of an equity fund should never be compare to the yield of a bond fund. Second, The SEC yield is simply looking at the last 30 days, where the distribution rate is much more accurate (based off the most recent distribution, annualized, relative to the most recent NAV Close). If you want to know what a fund is paying in current valuations, USE THE DISTRIBUTION RATE!

        • Ronald Delegge says:

          FYI Jay, the DISTRIBUTION RATE is a historical metric and not indicative of future yield. It’s not a perfect measure of yield because there is no “perfect” measure. And even with its flaws, the SEC Yield provides an excellent snapshot of a fund’s most recent yield.

          The benchmark of mutual fund cost and performance I use is always the passive alternative, not perverted peer group analysis. This approach is consistent and supported by academic research by people like William Sharpe. It’s not a measurement or analysis approach supported by the mutual fund industry or Wall Street. But I don’t care what they think.

  3. Ronald Delegge says:

    FYI Jay, the DISTRIBUTION RATE is a historical metric and not indicative of future yield. It’s not a perfect measure of yield because there is no “perfect” measure. And even with its flaws, the SEC Yield provides an excellent snapshot of a fund’s most recent yield.

    The benchmark of mutual fund cost and performance I use is always the passive alternative, not perverted peer group analysis. This approach is consistent and supported by academic research by people like William Sharpe. It’s not a measurement or analysis approach supported by the mutual fund industry or Wall Street. But I don’t care what they think.

Leave a Reply

Your email address will not be published. Required fields are marked *

*

One FREE Month of ETF Premium

Click the report icon to sign up and receive one FREE month of ETF Premium Membership.


Show Buttons
Hide Buttons

Get One FREE Month of ETF Premium

Simply provide your email address and we'll give you One FREE Month of ETF Premium!