This is a continuation of the last post, where I discussed my personal asset allocation, and answers some frequently asked questions about it.
Why 75% stock?
Benjamin Graham, in The Intelligent Investor, wrote that an investor should never have more than 75% equity or less than 25% equity. I obviously found his arguments persuasive. It was nice to have some dry powder to use in late 2008. Having 25% of the portfolio in bonds helped me weather the bear market with gusto. I do plan to gradually reduce the amount of equity to about 60% by the time I hit my early 50s.
Why so many asset classes?
Like Bill Bernstein, I'm an asset class junkie. I wish I could be as hands-off as Mike Piper with his single fund portfolio, but that's just not me. I like the tinkering, rebalancing, and trying to eke out a little more return. I'm very much aware that the mathematical benefits of adding additional asset classes above and beyond 7-10 suffers severely from the law of diminishing returns, but I just can't help myself.
How did you decide how much to tilt to small and value?
In an effort to balance Larry Swedroe's arguments for a heavy small/value tilt and Jack Bogle's arguments for an ultra-low cost total-market-based portfolio, I decided to do the value tilting on the domestic side and the total market thing on the international side. So the domestic tilt is basically 1/3 large cap, 1/3 mid cap, and 1/3 small cap.
What's with the micro-caps?
Since my 401K (the TSP) had only one small-cap fund, which was really a mid-cap fund, I needed a very small cap fund to get the 1/3, 1/3, 1/3 balance I was looking for. I also found Rick Ferri‘s arguments for micro-caps persuasive, so I added BRSIX, an index-like micro-cap fund to the mix.
Why so much (or so little) international stocks?
It is interesting that in the beginning, I was asked why I had so much in international. Now, the more frequent question is why I have so little. My allocation hasn't changed. I do find that the questions are usually related to the performance of the respective markets in the previous year. If international equities have done well, or the dollar has done poorly, the question is why not more? If vice versa, people want to know why I have so much. I honestly don't think the actual percentage matters, so long as it is somewhere between 20% of your equity and market weight (currently about 55% equity.) The important thing is keeping the same percentage through the years. So I picked something in the middle, and kept it there.
Why the high-quality, TIPS-heavy, short-duration bond portfolio?
Larry Swedroe's arguments to take risk on the equity side seemed compelling at the time. I've considered making changes here many times in the last few years, especially in our very-low-yield environment.
Why no significant changes in 5 years?
Like most investors, I am susceptible to performance chasing. In fact, even adding REITs to the mix was horribly timed. I bought in almost at the REIT peak, losing about 75% of my initial investment in the bear market. I more than gained it back by staying the course, but I learned a real lesson about market-timing and performance-chasing. My written plan requires a 3 month waiting period before making any portfolio changes, and that alone keeps me from making most of the ones I come up with. It just never seems like such an important, urgent idea after a few months.
What changes are you considering now?
I recognize that I am bordering on too many asset classes. It can be a bit of a pain to rebalance them and keep track of all of them. When adding an exotic asset class you're almost always paying higher expenses compared to a total market based portfolio. So some of my considered changes involve combining asset classes so that I have fewer. I have considered dropping the extended market (basically mid-cap) asset class and dividing it between total market and small value, dropping the large value asset class and dividing it between total market and small value, and getting rid of the micro-caps, probably again in favor of small value or international small.
As a true asset class junkie, however, I am always considering adding new asset classes. I have been very impressed with the way long treasuries acted in the last bear market. I suspect I'm just performance chasing, however. I've also given consideration to adding commodities in some form. Perhaps one of the newer index-based commodity ETFs, perhaps a small slice of gold, or maybe some energy MLPs. I'm not sure what I would drop to add these though. Vanguard has also come out in recent years with an international REIT fund, and I've considered splitting my REIT allocation to include that.I have also considered getting rid of the large developed market asset class and dividing it between the total market and the international small asset classes. It turns out that US large caps and developed market large caps have pretty high correlation, and that the main non-correlation between them comes from currency changes. There is much lower correlation between US large caps and international small caps, and you still get the benefits of changes in currency. I'm not sure taking on the additional expenses and tracking error as well as the loss of diversification are a good idea though.
The most likely change, however, is that I will probably add a small slice (5%) of peer to peer lending investments to the portfolio, so that my fixed allocation will be 10% TIPS, 10% G Fund, and 5% P2P. The risk is far higher than my other bonds, but the correlation between P2P Lending and my other asset classes ought to be very low, and returns are quite promising thus far (around 10%) for my tiny experimental portfolio. I figure if you're going to chase yield in this low-yield environment, you might as well go big. No point in taking on more risk for 0.2% more yield. Some of those P2P loans I hold yield over 26%.
What kind of returns has this portfolio had?
It's hard to say, exactly, although I suppose it could be calculated. What I can tell you is my own personal returns. These are heavily affected by the timing of new investments, of course. For example, adding funds in late 2008 and early 2009 was very beneficial to my dollar-weighted returns compared to time-weighted returns. But liquidating funds in early 2011 to do a Roth conversion caused me to miss out on some market gains, hurting my dollar weighted returns. These returns are dollar-weighted, after-expense returns. My after-tax returns are actually slightly better, since I have benefited far more from tax-loss harvesting and donating appreciated shares than I have lost paying taxes on investments.
| 2004 | 11.98% |
| 2005 | 8.12% |
| 2006 | 18.85% |
| 2007 | 4.40% |
| 2008 | -31.62% |
| 2009 | 33.63% |
| 2010 | 16.07% |
| 2011 | -3.51% |
| 2012 (though 3/14) | 9.10% |
| Annualized | 6.82% |
Is that return sufficient to meet your goals?
My investing plan calls for a long-term 5% real return. Inflation for the last 8 years has averaged 2.5%. That leaves me a return of 4.32%, which is a little low. If this keeps up, I'll need to save a little more, work a little longer, or live on less in retirement.
How much of your portfolio represents investment gains?
After 8 years of annually increasing portfolio contributions, approximately 20% of the portfolio is nominal investment gains and 80% represents nothing but brute savings and foregone consumption. In the throes of the bear market, I actually had less money in the portfolio than the sum total of my savings to that point.
I don't like your portfolio.
I don't care. It doesn't have to meet your goals, only mine. Besides, you're almost surely better off with one that you've designed yourself because you're more likely to stick with it. Is there an asset allocation that did better than this one over the last 8 years? Of course. But there are thousands that did worse. Any reasonable asset allocation is acceptable, as long as you stick with it, keep your expenses low, and save a sufficient amount.
My next post in this series will discuss how I've personally divided up my portfolio among my various investment accounts.
i like your attempts with being honest with yourself…ie when you realize that some decisions may be luck/timing or arent based on anything more than your personality. way too often people arent so honest. This leads to all kinds of problems. Ive only been active at this for about a year with the previous two stuck with a portfolio of 50% whole life and 50% annuities within a qualified plan and thus im still struggling with my portfolio. On the positive side, i have tremendous returns for the time period ive been self investing. On the negative, i havent truely tested myself on staying the course which of course is going to happen. What i also like is how you explain your mistakes. As health care becomes less lucrative for physicians, it will become increasingly more important to take an active role in investing. Its actually much easier and less time consuming then trusting a “financial advisor”.
Great article. It makes me think more critically about why I’ve made the percentage choices in asset classes over the years. I’ve followed the slice-and-dice theory as well, but it is harder to keep track of the long-term percentages.
I think getting a 5% real return is gonna being a little difficult. Since 1926 the real return of the s and p has been about 4% or so, and with the dismal economic growth I think a 5% real is going to be tough. Also, if you lose 50% in one year, you will have to make 100% the next year to break even. The reason you got back from 08′ was your 25% in bonds, if you were 100% in stocks you would still be negative.
5% may be difficult, you’re absolutely right. I’m hoping the presence of classes that are riskier than the S&P 500 will provide a bit of a boost to get me there. If not, well, I’ll have to save more.
It wasn’t my bonds that helped out in ’08. Anyone who bought and held any reasonable allocation from 50/50 to 100% stocks bounced back in 2009. My parents’ 50/50 portfolio had an 18% loss in 2008 and a 24% gain in 2009 with almost no money added. It did help a little that I plowed money in all the way down, at the bottom, and all the way back up. The main thing was to not sell out at the bottom, as two of my older partners did (who are now still working because of it.)