Category Archives: My Portfolio

Portfolio Review July 2017

This is my second portfolio review on the verge of the one year anniversary of this blog. The inaugural edition can be found here. Some background can be found here and here.


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

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.

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.

Investing Philosophy

I’ve been meaning to update the my portfolio post which is linked under the “portfolio” navigation tab, but I’m in the process of deploying cash as part of the on-going correction. So I figure I’ll write a separate post about my investing philosophy.

Below is a list of the basic tenets that I try to follow:

  • Long biased
  • Globally diversified
  • Minimize taxes and expenses
  • Diversify sources of return
  • Strategy diversification
  • Market timing according to cycles of years of duration or longer
  • Use options to generate income and smooth the ride

The first three bullet points are in the “main stream”. As a rule, I don’t have a regular “cash” allocation in either passive or active strategies. Instead, there is a separate emergency fund component in the total portfolio. I’m also far more comfortable being long than short. In the passive accounts at least, I maintain a 50/50 US/international split in equities, although the composition such as large/small US equity or international developed/EM can be fluid. To the third point, I maximize tax deferred contributions every year, including back-door Roth. All assets in the passive accounts are tax-advantaged with the exception of physical PM bullions. In the active accounts, the taxable fixed income CEFs are in tax advantaged as are about half of PM miners and bullion funds. Expenses are minimized by using best-of-breed funds for each asset and doing everything myself. In passive accounts, that means Vanguard index funds/ETFs or equivalent. For individual stocks, I use InteractiveBrokers where the commission is usually under 1 basis point, and partially covered by the interest from security-lending. My expense ratio for holding stocks is at least one order of magnitude less than that of the lowest cost index funds.

The fourth point “diversify sources of return” motivates me to look beyond the traditional stocks and bonds. It’s the reason I have a significant allocation to leveraged fixed-income CEFs (target 24% of active). Taxable multi-sector CEFs have equity like returns and volatilities but are no more than 40% correlated to equities (e.g. VTI, correlation is period dependent, cf. Leveraged muni CEFs provide tax-free income and even lower correlation to equities (same comment as before). In contrast, sub-sectors within equities are correlated to whole at 90% or above. In the context of mean variance optimization, assets with reasonable returns AND low correlations are extremely valuable in portfolio construction. This is contrary to the Bill Bernstein view that one should take risks in equities and fixed income is for safety — a view that unsurprisingly leads to equity dominated portfolios and equity dominated risk profiles. Note that when the fixed income allocation is viewed across my entire portfolio, the risk profile is a “bar-bell”: stable value funds in passive and leveraged CEFs in active. Diversification is also a reason behind my overall 15% allocation to PMs which I discussed here. The blog post by Charlie Biello is highly recommended — I think of it every time I read a straw man attack on gold along the lines of: gold is thought of useful as an inflation-hedge, data shows it is not; therefore gold is useless. Another often-heard objection is based on the inclusion of gold’s return data just 1975 when gold ownership was again legal despite data from PortfolioCharts shows gold’s ability to lower volatility from multiple starting and ending dates. From a portfolio construction perspective, the only requirement for the inclusion of gold is the low correlation to other assets. I haven’t seen any evidence or prediction that this correlation is going to change in the future.

The fifth point “strategy diversification” speaks to my adoption of both passive and active approaches. The passive/active debate is all the rage in financial media today. Passive is clearly winning and the shift is far from over. Lower fees is undoubtedly beneficial to the investing public. However in so far as the democratization of investing makes it easier to invest and funnels more capital to assets, their valuation must rise thus suppressing future returns. A recent post from the always-insightful PhilosophicalEconomics discussed from a similar perspective. As passive grows in dominance, another danger is the synchronization of investor’s emotional response to market declines. This is a major reason I employ both passive and active strategies so as to be able to hedge from within the active accounts when the time comes. I also try to avoid the most obvious pit falls in active, i.e. high fees, lack of diversification, to at least give myself a shot at beating my benchmark.

The sixth point “market timing” is perhaps the most controversial. My reasons were laid out this post. The primary objective is to avoid large draw downs in preparation for early retirement within 10-12 years. If my portfolio should suffer a 30% draw down, there would be a significant impact on the quality of retirement or alternatively the retirement date. I haven’t been able to find a static asset allocation that provides adequate protection while simultaneously provide a high return – that pretty much captures the main dilemma facing all investors. A more diverse allocation can reduce the size of the hedges necessary but no static allocation can ever be truly “all weather”. I believe the solution is market timing but only at the right intervals. The tools I rely on are a specific equity pricing model and technical analysis. A second objective of market timing is to enhance returns. I have been say since last November that we’re entering a blow-off phase in the stock market; the view reinforces my long bias and allows me to increase my equity exposure from a baseline of <50% overall. My current projection for the market top is S&P 3000+ sometime around Q4’18 to Q1’19. I also see PMs in a bull market which gives me license to go above a baseline allocation of 10% gold bullion to include silver and mining equities that are leveraged to gold. My current view is that PMs will top after equities, probably later in 2019. Gold should be over $3500 and has a good shot at $5000/oz.

Lastly I use options to enhance returns. More opportunities are provided by directly owning individual stocks than an index as the parts will move more than the whole. I’m a premium seller since it’s known that realized volatilities are lower than implied volatilities. I predominantly sell margin/cash secured OTM puts on stocks I’d like to own while use technical analysis for entry points. From time to time, I also use options for leveraged longs as discussed here.

So there you go, these are the seven tenets that guide my investing decisions. People attach an almost religious fervor to their chosen investment approach, so I’m not out to convert anyone. It is a human condition that no amount of back testing or modeling can predict the actual returns which will only be known at the end of our investing lives by which time it’s too late to change. I have made peace with my path and will accept anything that comes my way.

Performance Tracking January 2017

For calculation methodology see earlier post

2017 started with a bang — precious metals performed well even though it was looking to retest the 2015 lows at the end of last year. Since PMs are the main drivers in the “tracking error” (I hate that term!), my portfolio did well relative to the overall market. The S&P also had a good month, gaining 1.79% while the bonds gained 0.21%, meaning the benchmark 60/40 portfolio picked up 1.16% for the month.

Passive Portfolio

The total passive portfolio gained 2.11%, the portion outside of the 15% allocation to PMs gained 1.34%. In this post, I outlined my plan to increase the equity allocation by 5%. I’m about half way done. Funds has already come out of TBM but has not been added to equities just yet. The market has been directionless for a long time. Since the model has a low in February and I know it can’t be timed perfectly, I have already started to transfer funds slowly. I can only access the emerging market index fund, VEMAX, in a Roth IRA at Vanguard and the space is limited. Hence I had to dial down its allocation by 1% and shift to VTIAX. The allocation for the rest of 2017 looks like this:

Active Portfolio

The overall active portfolio gained 2.37% despite the drag from DGI whose main culprits were victims of presidential tweets and Target. Large changes are being made in FI: reducing muni CEFs in taxable and adding to taxable CEFs in taxed advantaged. I’m using this opportunity to cull back certain dividend stocks.

Plan and Forecast

Transition to my AA is straight forward and should be completed by the end of February. In the active portfolio, the goal is to maximize tax advantaged space for taxable CEFs. Consequently, dividend stocks will all end up in taxable. Tax considerations alone forces me to favor stocks with high dividend growth over high current payout. Currently, the blended payout ratio for my DGI stocks is 2.74% vs. 2.03% for SPY and 2.93% for VXUS. I expect this ratio to come down further. I’ve also started positions in MKL, aka “the baby Berkshire”. It doesn’t pay any dividends so doesn’t count towards DGI. I’m taking my time to buy the taxable CEFs as they have all been on a good run — patience is definitely a virtue. This process may continue well into March or April.

Portfolio Changes 2017

A new year is always a time for reflection and planning for the future. This is especially true for one’s investments. My investment policy statement (IPS) allows for a once-a-year plan review and gradual changes in my passive allocation. Those changes don’t have to be implemented right away and can subject to a range of dates or pre-conditions. The important thing is to keep a record of them and hold myself accountable.

2016 Results

I was quite happy with the portfolio level gains in 2016: 10.87%. It was calculated with the Simple Dietz method which meant contributions were properly accounted for. One of my pet peeves for many personal finance blogs is the co-mingling of contributions and investment returns. Another widely used formula is (end value – start value – contributions)/start value. It’s generally fine except when the contribution is large. The simple Dietz method adds half of the contribution to the denominator to approximate the time-weighted return. The 10.87% figure was calculated on an annual basis, more accurate would be to chain link monthly figures. Unfortunately the official record for this blog was only started in August. I’ll have much more data to work with in the future.

AllocateStartly had a summary of various allocation strategies for 2016. The Golden Butterfly portfolio which I drew inspirations from was the top dog at 10.79%, while the benchmark 60/40 portfolio returned 7.71%. So it doesn’t seem I have much to complain about. Though in all fairness I took on more risk — I have silver/miners in my PM sector, my equities are higher and cash position lower. Conversely, the equity slice-and-dice to include international hurt my returns. The timing of the start of this blog was unfortunate as July was the high watermark in terms of percentage gains. I gave back more than 3 points in the 2nd half of the year while the S&P was going gang-busters, so the results from August look rather poor. I’m an unabashed market timer, so that’s definitely something to improve on.

A New X

I have no plans to disclose actual dollar amounts — I hope it doesn’t detract from the ideas discussed here. At times I have spoken about the portfolio value in terms of X, where X is my non-inflation-adjusted, no-mortgage, target annual pre-tax retirement income. More recently, after some thought about desired life-style and future medical expenses, I’ve decided to increase X by about 10%. I don’t foresee any further changes to this figure.

Current investible assets stand at 17X after a contribution of 1.3X and a gain of 1.6X in 2016. I define “financial independence” as 25X plus a paid-for primary residence. There is still 4.5X left on the mortgage. Being naturally conservative I’ll probably keep working until reaching 30-35X. This amount will also include any future financial support for my daughters. There’s definitely some margin of safety in X, such that I call investible assets at 20X “financial independence lite” even without paying off the mortgage. It’s tantalizingly close, with luck may even be reached in 2017.

Passive Allocation

My guiding assumptions for the next couple of years are based on an equity pricing model I have been following. So the plan is to increase the equity allocation slightly after a drop in the market in the first quarter.

I’ll maintain the 50/50 split between US and international and increase the overall equity allocation by 5% which comes out of TBM. No changes in PMs.

Active Portfolio

The active and overall portfolios don’t follow a set allocation, although I do check it for risk management purposes. The overall equity allocation may grow to 55% by the end of 2017 from 50%. I expect the DGI portfolio that is heavy in consumer staples to under perform the broader market but don’t plan to make any major changes. Additions to the DGI will likely be old tech (MSFT, QCOM, CSCO), or a high-growth, low payout name like V. I plan to add more to growth stocks, currently at 7% of the active portfolio, and bring it up to 10%.

Option writing was a reasonably successful endeavor last year but my activity tapered off as job responsibilities increased. It’s still something I plan to continue this year, although I don’t have a target in mind. It is reassuring to know that if I ever lose my job I can generate some income this way. I do plan to use more synthetic equities (buy call, sell put) as a means to increase leverage. More details will follow when I open such positions.

Closed End Funds

My current asset allocation has about 35% in fixed income/cash, which is about age – 10. Within the passive portion, 40% is fixed income (FI), split between stable value (SV) funds and the total bond market (TBM) 35/5. The interest rate is about 2% for the SV funds in my 401K and an outstanding 3+% in my wife’s 401K. They compare favorable to current bond yields such that I’m considering getting out of TBM altogether. Views on my approach to FI in my passive accounts may vary from mainstream to conservative.

The opposite is true in my active accounts where I use leveraged closed end funds (CEFs) for the FI allocation. In open-end mutual funds, investors transact with the mutual fund company. In closed-end funds, investors buy or sell fund shares with other investors on an exchange. CEFs operate just like an ETF except usually they’re actively managed. ETFs have a fund sponsor who can create/destroy fund units in response to demand so that fund price tracks closely its net asset value (NAV). In contrast, CEFs can have market values that deviate substantially from NAV. Such discount/premium is a key evaluation criterion for CEFs.

One outstanding feature of many CEFs is their high current yield. For example, I own PCI, PDI and PTY in my tax-advantaged accounts. PCI/PDI are multi-sector funds, whereas PTY is a corporate bond fund. All are managed by Pimco. Yields in the trailing 12 months were 12-14%. Double digit yields were made possible by employing leverage, typically around 40% (achieved by issuing lower-yielding preferred shares). Leverage works both ways so you can say my overall approach to FI is a “bar-bell” in terms of risk. CEF management fees are on par with (the more expensive) active mutual funds but obviously the after-fees return is the primary consideration. Pimco funds are known to employ derivatives to hedge interest rate risk which makes them particularly valuable in this environment.

In my taxable account, I also own leveraged muni CEFs, PCQ and PCK, both CA muni funds managed by Pimco (yes I think they are the best in this business). They’re yielding 5.5-6% which is close to double digit pre-tax yields depending on your tax bracket. They dropped quite a bit post election since certain anticipated tax changes will make them less attractive. I’m less worried about these tax changes than the longer term fiscal situation in California. For now they are medium term (~2 years) holds. I will not add to them, but rather will seek opportunities to sell especially if I can create more space in my tax-advantaged accounts.

The backdrop of any FI discussion is of course the direction of interest rates. I believe rates have in fact bottomed. Not all is lost for FI though. Hedging with interest rate derivatives is one approach. For now, MBS (mortgage backed securities) should do quite well as pre-payments stop. Floating rate loans should do quite well, too. In fact, I’ve already picked out a CEF in the latter category for my watch list.

There is far more diversity in FI as I pointed out in Beyond 60/40. A recent post from Newfound Research did an excellent job decomposing risk factors in various FI instruments:

Most individual investors have an FI allocation heavy in treasuries and investment grade corporates which is a lot of rate exposure (see LQD and TLT in the graph). I find it ill-advised giving my outlook on rates. At any rate, individual investors tend not to pay much attention to FI, since they tend to be overweighted in equities anyway. Readers of this blog though should not be surprised by where I stand. I don’t think a TBM index fund works nearly as well as its equity counterpart. One reason being the index is weighted by issuance. That there are non-economic, state actors with heavy footprints is another. Not to mention it doesn’t cover SV funds, CDs, and bank loans if one considers all the FI options available.

Supplementing DGI for Retirement Income

A common criticism for DGI for retirement income is that it requires a higher portfolio value due to current low yields, thus over-saving and longer working years. That is a valid point. The canonical approach for retirement income generation is to withdraw a fixed percentage, e.g. 4% from a $1M portfolio for an initial annual income of $40K. The S&P 500 yields just over 2% today. A 4% yielding portfolio will force one into high yielding but low growth sectors such as utilities, telecoms, and REITs, etc. This naturally increases portfolio risk.

My solution is: supplementing a well-rounded, high quality DGI portfolio with high-yielding CEFs. Let’s do some quick math. Assuming the DGI portfolio yields 2.5% and has a 7% annual growth rate. We can also construct a CEF portfolio with 8% yield and assume no principle growth. Then the combination of $727K in the DGI portfolio and $273K in CEFs will generate $40K initially. The weighted portfolio growth will be 0.727 x 7% > 5%, more than enough to overcome inflation. All of the assumed numbers are quite conservative and can easily be constructed from securities available today.

Readers interested in investing in CEFs should do their due diligence. Two resources I find tremendously helpful are CEFConnect and the MorningStar discussion forum.