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PORTFOLIO STRATEGY

The Two-Minute Portfolio follow-up: Your queries answered Add to ...

Even simple investing strategies should be questioned aggressively by investors.

Take the Two-Minute Portfolio, nicknamed 2MP, for example. It gives you a well-diversified, mostly blue-chip portfolio of Canadian stocks in just a few minutes. You simply invest equal amounts of money in each of the two largest dividend-paying companies in each of the 10 sectors of the S&P/TSX composite index, then rebalance annually. In 2013, the 2MP had a total return (share price gains plus dividends) of 23 per cent compared with 13 per cent for the S&P/TSX.

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I’ve been writing about the 2MP since 1999, and the helpful data crunchers at Morningstar Canada use a 1986 start date for their monitoring of the portfolio. Yet the 2013 update for the 2MP (read online here) has, gratifyingly, generated more questions from readers than ever before.

Any and all questions are welcomed here. Now for some answers.

What’s meant by the two largest dividend stocks in each sector?

The largest dividend payers by market capitalization, which is shares outstanding multiplied by share prices. The 2MP strategy has no interest in the dividend yield of a stock; all that matters is the mere fact that a stock pays a dividend.

How often should the portfolio be rebalanced?

Once a year. The back-testing results use a first-of-the-year rebalancing, which means adding the new market cap leaders and discarding any stocks that no longer qualify for the portfolio. Also, positions in stocks being retained may need to be adjusted so that all stocks in the portfolio are in equal proportion. Some readers have proposed a more frequent rebalancing, but that would add cost and effort to a strategy that already has a history of solid returns.

What is the minimum portfolio size suggested for the 2MP?

It depends on how much you pay to buy and sell stocks. With the online brokerage Virtual Brokers, the penny-a-share commission option makes the 2MP economical for small accounts. At Questrade, with a minimum $4.95 commission, $20,000 sounds like a good minimum. At brokers charging $10 per trade, $50,000 becomes a sensible minimum.

Here’s the reasoning: To set up and rebalance the 2MP, you should expect to make an average 20 or so trades a year. If the total cost of trading is greater than 0.5 per cent of your portfolio, then it would be expensive in comparison to other options for do-it-yourself investors, such as exchange-traded funds.

Many investors have asked whether they must invest in board lots of 100 shares. Short answer: No. You can trade odd lots of any amount and, because you’re mostly buying heavily traded blue chips, you should be able to buy and sell at a competitive price.

Is there a U.S. version of 2MP?

No. Morningstar tested one for me back in 2010 and the results were lame – a 16-year annualized gain of 3.6 per cent in Canadian dollars, compared with 6 per cent for the S&P 500. Morningstar tried a tweak – picking the two highest yielding stocks in each sector – and it produced gains of 8.8 per cent annually. I consider this a spin on the Dogs of the Dow strategy, where you invest in undervalued stocks (high yields are caused by falling share prices).

Is the 2MP suitable for a TFSA?

Yes. In a taxable account, you’ll have to keep track of capital gains and losses on an annual basis, as well as dividends. Both are taxed advantageously compared with regular income, but you’ll nevertheless have some work to do in filing your tax return. A tax-free savings account gets the taxman off your back and allows you to reap full benefits from the portfolio. RRSPs are okay for the 2MP, but you lose the benefit of those capital gains and dividends. When money is withdrawn from an RRSP or registered retirement income fund (RRIF), it’s treated as regular income.

Can I substitute stocks?

Some readers cringe at the idea of buying Barrick Gold, for several years a materials stock in the 2MP, and others are nervous about buying the small-cap stocks that populate the S&P/TSX capped health care and technology indexes. Freelance all you want in your stock picks, but recognize that the portfolio’s strong past returns become meaningless if you deviate from the strategy.

How are 2MP returns calculated?

Total returns are used, which means share price gains and losses plus dividends. Long-term results are expressed as an annualized total return.

Is there an ETF or mutual fund that follows the 2MP strategy?

Been asked that a lot. No is the answer.

Is the 2MP a complete stock portfolio?

It will do for Canada, but you’ll need exposure to U.S. and global markets to properly round out the stock portion of a diversified portfolio.

How can you find the annual 2MP stock list on your own?

The stock screener on the TMX Money website will help you do the job. For screening criteria, choose “exchange” (Toronto Stock Exchange), “sector,” “market capitalization” and “dividend yield.” Once you’ve got a full list of dividend payers in each sector, click the “market cap” column heading twice to order the list from largest company to smallest.

What about selling a Canadian market ETF and switching to the 2MP?

Don’t do it without first considering the many advantages of an ETF, including low cost, diversification across a larger group of stocks and the simplicity of buying the market in a single product. The 2MP beat the S&P/TSX composite index by a wide margin last year, but investment decisions should never be made on the basis of one year’s results.

I contribute to my RRSP twice monthly – how do you suggest I manage the 2MP?

The 2MP is not suited for periodic investment. However, you could collect RRSP contributions through the year in an investment savings account that trades like a mutual fund and then invest it in the 2MP at the beginning of the year.

It all seems too good to be true – are there other down sides?

As with any investment, past returns do not predict the future. So be prepared for the possibility of one or more years of underperformance versus the index.



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Four views of the Two-Minute Portfolio

Here's a look at the stocks in the 2MP from 2011 to 2014 (first and second in market cap, top in each pair being the first). The 2MP must be rebalanced at the beginning of every year, which means adding a few new stocks, selling others and making sure all 20 stocks in the portfolio have an equal weight.

 

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