The PoF Portfolio
[In my best Ron Burgundy voice] “My portfolio looks good. I mean really good. Hey everyone! Come see how good my portfolio looks!”
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 Porftolio 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 miniscule 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 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 with 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 in 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 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 like to compete and win. Like 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, 2017 Q2 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 advice and criticism and I would expect nothing less from my friends on the internet. Sound off below!