Stock sale (& purchase)

I made another consolidation in my Income Fund today to simplify the portfolio. This involved selling two holdings and making two replacement purchases. Nothing major and no panic involved, so click on for the details!

The transaction

I’ve been holding two ETF stocks in my portfolio – Vanguard Utilities ETF (VPU) and Vanguard Energy ETF (VDE). I bought my shares back in 2013 and have added to them from time to time over the last 3 years.

However I sold out of both positions today as I adjusted my asset allocation.

Sold 22 shares of VDE for $2,135
Sold 27 shares of VPU for $2,967
Bought $3,400 of VHDYX
Bought $1,700 of VIHAX

The proceeds from the sale are re-invested back in the two core holdings in my Income Fund at their target 2:1 ratio.

What are ETFs?

Exchange Traded Funds (ETF) are a relatively new investment product, with the first one, SPY, being created in 1993. The story of how ETFs came about is quite interesting too and worth a read.

When you buy an ETF, you buy a share in a portfolio of stocks that is managed along a particular strategy, e.g. matching the S&P 500 index, or investing in a particular stock sector or class of stocks. They can be bought & sold during market hours and pay distributions. And compared to mutual funds, they are more tax efficient in taxable accounts since they don’t generate capital gains. While they can be commission-free to buy, they do charge fees (the expense ratio) which you don’t actually get to see since it lowers the share price.

Of course like anything created by Wall Street, there are more flavors and varieties available now; some based on complicated leveraged / derivative products, and some with high fees. If you are considering to buy an ETF, then look for a simple index / sector ETF with low expenses (< 0.20%).

Vanguard Energy ETF (VDE)

This ETF holds 140 energy companies, the top five being Exxon Mobil (19%), Chevron (13%), Schlumberger (7%), Conoco Philips (4%) and Occidental Petroleum (4%). The top ten holdings in the ETF compromise 60% of its total assets. Its expense ratio is low at 0.10% and it pays a dividend yield of around 2.5%.

The holding percentages really means that if you own $100 of VDE, you own $19 worth of XOM shares, $13 of CVX and so on through the 140 holdings. As of now, the share price is $97 so buying one share can be considered an alternative way to own a collection of stocks vs fractional shares in a sharebuilder or motif type account. The downside is that you give up control over the asset allocation to specific companies (which can sometimes be a good thing).

Vanguard Utilities ETF (VPU)

This ETF holds 80 utility companies, the top five being Duke (7%), NextEra (7%), Southern Co (6%), Dominion Resources (5%) and Exelon Corp (4%). The top ten holdings in the ETF compromise 48% of its total assets. Its expense ratio is low at 0.10% and it pays a dividend yield of around 3.25%.

So what’s changed?

I originally bought these two ETFs when I wasn’t finding a many individual Utility and Energy company shares that I wanted to hold in my individual stock portfolio. They provided a simple way to add instant diversification to round out those two sectors. I could buy XOM and CVX, yet also own a portion of 138 other energy companies via VDE. Although in reality, the amount of diversification is less than it seems.

At the end of May, my Energy sector stocks looked like

Stock Value Asset Allocation
XOM 2092 38%
CVX 1394 25%
VDE 2046 37%
Total $5,533 100%

Now expanding the ETF into its holdings, provides a different picture.

Stock Value Actual Asset Allocation
XOM $2,497 45%
CVX $1,657 30%
SLB $154 3%
COP $81 1%
OXY $80 1%
135 other companies $1,064 19%
Total $5,533 100%

This isn’t a problem by itself, it just illustrates that my asset allocation has been ’tilted’ towards a different weight because of the ETF. Or, to say that another way, I’ve modified the current (market) allocation of the ETF index by adding additional XOM and CVX shares and shifted it in favor of XOM and CVX. Dividend income and capital growth is now driven proportionately more by XOM’s performance than it would be if I just owned the ETF on its own.

Why sell?

I’ve mentioned previously my long-term goal of simplifying my Income Fund investments and limiting the value of individual shares that I own as a percentage of the total portfolio.

Selling these two ETFs and exchanging the proceeds into my two core funds (VHDYX and VIHAX) is a simple step towards that goal, since I count the ETF market value as part of the individual stock portion of my Income Fund. There is a small tax impact from the sale; VDE and VPU are up 5% and 20% above their cost basis respectively, for total capital gains of around $470 which is mostly long-term. I’ll receive a lower tax refund next year as a result (but I will have forgotten this sale by then and my future self will still be happy to have a refund that he can re-invest).

But on the plus side, there will be two fewer individual holdings to track, eight fewer dividend transactions per year, a smaller tax 1099-DIV form to read and I may even receive higher overall dividend income because the replacement funds have higher yields.

But what if the Energy sector has amazing growth this year?

Now perhaps the Energy sector is under-valued and VDE is going to double or triple in value this year compared to say VHDYX? Of course this is possible (but not necessarily likely), and the reverse holds true as well since it could under-perform. This is all just noise since this exchange of ETF into funds is really just a tiny adjustment of the percentages in the stock holdings in my portfolio. This is because of the same ’tilting’ factor mentioned above.

The value of my VHDYX investment at the end of May was $83,692. The fund holds 427 dividend-paying companies and it includes XOM as its second largest holding at around 4%. CVX is in there too at around 2%.

But in selling $2,046 of VDE and buying the equivalent amount of VHDYX I’m simply lowering the percentage of energy stocks that I own by a small amount. Here’s a worked example using XOM.

Before After
VHDYX Value $83,692 $85,738
VDE Value $2,046 $0
XOM (4.3% of VHDYX) $3,598 $3,686
XOM (19% of VDE) $404 $0
Total XOM $4,003 $3,686
XOM % of total value ($85,738) 4.67% 4.3%

Although I have $300 less of XOM in this example, I’ve also increased the amount of MSFT, JNJ, GE, WFG, T etc since those are stocks held by VHDYX that weren’t in VDE.

I’ve also conveniently ignored that at the end of May, the total value of my Income Fund was $245,188 so the overall impact of this transaction is one-third smaller still.

Summary

You might find it ironic that I include a detailed asset allocation calculation in explaining how I’m simplifying my portfolio. I really just included that to put the transaction into perspective.

The capital gains trigged by this transaction have far more impact on investment performance than the minor asset allocation change. I’m mentally accounting the taxes away since I don’t calculate the tax-adjusted return of my investment. The taxes are an easy problem to avoid too – just don’t sell until the market drops in the future.

I should point out I am exchanging some US stocks (via the ETF sales) into International stocks, so the total asset allocation is not just a change in weighting among US stocks. But I’ll let the market and global economy worry about that.


Quote of the Day

What happens is not as important as how you react to what happens.

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