[Editor’s Note: This is a republished post from Physician on FIRE, a member of The White Coat Investor Network. The original post ran here, but if you missed it the first time, it’s new to you! In this one the PoF lets us check under the hood of his aggressive financial portfolio to see how it has performed over the last year. Enjoy!]
The PoF Portfolio
[In my best Ron Burgundy
I’ve touched on the importance of investing early and often, but I haven’t given you a clue as to how I invest. It wasn’t until sometime last year that I wrote myself an Investor Policy Statement and came up with an asset allocation that felt appropriate. I made a few transactions to apply the allocation across my various accounts. This is the allocation I’ve decided upon:
- 60% US Stocks (with a tilt to small and value)
- 22.5% International Stocks (50 / 50 developed and emerging markets)
- 7.5% REIT (Real Estate Investment Trust)
- 10% Bond & Cash (mostly bond plus cash emergency fund)
Is this the perfect asset allocation?
No. The White Coat Investor has identified 150 other asset allocations that are “better than yours“, although I think mine is definitely better than some of them. The only way to know, of course, is to look back at some future date and determine which portfolio performed the best. We could look in the rearview mirror and backtest a bunch of portfolios, but as we all know, past performance does not predict future results.
How has the portfolio performed?
Let’s take a look at the You IndexTM representing my entire portfolio, provided by Personal Capital, which is plotted against the S&P 500 for 2016.
Hooray, I win! 11.52% up in 2016, compared to 9.54% for the S&P 500.
Not so fast.
Personal Capital likes to make you feel good about yourself by apparently reporting the S&P 500 returns without dividends reinvested. With dividends reinvested, the S&P 500 actually returned 11.96%. So we didn’t win, but came pretty darned close. Considering we were well diversified with a 10% bond allocation and 20% international, I’d say we did well to approach the returns of the S&P 500.
More recently, I’ve published quarterly updates. Here is a look at the first three quarters of 2017.
2017 Q1 PoF Portfolio Performance
I track all my investments with Personal Capital. If you choose to do the same, please sign up from a link on my site to further my charitable mission.
Like last year, we’re tracking pretty darned close to the S&P 500 so far this year. The S&P 500 has returned 5.21% and the PoF Portfolio is up 4.99%.
There was a decent gap there for awhile, but the gap has closed in the last 30 days, with the PoF Portfolio up 0.79% while the S&P 500 dropped 0.72%.
The top performer so far this year has been Emerging Markets, with VEMAX returning nearly 11% already in 2017.
Bonds have been rather flat, and have been the poorest performing class in the portfolio, eking out a minuscule gain year-to-date.
2017 Q2 PoF Portfolio Performance
The market hummed along in the second quarter. Volatility remained low, and gains were slow, but steady. The S&P 500 (Personal Capital’s standard benchmark) returned 2.57%, while my portfolio returned 2.78%.
Returns were boosted by the strong performance of international stocks. Developed markets outpaced emerging markets, making Vanguard’s Developed Markets Index my strongest performer at 6.38% for the quarter.
My bond fund did what bond funds tend to do. While they typically underperform in good times, they also can be expected to outperform when stocks are down. As JL Collins says, they “smooth the ride.” In the second quarter, Vanguard’s Total Bond Fund gained 0.84%.
2017 Q3 PoF Portfolio Performance
At the risk of sounding like a broken record, we had another good quarter. According to Personal Capital’s You Index, my portfolio delivered returns of 4.17%, as compared to 3.96% for the S&P 500.
Impressive? Not so fast. My S&P 500 index fund outperformed both, with a quarterly return of 4.48%. That figure includes reinvested dividends, which are oddly excluded from many reports of the index returns, including the default view from Personal Capital. I’ll omit that orange line from the remaining figures after this one, using my You Index as the comparison.
my S&P 500 > your S&P 500?
My top holding from the last quarter happens to be my favorite (and only) individual stock, Berkshire Hathaway, with a return of 8.24% or nearly double that of the overall portfolio.
Another top performer of the third quarter was the emerging markets index fund, returning 7.77%. You tend to see more volatility in emerging markets, but good stretches can be really good.
The dud of the bunch, which should come as no surprise, is the total bond market fund. Most of the time, I’m glad I keep my bond allocation low at 10%. The smooth ride ended with a 0.09% quarterly return.
How Did I Come up With This Allocation?
I read a couple books, spent some time exploring Bogleheads and WCI, and determined my risk tolerance. Vanguard has a simple risk tolerance questionnaire that takes a couple minutes to complete. Researching for this post, I played around with it a little bit and couldn’t actually come up with a 90 /10 stock bond recommendation. I’m not sure that outcome is even in the algorithm. I usually got 100% stock or 80 / 20 or 70 / 30 depending on when I said I would start taking the money from my investments.
The majority of my portfolio is invested in US stocks. I like stocks for the returns, which have delivered an average of about 10% a year for a very long time. Small and value stocks are favored by people smarter than me for potentially higher returns, so I tilt a bit that way.
I have international stocks for diversification. I overweight emerging markets for the same reason I tilt to small value. Experts with much more experience than me recommend anywhere from 0% to 50% or more of your stock portion be international. I’ve gone with a nice round number in the middle.
REIT funds are considered part of the stock portion, but provide some additional diversity. High volatility has been rewarded with solid returns, particularly if you look back more than 10 years. That says nothing about the future, but real estate will always be required by businesses and people.
Bonds are there as a safe haven and diversifier. If we experience a downturn worse than the Great Depression, I should have something left. I doubt that will happen, but I feel better having a small bond allocation than none at all.
Let’s Look Under the Hood.
Below you will see my asset allocation with the money I’ve got earmarked for retirement. Several items are not listed, including our:
One could argue for inclusion of the first two items as those have value and could be sold to fund retirement. I do include those when I calculate our net worth. I also include our 529 Plans in our net worth (it’s about 8%), but do not include it in our retirement portfolio, as it’s earmarked for a different purpose.
The DAF money, which would represent about another 8% of our portfolio, is no longer mine and will eventually be granted to charities of our choice. I don’t include that in our net worth or the retirement portfolio, but it will certainly serve a purpose in our retirement.
The taxable account has US stocks and International stocks. I tax loss harvest from this account, so the particular fund(s) used will vary as I exchange from one fund to a similar fund.
The Roth accounts have my small-cap and mid-cap value stocks, emerging markets, and REIT. The REIT fund is not very tax efficient, so this is a good place for it.
You might wonder how I have such a large percentage in the Roth IRA. Back in 2010, I converted pretty much all my retirement savings, which was in a SEP-IRA to Roth. In hindsight, it was probably not the smartest move, but the prevailing thought at the time was that the window to make a conversion would only be open to high earners for one year. The window never closed, and I paid 6 figures in extra income tax by making the conversion when I did. Live and learn.
I keep bonds in the 401(k). A total bond fund is not particularly tax efficient, so this is a good place for my bonds. After I retire, I anticipate rolling this over to a traditional IRA, and likely doing some Roth conversions. Whatever hasn’t been converted when I turn 70 will be subject to RMDs, so I also like bonds here for the likely lower long-term return.
The 457(b) has small-caps and mid-caps. Since I tax loss harvest in the taxable account, I avoid keeping identical funds here or anywhere else in the portfolio. Automatic investment and reinvestment of dividends could trigger a wash sale. The 457(b) fund will start paying out the year after I retire. I will eventually put some bonds in here since this will be part of the portfolio that I will be spending from in early retirement.
Nearly all funds are with Vanguard. The portfolio consists entirely of mutual funds and a bit of cash. I could also use ETFs, which are very similar to mutual funds, but trade a bit differently. My mutual funds are passive, index funds. There is no active management of these funds, and each passive fund tracks an established index. This keeps fees low, and it’s not common for an actively traded fund to consistently outperform the index.
Why So Aggressive?
I’ve chosen a rather aggressive allocation. Increasing risk increases potential reward. I know from experience (that ugly 2008) that I’ve got the mental fortitude to watch my accounts lose half their value and not sweat it. Those accounts have bounced back nicely and I was buying on the way down and on the recovery upswing.
My goal is to have > 36 years of anticipated expenses saved up before actually retiring; this is considerably more than the 25 years worth often cited as required to be FI (financially independent) and RE (retire early) and allows for a withdrawal rate of less than 3%. I like to call this financial freedom, which is a level up from financial independence.
There seem to be two schools of thought as to how to invest an oversized nest egg. Some would say, “You’ve won the game. Why keep playing?” Put that money in a very safe portfolio and you’ll never run out. You could go with a conservative portfolio of 80% bonds / fixed income and coast.
I say phooey to that. My plan is to hold about 5 years worth of expenses in bonds. Assuming I still have my site, I can also count on an income stream from it, which is a nice bonus I didn’t necessarily anticipate when I first wrote this post.
With the remaining funds, I can be as aggressive as I wanna be. I’m not saying that I’m putting half my portfolio into Malaysian microcaps. I just don’t have a good enough reason to play it safe with this half of the portfolio. It’s a cushion that I would love to see grow, but if it dropped in half it wouldn’t phase me or affect my long-term plans whatsoever. It’s also money that I may not touch for a very long time, if ever, and if the market does tank, I’ll have time to allow it to recover while spending from the bond portion.
Does this plan expose me to unnecessary risk? I suppose, although a diversified portfolio of index funds is light-years away from the riskiest way to invest a big pile of money. So why would I choose stocks over bonds for the overflow portion of my retirement portfolio? Because I can. Because I’m a man who likes to compete and win. Like Ron Burgundy.
The Legendary Ron Burgundy
I’m willing to take the slight risk that my accounts could lose value and never recover in order to reap the benefits of the much more likely outcome of continued growth that outpaces both bond returns and inflation.
I’m not interested in working until I’ve amassed an 8-figure portfolio, but I’d be lying if I told you I don’t like the idea of maybe having one someday. If it happens, I’d prefer to let the portfolio do the heavy lifting for me.
Portfolio Performance Updates
- May 16,2018: Pof Portfolio Performance Update
- January 3, 2017: Pof Portfolio Returns: How Did We Fare in 2016
- April 11, 2017: 2017 Q1 PoF Portfolio, Spending, and Blog Performance Update
- August 15, 2017Q2 PoF Portfolio, Spending, and Blog Performance Update
- October 10, 2017: Q3 PoF Portfolio, Spending, and Blog Performance Update
What do you think of the PoF portfolio? Is it a PoS portfolio, or something you could live with as your own? I’m open to advise and criticism and I would expect nothing less from my friends on the internet. Sound off below!
I don’t fully understand the logic behind playing things safe just because you can. I think for some people there’s comfort in knowing their assets are less likely to suffer a substantial loss, but that fear comes with a price tag in the form of lower long-term returns.
There’s some excellent SWR research showing that a “safer” portfolio containing > 25% bonds is less likely to last as long as portfolios with 75% or 100% stock. https://earlyretirementnow.com/2016/12/07/the-ultimate-guide-to-safe-withdrawal-rates-part-1-intro/
Best,
-PoF
Even if the historic ‘success rate’ of a portfolio with 50% equities is equally as high as that of a 100% equity portfolio, that belies that the median ending portfolio balance over a 30 year period has been far higher with the 100% equity portfolio. That means that a higher stock allocation, while perhaps not increasing your historic success rate, is more historically likely to lead to you being able to ratchet up your retirement spending and/or the funds that you leave to heirs and/or charity; the ‘game’ will never be over for me.
It has been well known that even though stocks have had a long-term historic real return of about 7%, a static all-stock portfolio in the withdrawal phase could not support a 7% withdrawal rate in a substantial portion of the historic periods due to the volatility of those returns. This is what led to the SWR research pioneered by Bengen and continued by others now. The general consensus seems to be that the ‘ideal’ AA for the purposes of maximizing one’s historic SWR success is 60-80% equities, and that the corresponding SWR is between 3.5% and 4.5%. ‘Giving up’ some of the long-term returns of equities has, both historically and in many Monte Carlo simulations, actually benefited retirees’ success rates by stabilizing their returns and reduce sequence-of-returns risk.
This has made me wonder if there were a better way to reduce portfolio volatility than just trading stocks for bonds or some other fixed income investment the way that most financial experts advocate. So I swallowed the red pill and decided to examine…market timing. Yes, I said it. While many will probably believe this to be heretical to even voice aloud, some preliminary research I’ve done using Portfolio Visualizer and Excel indicates that some of the market timing systems (as Paul Merriman says, ‘mechanical’ market timing, not using emotions, day trading, or trying to predict the future), such as the long used 200 day moving average approach, when used in conjunction with stock and bond index funds, have been able to reduce the volatility of stocks to a point where the SWR could be much higher than otherwise (I won’t say how much higher I’ve discovered they could be because many would think I was lying or trying to sell something), even when the long-term returns are lower than that of a buy-and-hold approach. It seems certainly possible to use these systems in the withdrawal phase to at least ‘get out of the way’ of the worst periods for stocks (e.g. 2000, 2008), which are what have really held back the SWR and, correspondingly, the success rates of higher withdrawal rates.
Historically, it seems that even if a market timing method like the 200 DMA approach (i.e. buy stock indexes when they are above the 200 DMA and move into bonds when stocks are below the 200 DMA) results in lower long-term returns than a buy-and-hold approach, which it often has, during the withdrawal phase, reducing volatility seems of roughly equal importance to returns from a withdrawal rate standpoint. Few dispute that market timing strategies can help investors to avoid 50% declines like those experienced by many in 2008. So even an investor who was ‘dyed in the wool’ buy-and-hold in the accumulation phase might be well served by changing their approach in the withdrawal phase, where getting the majority of stocks’ returns and avoiding huge downside risk may be extremely helpful.
Some might say that this is merely backtesting and nothing worthwhile. But I would kindly remind such folks that the “4% rule” and other SWR research is almost entirely based on backtested data. Like it or not, we all rely on historic data to some extent. That being said, there are obviously no guarantees, and the future could look very different from the past, and those with sizable taxable accounts in retirement might be no better off, possibly even worse off, from a tax standpoint with this approach. I merely say all of this to offer a possibility that some might not have considered and to encourage them to do their own research and come to their own conclusions.
That philosophy in your first paragraph suggests you retired without “enough.” i.e. that you would be happier if you could spend more money than you’re spending in retirement. Now, while there is obviously no cap on how much money you can give away, I think it is folly to assume that more spending will equal more happiness beyond a certain point.
If you’re going to market time/do technical analysis/whatever you want to call it, I think a robotic, unemotional strategy like following a 200 day moving average is a reasonable way to do it and certainly has its merits, although I don’t think they’re any different in the accumulation stage vs the distribution stage. I prefer a static asset allocation approach myself.
“If you’re going to market time/do technical analysis/whatever you want to call it, I think a robotic, unemotional strategy like following a 200 day moving average is a reasonable way to do it and certainly has its merits, although I don’t think they’re any different in the accumulation stage vs the distribution stage.”
They may or may not be different across the two stages; it depends on how the markets and the timing approach both perform. But it is entirely plausible that buy-and-hold may have better long-term returns, making it preferable for the accumulation phase, and market timing may have a better return/volatility ratio, making it preferable for the distribution phase.
“I prefer a static asset allocation approach myself.”
That’s why it’s called personal finance. However, if you saw the difference that market timing could make in your withdrawal rate in the distribution phase (again, I won’t say how much here because people would think I was off my rocker or selling something), I suspect that you might reconsider that stance.