Monday, July 3, 2017

Change of Strategy for my Roth IRA

Image result for ira
In this post, I mentioned that I was skeptical about using the Dogs of Dividend Aristocrats strategy for my Roth IRA investments and will readjust if necessary. So far, this year's return is a meager 4.64%, which the S&P 500 returned 9.34%. This seems to be losing strategy. The reason is probably that the Dividend Aristocrats stocks are too richly valued. They have become the new Nifty Fifty stocks. Also, high yields is probably is drag on growth, contributing to the underperformance. So it seems high time to cut my losses with this strategy.

Recently, I came across the Value 40 Fund from the University of Michigan which apparently has beat the market by a healthy margin since inception of the fund in 2004. Since 2004, the S&P 500 had a total return of 157% (7.52% annualized), while the fund delivered a total return of 1490% (23.71% annualized)! The fund holdings are updated monthly, and the turnover tends to be high, around 50%. (The high turnover is mainly why I am only considering this strategy for my Roth IRA because in my taxable accounts I would incur too much tax liability.) It would be a pain to buy and sell 40 stocks every month, but 20 should be manageable. It would probably be unwise go lower than 20, because a quick glance at the list of 40 stocks reveals them to be quite risky issues. A portfolio of 10 blue chips stocks is diversified enough, but the number of holdings should be at least 20 for speculative stocks. Buying half the portfolio should be representative enough and capture the return of the fund. Which 20? I figured the most reasonable way is to buy the 20 stocks with the lowest market cap. That way I maximize the small cap premium. I'll label this the Small Value 20 Fund. Whereas the 40 stocks have an average market cap of 2268 mil, the small 20 stocks have an average market cap of 238 mil. P/E is similar (13.51 for all 40 versus 12.85 for the small 20) and 52-week price percentile is similar (72.26% for all 40 versus 69.15% for the small 20). See table below, which sorted the 40 stocks by market cap from smallest to largest; green highlights the smallest 20. I expect the small 20 should produce returns at least as good as the Value 40 Fund.

StockPriceP/EMarket Cap (M)PercentileVolume
Avg of small 20$24.5712.8523869.15%146661

Having made my decision, I put in market orders to sell all my Roth IRA holdings as soon as the market opened today. I liquidated everything including the ten DoDA stocks I held (HCP, EMR, ED, XOM, KMB, CVX, KO, PG, T, ABBV), and put the proceeds (total cash $74,464.55 after selling everything in my Roth IRA) into the small 20 stocks. Here is my new portfolio.

TickerCompany NameTotal InvestedSharesCost BasisPriceMarket ValueG/L ($)G/L (%)% Acct
HVTHaverty Furniture Companies, Inc.$4,174.90166$25.15$25.85$4,291.10$116.202.78%5.77%
MPOMidstates Petroleum Company Inc.$3,728.07289$12.90$13.33$3,852.37$124.303.33%5.18%
SORLSorl Auto Parts, Inc.$3,729.99547$6.82$7.03$3,845.41$115.423.09%5.17%
MLPMaui Land & Pineapple Co.$3,708.00180$20.60$21.25$3,825.00$117.003.16%5.14%
SDLPSeadrill Partners LLC$3,719.461107$3.36$3.44$3,808.08$88.622.38%5.12%
MITTAG Mortgage Investment Trust Inc$3,731.14203$18.38$18.53$3,761.59$30.450.82%5.06%
CFNBCalifornia First National Bancorp$3,732.28198$18.85$18.85$3,732.30$0.020.00%5.02%
BCRHBlue Capital Reinsurance Holdings Ltd$3,726.88202$18.45$18.45$3,726.90$0.020.00%5.01%
CZWICitizens Community Bancorp Inc.$3,723.97266$14.00$13.95$3,710.70-$13.27-0.36%4.99%
WSTGWayside Technology Group, Inc.$3,714.24192$19.35$19.05$3,657.60-$56.64-1.52%4.92%
FONRFonar Corporation$3,702.60132$28.05$28.05$3,702.60$0.000.00%4.98%
REGIRenewable Energy Group Inc$3,715.35282$13.18$13.10$3,694.20-$21.15-0.57%4.97%
AVHIAV Homes Inc$3,716.62184$20.20$20.05$3,689.20-$27.42-0.74%4.96%
CHMGChemung Financial Corp.$3,691.7289$41.48$41.37$3,681.93-$9.79-0.27%4.95%
TACTTransAct Technologies Incorporated$3,732.30429$8.70$8.50$3,646.50-$85.80-2.30%4.90%
ABCDCambium Learning Group, Inc.$3,728.92713$5.23$5.10$3,636.30-$92.62-2.48%4.89%
PNRGPrimeEnergy Corporation$3,696.0077$48.00$46.05$3,545.85-$150.15-4.06%4.77%
DITAMCON Distributing Co.$3,637.6634$106.99$105.50$3,587.00-$50.66-1.39%4.82%
GPICGaming Partners International Corp.$3,656.61298$12.27$11.74$3,498.52-$158.09-4.32%4.70%
FSFGFirst Savings Financial Group Inc$3,684.9967$55.00$52.21$3,498.07-$186.92-5.07%4.70%
TotalRoth IRA$47,500.005657.32$8.40$13.15$74,393.54$26,893.5456.62%100.00%

I wanted to equal weight the 20 stocks, so I calculated 5% of the $74,464.55 cash = $3723.22, with which I bought as many shares I could of each stock at the ask price, starting with the smallest stock. HVT is the largest cap stock of the 20, so by the time I finished buying the other 19, I had more cash left, which is why the cost basis is much higher for HVT compared to the other 19. One thing I noticed from buying these stocks is that the bid-ask spread is huge!! In contrast to more liquid large stocks I was used to that have spreads of only a penny, some of these stocks have spreads of a dime or even several dollars! FSFG is the worst of all with a $4 spread which is like 8% of the stock price. I almost wanted to give up, but I did end up buying all 20 at market price. Now I see why transaction costs can be significant for thinly traded stocks, and why fund managers cannot earn huge returns as their AUM balloons. In the future, I might need to put in limit orders, possibly skip stocks with large bid-ask spreads and just move down the list to the next smallest stock on the Value 40 Fund list. Rebalance every month will keep me busy on the first trading day of each month.

Another caveat to the high turnover is that this strategy is contingent on my IRA broker (Merrill Edge) continuing offering 100 free stock trades every month. Should this come to an end, the strategy probably will also, as the commissions can add up quickly.

By changing my Roth IRA investment strategy, I am going against Peter Lynch's advice to buy what you know. In contrast to the familiar names I sold, the 20 stocks I bought today are companies I have never heard of. I decided to put my trust in academic research instead. Let's see how this works out.


  1. Interesting change and I hope it works out for you. I would have been more apt to do this a few years ago when everything was melting up, but not with the market at/near all time highs. Be interesting to see how the experiment works out for you. Good Luck!

  2. Thanks for stopping by! Yes, I agree the market is a bit high, but it probably still has some legs to run. Also, the Value Fund has a reasonable P/E around 14 which is much less than the general market, so hopefully won't get hurt as badly when the bear strikes. The upside is much greater than the downside, so I don't let fear hold me back from investing in a sound strategy.

  3. Interesting, let us know how it performs. Thanks

  4. This experiment has done horribly for me and I realized that it probably will not work, so I am cutting my losses. Please see for update on this article.