2017 Review

Now that 2017 is in the books it’s time to have a more in-depth review of our investment activities. With more monthly returns available, we can also make more meaningful comparisons to the benchmarks. Accurate return analysis is a critical part of self-evaluation: if we were better of putting our money in index funds then we would need to face up to that fact.

Let’s start with our overall FI progress. I track our total invested (total portfolio reported here + 529s + a small pension) in the table below. The values are shown as a multiple of X: our projected future annual retirement spend. There is some slack in X, such that I consider 20X financial security: a softer form of financial independence where we can sustain a bare-bones standard of living indefinitely. My goal of reaching financial security by the end of 2017 was reached two month earlier. In fact, we reached 22X before 2017 ran out. The next milestone is 25X and mortgage-free which is the canonical definition of financial independence. Assuming the mortgage is still around -4X, it implies a total invested value of 29X or about a 30% gain plus additional contributions from here. My (somewhat dated) stretch goal for reaching FI was EOY 2019. If the market cooperates, we may reach this goal by mid 2019 or even the end of 2018.

The table below describes the increase in the total invested amount in the last two years. My compensation from work was leaner than usual in 2017 hence the reduced contribution vs. 2016. In addition, I exited the majority of my cryptocurrency positions in December, incurring tax liability which was deducted from the contribution amount. Nonetheless, the investment gain of 5.07X more than made up for the lack of contributions. For reference, the gain outstrips my W2 income even in a good year. The return rate of 30.01% was calculated using the Simple Dietz formula applied to the year as a whole: return = (End Value – Start Value – Contributions)/(Start Value + Contributions/2). It assumes all contributions are made at the middle of the year which is a decent enough approximation: I tend to make Roth and 529 contributions early in the year, the bonus and RSUs hit late in the year, and 401K/HSA contributions are made evenly throughout.

Of the dollar amount gained from investments, cryptocurrencies contributed the most, about 1.4X, followed by 0.9X from options. Other sources of outperformance were individual stocks and closed-end funds. Precious metals related positions were a net detractor. In 2018, I expect the majority of the speculative gains to be from options.

Counting back to blog inception there are 17 monthly return data points (see the December update). The first figure below plots the monthly returns for my passive, active accounts, the total portfolio, $SPY and the 60/40 portfolio; while the second figure shows the normalized cumulative value. Immediately after blog inception, losses in both PMs and the muni CEFs put my accounts “in the hole”. They clawed back slowly, and started accelerating in June’17 when I started building up leverage through options. Currently both active accounts and total portfolio are above their benchmarks (total portfolio vs. 60/40, active accounts vs. 80) by a significant amount. The results of the portfolio shuffle at the start of 2017 where I revamped both the individual stocks and the CEFs were not as visible on these charts but were present, e.g. the individual stocks were about +3.7% vs. SPY since April.

The final two figures compare my monthly returns vs. the benchmarks in the same way that CAPM extracts the alpha/beta parameters. We can make some qualitative statements based on these figures: the slopes are positive indicating broadly positive correlation to stocks, the slope is greater than 1 for active and less than 1 for passive indicating respective risk orientation, the low R^2 indicating lack of correlation/presence of other return drivers, etc.

Lastly I want to comment on risk and volatility. Cryptos were a huge return driver but also highly volatile, with a daily STD around 5%. My rule of thumb was to limit monthly exposure to 2% or a 5% allocation assuming they can lose up to 40% in a month. This allocation was briefly exceeded in December before I exited 90% of the position. I may engage in more short term trading in 2018 but do not expect crypto to be as big a return driver or contributor to volatility. My equity exposure has hovered between 110% to 130% in the last couple of months, around half provided by options where the leverage ratio was up to 40 at times. In 2017 the Sharpe ratio of my total portfolio almost exactly equals that of $SPY, although much of the volatility for my portfolio was from the large gains in Q4. 2017 was a historically low volatility year. In general, I’m comfortable with an annual STD around 10% but in the end it’s all about realized returns. My main risk control method is market timing, and I expect hedging based on my equity pricing model to kick in around the middle of 2018.

17 months is still a very short amount of time to draw any conclusions about my portfolio management skills. Professional fund assessment usually needs at least 3 years of data. However, the returns so far has been encouraging and the out-performance more than justified the amount of time I put into active management. I can’t promise this level of performance will continue but I can promise to keep tracking them as I have been.