CAUTION: This document describes how I construct my personal investment portfolio. It is not investment advice. For investment advice, please consult a licensed investment advisor. HOW TO CONSTRUCT A STOCK PORTFOLIO ================================== This document gives step-by-step instructions for constructing a well-diversified passive investment portfolio. This document assumes that the investor is using Marketguide (http://www.marketguide.com) to research his portfolio. The goals in constructing the stock portfolio are these: 1) Replicate as closely as possible the return of the market-capitalization weighted world-wide stock index. 2) Minimize fees. 3) Minimize capital gains taxes. Construct the portfolio by following these steps: 1) Compute how much money to put into each region of the world. 2) For each region, construct a market-capitalization weighted portfolio based on the market capitalization numbers from the Marketguide stock screener. 1) HOW TO COMPUTE HOW MUCH MONEY TO INTO EACH REGION of the WORLD If all investments from all countries were available from Marketguide, this step would be unnecessary, because the unfiltered market-capitalization weighted stock list from Marketguide stock screener would equal the market-capitalization weighted world stock index. Unfortunately, an unfiltered market-capitalization weighted stock list from Marketguide is heavily biased toward USA stocks; almost all USA stocks are included, but many or most foreign stocks are excluded. To correct this bias, I recommend allocating investment funds to regions of the world in proportion to the capitalization of each region. Here is the region breakdown I recommend using: REGION FRACTION INVESTED COUNTRIES IN REGION ------ ----------------- ------------------- Greater USA 30 % Canada, USA, Virgin Islands Greater England 5 % Ireland, UK Western Europe 15 % Austria, Belgium, Cyprus, Denmark, Germany, EU, Finland, France, Gibraltar, Greece, Italy, Iceland, Luxembourg, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland Japan 10 % Japan Small Asia 5 % Australia, Indonesia, South Korea, Malaysia, New Zealand, Philippines, Singapore, Taiwan, Thailand Greater China 7 % China, Hong Kong Greater India 7 % India, Pakistan, Sri Lanka Israel & Middle East 5 % Israel, Jordan, Turkey Latin America 5 % Argentina, Bolivia, Brazil, Chile, Columbia, Dominican Republic, Mexico, Peru, Venezuela Russia + East Europe 5 % Hungary, Poland, Russia Other 6 % all others --------------------------------- Total 100 % For each region, to obtain the amount to invest, use the following formula: formula 1.0: = * Record the amount to invest in each region, and use this number in step 2 below. 2) HOW TO CONSTRUCT a MARKET-CAPITALIZATION WEIGHTED PORTFOLIO for a REGION of the WORLD To construct a market-capitalization weighted portfolio for a region of the world, follow these steps: 2.1) Use the Marketguide stock screener to create a list of stocks in the region, sorted by market capitalization, and with total market capitalization for the region displayed. 2.2) Compute the portfolio using the sorted list of stocks. 2.1) HOW TO CREATE A SORTED LIST of STOCKS using the MARKETGUIDE STOCK SCREENER This section describes how to use the Marketguide stock screener to create a list of stocks in your region, sorted by market capitalization, and with total market capitalization for your region. Price, beta, dividend yield, and market capitalization are included for each stock. Create the stock list by following these steps: 2.1.1) Enter the Marketguide stock screener. Click "Screening Tools" on the left part of your screen, and then click on "NetScreen". You should now be running NetScreen. 2.1.2) Select the countries of your region. Use the right scroll bar to scroll down to descriptive screening category "Country Code", and click on the down-arrow on the right side of the text-box. A new window with a check box for each country appears. Check the countries of your region. Remember to un-check countries which have been checked from previous runs of NetScreen. When you are finished, click the "OK" button. 2.1.3) Generate the stock list. Use the scroll bar on the right to scroll up until the "Run Screen" button becomes visible. Click the "Run Screen" button to generate a list of stocks from countries in your region. 2.1.4) View the stock list. In the "Screen Results" area, find the text which begins "Is In Set....". Below this, find bold blue text which says " Companies". Click on this blue text. A report listing all stocks in you region appears. 2.1.5) Format your report. If you have not previously formatted your stock list report, you will need to format, sort, and generate total market capitalization for your report. Do this as follows: 2.1.5.1) Add data you need to your report. Click the "Add/Remove/Arrange Columns" button. A worksheet appears which allows you to select which data appears in your report. Click on "Value Categories" "PRICE & VOLUME" item. Click on "Variables" "Beta" item; click the ">" button to include in your report. Click on "Variables" "Price" item; click the ">" button to include in your report. Click on "Value Categories" "DIVIDEND INFORMATION" item. Click on "Variables" "Yield" item; click the ">" button to include in your report. Click on "Value Categories" "SHARE RELATED ITEMS" item. Click on "Variables" "MktCap" item; click the ">" button to include in your report. Click the "OK" button on the bottom of the page to include this data in your report. 2.1.5.2) Sort your report by market capitalization. Click the "Sort" button. A sort window appears. Click on the box in the column headed by the title "Desc." and in the row labelled by the variable "MktCap". Then click the button "Sort". Your report is now sorted by market capitalization, largest first. 2.1.5.3) Compute total market capitalization for your region. Click the "Statistics" button. A statistics window appears. Click the box in the column labelled "Total" and in the row labelled "MktCap". Then click on the button "OK". Your report now shows total market capitalization for the region at the bottom of the report. 2.1) HOW TO COMPUTE the PORTFOLIO USING the SORTED LIST of STOCKS Once you have your list of stocks with market capitalizations, it is theoretically a very simple matter to buy a portfolio with fraction of funds invested in each stock equal to market capitalization as a fraction of total capitalization for the region. Obviously, the appropriate equation is formula 2.1.0: <$ to invest in stock X> / = / Rearranging this equality gives a formula for calculating the appropriate $ investment in each stock: formula 2.1.1: <$ to invest in stock X> = ( * ) / This formula works well for large capitalization stocks, but for medium and small capitalization stocks it yields many many very small investments in a great many different stocks. Brokerage fees make it uneconomical to make investments much smaller than $2000. The approach we recommend is to use formula 2.1.1 for large capitalization stocks, starting from the top of your sorted stock list, until you get a <$ to invest in stock X> less than the $2000 minimum. Then switch to a sampling method where you invest $2000 in some stocks in an attempt to statistically duplicate the return of the total market of smallers stocks. Specifically, the steps to follow are these: 2.1.1) Compute exact investment amounts for large stocks. First, compute the following constant: formula 2.1.1.1: const = / Next, start at the top of your sorted stock list, and do the following steps for each stock: 2.1.1.1) Compute dollars to invest in the stock. Use this formula: formula 2.1.1.1.1: <$ to invest in stock X> = * const If the dollar value yielded is less than $2000, the formula has failed, and it is necessary to sample. Go to step 2.1.2 below. 2.1.1.2) Compute the number of shares to buy of the stock. Use this formula: formula 2.1.1.2.1: = <$ to invest in stock X> / 2.1.2) Compute smaller stocks to buy using sampling technique. Note that to the left of every stock in your sorted list is a number which specifies the stock's position in the list. The sampling method works by computing the position in the list of stocks to buy. Start by recalling the position of the last stock where formula 2.1.1.1.1 worked. Call this position "old_position". Now set old_position = old_position + 0.5 If formula 2.1.1.1.1 never worked, set old_position to 0.5 Then, compute the following constant: formula 2.1.2.1: const2 = 2000 / const where "const" was computed in formula 2.1.1.1 Next, do the following steps until all of the money for the region is invested: 2.1.2.1) Compute the following number: position_increment = const2 / Note that "old_position" and "position_increment" could contain fractional parts. To find the stock at old_position, ignore the fractional part. 2.1.2.2) Compute the position for the next stock to buy: new_position = old_position + position_increment old_position and position_increment could contain fractional parts. DO NOT IGNORE THE FRACTIONAL PART IN THIS CALCULATION. 2.1.2.3) You should buy $2000 worth of the stock at new_position. If new_position has a fractional part, ignore the fractional part when finding the stock to buy. 2.1.2.4) Compute the number of shares to buy. Use the following formula: formula 2.1.2.4.1: = $2000 / 2.1.2.5) If the investment funds dedicated for this region are exhausted, then stop. 2.1.2.6) The number called "new_position" is now old. Call it "old_position". Don't forget the fractional part. Go to step 2.1.2.1