First of all, I want to update the table in the Financial Independence Progress Report.
The portfolio is well on its way to achieving the moderately aggressive goal of “Financial Security” by the end of this year. This milestone is defined as having 20X in the “Total Invested”; where X is, with some padding, the projected post-retirement annual spend. I’d still have a mortgage balance but 20X is such that even if I were to lose my job we would still be able to survive. There would be some painful belt-tightening but at least we wouldn’t end up in the street. YTD, the portfolio has already matched last year in percentage gains (10.87%) as calculated by the simple Dietz method. It’s currently positioned to take advantage of accelerating gains, especially in technology stocks.
“Total Invested” in the table includes the “Total Portfolio” as tracked in this blog as well as the 529 accounts for my daughters and the cash value of a small pension from my wife’s previous employer. “Total Portfolio” is about 90% of “Total Invested”. Networth is defined as “Total Invested” + home equity. We don’t own any investment real estate. I also find it too cumbersome to track the worth of miscellaneous items. The two pie charts below break down the location of various assets.
We’ve always maximized contributions to tax-advantaged vehicles for as long as I can remember. Since my wife is a SAHM these days, current contributions are for my 401K, HSA, and two backdoor Roth IRAs. The backdoor Roth is one reason we kept my wife’s 401K with the previous employer, besides the outstanding stable value fund and other low-fee index vehicles there. Taxable is just shy of half of “Total Invested”, to be drawn upon in early retirement. In a typical year, our taxable contribution outweighs the tax-advantaged kind by some margin, but it does vary since a large part of my pay is incentive-based. Unfortunately I already know 2017 will be leaner than any of the 3 previous years — that I’m still confident about hitting the year end goal is testament to the strength of this market.
Portfolio Strategy Diversification and Asset Allocation
There are two ways to cut across the total portfolio, the first is by different strategies, whether active or passive. Passive stands at just over 40%, active at 56% and the emergency fund (EF) occupies 4%. During the past year, I moved a portion of EF into active accounts due to higher confidence about my position with my employer. The EF is equivalent to about 10 months of current expenses, including potential outlay for medical insurance if I were to be laid off. Total portfolio returns are calculated with cash drag from the EF. The total portfolio and its subcomponents are compared against the benchmark 60/40 SPY/AGG each month.
Before going into each of the passive and active strategies, there is another, more conventional way to look at the overall asset allocation. By that measure I’m at 56% equities, 24% fixed income, 12% precious metal (PM) bullion and miner (miners are not counted towards general equities), 6% cash (includes EF and undeployed cash in active accounts), and finally 2% other that includes cryptocurrencies and options (marked to market). It is difficult to gauge the risk level of this portfolio using conventional stock/bond metrics. 56% equity is very conservative for my age; 24% fixed income + 6% cash is in-line with main stream recommendations. But the fact is I’m already close to the far end of my risk scale since there are assets that are, shall we say, quite volatile. I’m currently underweight PM, 12% with partial hedge vs. 15% target. In addition, I may take on additional option positions. These changes should be completed by the end of August.
Passive accounts is where I use Vanguard or equivalent index funds for the equities including REITs. The discussion in May is still current. Target allocation is 55% equities, 30% fixed income (stable value funds only) and 15% PM (mostly bullion). At the start of each year, I conduct a review and set the asset allocation for the rest of the year. Mid-year changes are allowed as long as they are part of the yearly plan. Changes are usually in 5-point steps and there is a maximum swing of 15 percentage points from equities to fixed income. I’m already at the most aggressive stance in my passive accounts and cannot take on any further risks.
Within equities I take a mild slice and dice approach. US is slightly tilted to small and international moderately tilted to EM. The split between US/international is 50/50, and there is a dash of REITs since I don’t have any in my active accounts.
The active accounts are purely discretionary. They are currently allocated at like this: PMs, 11% actual vs. 14% target; fixed income CEFs, 22% target and actual; growth stocks, 14% actual vs. 15% target; DGI stocks, 45% target and actual; other, 4% actual and target; and cash, 3.5% actual vs. 0% target. Among these categories, I expect the “other” which is cryptocurrencies and options to drift away from the target and I’d be quite alright with that.
In a previous post I spoke of structuring the portfolio to take advantage of both asset bubbles and the supposedly “normal” markets. Given the very nature of bubbles the portion devoted to them needs to be small. Right now that function is taken up by the “other” category which is a combination of cryptocurrencies and directional option combos on tech stocks. My posts on cryptocurrencies can be found here. They are known for extreme volatility. For example, the daily volatility of bitcoin is over 4%, or about 4 times that of gold. Other coins such as Ethereum are even more volatile. So to make the volatilities equal the cryptocurrency position needs to be less than a quarter of the gold position, assume zero correlation. Although I have been writing more about cryptocurrencies lately, larger return potential ought to lie in the developing tech bubble, most likely with AI as the major meme. My chosen vehicles here are option combos that offer high leverage. Similar option strategies were discussed here. Besides cryptocurrencies and tech stocks, I also expect PMs develop into a full-fledged bubble but maturing after the tech stocks.
The rest of the active accounts is geared towards a “normal” if growth-biased market with the same broad categories as passive: PMs, fixed income, and stocks but with more risk. For example, miners, i.e. GDX/GDXJ are a large part of PMs, and they are leveraged to gold price by a factor of 3-4. Fixed income consisted of all leveraged CEFs, which are diametrically opposed to the stable value funds in risk. One major portfolio shuffle this year was to reduce the muni allocation, as it was one source of the major hit last November, increasing taxable CEF allocation in tax-advantaged accounts and move all DGI stocks into taxable accounts. The taxable CEFs have had outstanding performance YTD. This too will one day pass I’m sure, but for now the CEFs are the most reliable performer I have.
At a combined 60% of the active accounts, the actively picked stocks are the largest segment in my portfolio. Performance of the DGI stocks have been tracked since blog inception and I found them rather disappointing to tell you the truth. After the portfolio shuffle, the growth stocks are also being tracked and so far the combined performance just about matches that of SPY. That underscores again how difficult it is to beat the index. I have given myself all the advantages of low cost (one time transaction fee much less than 1 basis point), long holding period, balance between diversification and concentration (~30 stocks total). Of course, there is still the issue of positive skew to contend with. The main advantages I can really see for active stock picking are:
- More opportunities to sell options
- The blended dividend rate of the DGI and growth stocks are currently under 1.6%, lower than that of SPY or VTI, so there is some tax savings.
- It potentially allows me to be more nimble when the market peaks.
The last point is purely hypothetical for now. At any rate, I don’t expect any appreciable out-performance over the index. Below is the sector weight vs. that of S&P. This is something I monitor only, the market weight is not being viewed as a target. If anything, I’m interested in avoiding the under-performing sectors such as energy. Even though the energy sector may have reached a short-term bottom, I’m not optimistic about the secular trend, at least as far as the most vanilla holdings that I have: Exxon and Chevron.
So that’s it, a comprehensive view of the current portfolio. It feels like the major pieces are all in place. With luck, we’ll have the wind behind us for the next 12 months and I’m stoked to see how far it can go.