My investing strategy part 2

My early retirement dreams started when I first got out of college. I was lucky enough to find a job after the 2008 stock crash that had a relatively solid starting salary of 45000 which didn’t go a long way in my state but was enough to start putting some money away. I knew back then that the work until 65 in a corporate job lifestyle wasn’t for me and I wanted some flexibility to do something else before than if I wanted to so that’s where my journey stared.

I had a background in finance and had read a good deal about retirement planning back then coming to the same conclusions that I still hold now.

I believe that active trading while sometimes very profitable was hard to pull off consistently and in the long term often fell behind passive investing in terms of total return. Based on that philosophy I developed an asset allocation plan back in 2008 that I still mostly stick to today.

2008 Asset Allocation
US Large Cap 42.5%
US Mid Cap 10%
US Small Cap 10%
International Developed Markets 15%
International Emerging Markets 5%
US Bonds 7.5%

The idea behind this portfolio was to have a portfolio that provided a return that was similar or slightly better than the S&P 500 while reducing volatility a tiny bit. I knew that the long term return of the stock market was heard to beat so why mess with it and stuck to an asset allocation that was relatively similar to the broad market with some tweaks to increase potential returns.

The US Stock Market is about 72% Large/19% Mid/9% Small Caps and I knew that if I wanted to beat that then I had to tilt slightly more towards the riskier and more volatile small caps which had a higher historical return. In my portfolio, my spread is about 68% Large/16% Mid/16% small so not a huge change but just enough to add some additional potential return without increasing volatility by a whole amount.

I also wanted to add some exposure to the REIT marketplace which would provide me with an alternate investment vehicle that behaves a bit differently than a typical stock and is more focused on income streams along side capital appreciation and adds a bit of diversification to the overall portfolio.

The international markets haven’t performed particularity well in recent years when compared to the US markets but I still think they belong in a well rounded portfolio. The int’l stocks provide some diversification benefits and have been known to outperform US securities at times so they provide a slight reduction in volatility without sacrificing too much in return.

The same can be said for bonds. Their return certainly isn’t anything spectacular but they’re in the portfolio as a volatility reducer and income generator to add some piece of mind during heavy downturns. These are there to reduce your maximum potential loss during a stock downturn and also to serve as a way to sell high and buy low when doing your end of year re-balancing. This isn’t designed to improve returns or anything like that but is more of a safety net against emotional selling or buying when the market is in turmoil. I think a lot of us need something like that and that’s why I have some bonds in my portfolio despite the fact that a 100% pure stock asset allocation would generally produce better results.

So that was part one of my journey – to develop my asset allocation and to stick with it and stick with it I have with only some minor changes. Periodically from time to time, I’ll run a back test simulator using a website like to make sure that I was still happy with the level of projected return and volatility I was getting with my portfolio. Back testing isn’t perfect since historical returns don’t necessarily translate to future gains but it does give you an idea of how your portfolio might fare against something as simple as putting all your money into the S&P 500 and forgetting about it.

Below is a look at a test I just ran comparing a standard 50 US/30% Int’l/20% Bond three fund portfolio to mine and then to the S&P for the last 20 years assuming a 10k initial balance with a 5k/yr addition. The results confirm that the asset allocation I chose is doing what I wanted within that time period. It’s maximizing my return as it beats the S&P 500 while lowering my volatility by a good deal and reduces the worst year as well. This is still a pretty risky portfolio but such is the way with stocks and as I have a pretty long term horizon, I’m not worried about it right now as I’m still well into my accumulation phase. I might revisit it in 5 years or so to see if I want to reduce the possible max loss but for now, I’m OK with wild swings such as this.

The above photo is a bit hard to see so I’ve also formatted it into the table below.

Initial Balance Final Balance CAGR IRR Std. Dev Best Year Worst Year
Portfolio 1 10000 334950 18.20% 7.36% 14.85% 28.57% -30.74%
Portfolio 2 10000 396613 19.16% 8.74% 16.21% 32.64% -35.68%
S&P 500 10000 385760 19.00% 8.52% 19.24% 37.58% -37.00%

As you can see the portfolio is rather risky when it comes to the worst year as there’s a potential for a 35% reduction in portfolio size based on historical data. That is one of the reasons I structured my portfolio as I have because I want some income generators(Bonds/REITs) and something less volatile(Bonds) to add some safety to the portfolio. I feel like I’ll be a lot less likely to sell if the market drops 30-50% any given year because I know I can re-balance(buy high) and have an income stream that I can use to buy more securities for when the recovery takes place. I think this level of piece of mind is important as investing can be very emotional when you see your life savings drop by a ton.

That’s why a lot of investors also like dividend paying stocks; it’s all because that income stream seems(not always is as dividends can be cut) like a constant in a market that is always in flux and adds a feeling of safety which I think is important when it comes to investing. One of the biggest risks to your long term return is emotional buying or selling when you shouldn’t be an a well devised asset allocation like this one will prevent that as long as you believe in it from the beginning. This type of aggressive allocation isn’t for everyone and it’s important that you understand your own risk tolerance and what kind of market movements you’re willing to stomach before you commit to one in the first place. Sites like portfolio visualizer are a good starting point but some additional reading and thinking may be required before you decide on where you want to be and what your goals are since the main purpose of an asset allocation is to help you reach those goals.

My goals are to add a modicum of safety to an aggressive plan that will lead to early retirement so I’m not worried about potential yearly jumps my goal is quite long term. Others may have a different goal or view point and be more or less aggressive but I feel like this strategy works for me.

I’ve mainly stuck to this patch since I started it in 2008 with some minor tweaks. In 2011, my employer began to offer an ESPP where you could buy stock at a good discount to market price and with that came an individual trading account which I began to use sporadically as I got back into investment analysis as a hobby. I own a few individual stocks but am very selective as to what I buy as I plan to hold these for the long term and understand the additional risk that comes with individual stocks. Beyond stocks, I also use this account and another I opened with Vanguard to get access to their free trades to purchase ETFs.

I do have a propensity to switch to keep a certain % of funds in cash when I think stocks get overvalued and I can’t find anything in the market that I want to invest in at current prices. Despite this, I always keep 90% of my investments in the stock market/bonds as per my asset allocation to make sure I’m not missing out on any potential gains. The 10% max protects me from any foolish moves but does allow me some flexibility within my individual trading accounts.

Lately, as I mentioned in other posts, I’ve gotten a bit off track in this plan so I’m sure my asset allocation has wavered a bit – but that was the idea behind this block. To do the research and get back on track with my original goals and invite you on the journey with me.

There’s more to investing than just asset allocation and I want to talk about taxes next but since this post has run a bit long, I’ll continue with that next time.

Please check out the next post in the series right here!

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