Tag Archives: Asset Allocation

How we reached a $1,000,000 Net Worth

What does it take to reach a $1,000,000 net worth?  In our case, it took a long time, hard work, saving a large percentage of our income, and putting our money to work for us by investing wisely.  Rob from Mustard Seed Money has a great post on how much you have to save each month to reach a $1,000,000 net worth.

I initially was going to title this post “reaching a $1,000,000 net worth by age 40”, but that would have been misleading.  Even though I was, in fact, age 40 when I reached this financial milestone, I did not do it alone.  Individually, I would not have reached this milestone.  My wife and I worked as a team and did it together, so I must give her the credit she deserves.

When we got married, I had over $100,000 saved up in my investment accounts.  As far as assets go, she brought our current house to the marriage. There was a mortgage on the house, but she had about $100,000 in home equity at that time.  By combining our assets, we started out with about $200,000 based on our investment accounts and home equity.

Career Growth

Over the past 10 years, we managed to double our household salary.  Considering that we both have college degrees, we never earned a large salary.  When we first got married, my salary was only $30,000 per year.  My wife was teaching for a few years and was earning about $50,000 per year.  In the past 10 years, our combined salaries have grown to over $150,000 per year.

Savings

When we first got married, our savings rate was 38% of our gross earnings.  We started by maxing out our Roth IRA accounts, I contributed 15% per year to my 401K, my wife contributed 10% to her 403B, and 8% to her defined contribution pension plan.  We also built up a large emergency fund and invested money in taxable accounts.

Every year, we have tried to increase our savings rate by 1% or more.  Our current savings rate is 50% of our gross earnings.  We still earn under the IRS threshold that allows us to max out our Roth IRA accounts.  I now work at a not-for-profit and max out my 403B.  My wife is close to maxing out her 403B and still contributes 8% to her pension.  We are happy with the size of our emergency fund and now just add to our taxable accounts.

Lifestyle Creep

We are always aware of how much we are spending each month.  While some lifestyle creep has occurred, we manage it well.  We travel, but do not fly first class or stay in 5-star hotels.  We buy reliable new or 1-year old certified used cars and drive them for over 12 years/200,000 miles.  We eat at home during the week and only go out to eat on the weekends.  We closely monitor the cost of monthly subscription expenses such as internet, electricity, Netflix, and other bills.  When we do spend money on needs or wants, we always shop around for the best value.

Investing

Our approach to investing has been very simple.  We have invested primarily in index funds.  Our asset allocation has been 25% in bonds and 75% in stocks for the past 10 years.  In the stock allocation, it was well diversified with large-cap, small-cap, and broad international index funds that included emerging markets. From 2007 until 2017, that asset allocation averaged a return of 10.5% per year.

Asset Breakdown

House (appraised in 2012): $220,000

PSERS Pension (Cash Value): $100,000

Taxable Accounts: $240,000

Combined IRA & 403B Accounts: $480,000

Other assets not included (cars, firearms, collectibles, jewelry, electronics, etc)

Debts

Mortgage Balance: $30,000

Monthly Expenses: $2,800

What’s Next

We have more work to do.  We have ambitious goals.  Our next goal is to reach $1,000,000 in investable assets.  We should be able to reach that in the next 3 years based on savings and historical returns for our asset allocation. We also want to pay off the balance on our small mortgage over the next five years.  Our goal is to have $2,500,000 saved by the end of 2028 (see the countdown to FIRE on the right margin).  To reach that goal, we have to keep up our savings rate and have our investments return an average of 6.5% per year.  That is well within reason with our current asset allocation of 65% invested in stocks and 35% invested in bonds.

Conclusion

The main purpose of this post was to share that it is possible to reach a $1,000,000 net worth by just being average.  My wife and I went to average universities, have average jobs, live an average lifestyle, and accept average market returns.  Yes, our savings rate is above average, but that too is possible for almost anyone to achieve if they create a solid financial plan.

If you want a more comprehensive list of steps to follow, check out The K.I.S.S. Approach to Financial Independence.  That is the foundation of our financial plan.  For more reading on reaching financial independence, please check out the Resources page.  It is full of a collection of great books, blogs, and forums that will provide you with unlimited wealth building information.

Where are you at on your journey toward financial independence?

Please share your financial milestones and what you did to achieve them in the comment section.

How to Invest A Million Dollars

While a million dollars might not have the purchasing power that it once had, it is still a large sum of money.  If you watch professional sports on ESPN, follow entertainment gossip on TMZ, or read Forbes, you are sure to come across stories about the huge salaries that some high-profile people earn.  NFL quarterbacks earn over $25M per year.  Hollywood actors earn over $22M per movie.  The CEO’s of the Fortune 500 earn 600 times more than the average employee.  The late Dr. Thomas J. Stanley would refer to those people as the “glittering rich”. Compared to the salary that the average person earns, those people are more along the lines of a rare commodity.  While it is interesting to pay attention to what those people earn, it is not something that the average person should use as a benchmark of their financial success.

Today, the average household salary in the U.S. is about $58,000.  With that being the current financial situation, having one million dollars would be a game changer for most people.  It would not be enough to live as the rich and famous do.  It is enough, however, to give the average person some financial freedom and peace of mind.

One million dollars is seventeen times the annual earnings of the average household salary.  Many financial experts consider having 25 times your annual expenses in savings to qualify as being financially independent.  If you had one million dollars, you would be well on your way as long as you do not drastically upgrade your lifestyle.

How would I suggest that someone invests a million dollars?  For me, I like to follow a keep it simple approach.  The core of the portfolio should be largely invested in stocks.  Stocks are important for growth and keeping ahead of inflation, I also believe that there should be some fixed assets in a portfolio.  Bonds are used to reduce the market volatility that comes with investing in stocks.

How should you construct this portfolio?  You should consider your age and your risk tolerance.  A young person has more time to recover from a major market correction than a person who is retired and is drawing down money from the portfolio to pay for living expenses.  The second factor to consider is how much of a loss can you can tolerate before you sell off your equities at the wrong time.  If you can stomach a 50% loss in value, consider investing 100% the money in stocks.  If you are more risk adverse and think that you could handle a 20% loss in value, consider a balanced portfolio of 60 invested in stocks and 40 percent invested in bonds.

Jack Bogle suggested that an investor should subtract their age from 100 and that would equal how much they should invest in equities.  For example, if you are 25 years old, you should have 75% of your portfolio in equities.  If you are more aggressive or not a fan of the current bond yields, subtract your age from 110 instead of 100.

While bonds might not be an attractive option for growth, they do serve a role in almost every diversified portfolio.  They allow investors to buy low and sell high in the form of rebalancing.  If the stock portion of a portfolio has a negative return for the year, an investor can exchange money from the bond portion of their portfolio and take advantage of buying stocks low while selling bonds high.

I am not a financial planner or a professional investor.  I can only share my experience, what I have learned, and what I hope to achieve as an investor.  When I was a new investor, I held 100% of my portfolio in stocks for over ten years.  That period included three years of negative returns from 2000 until 2003.  I have also followed the rule of 110 minus your age in equities.  By adding bonds to my asset allocation, it helped to smooth out the market volatility of the great recession. 

Since the purpose of this post is to give advice on how to invest a million dollars, I would suggest the Sweet Dreams Portfolio.  The Sweet Dreams Portfolio is my current asset allocation.  It is a balanced-growth asset allocation of 65% in stocks and 35% in bonds.  This portfolio allows you to own every U.S. and international stock including emerging markets.  It is based on 110 minus the average age of my wife and myself in equities.  Let’s examine the growth and performance of one million dollars over the course of the past 20 years.

The Sweet Dreams Portfolio

Vanguard S&P 500 or Large Cap Index Fund = $380,000

Vanguard Extended Market or Small Cap Index Fund = $110,000

Vanguard Total International Stock Market Index Fund = $160,000

Vanguard Total Bond Market or Inter-Term Tax-Free Bond Fund for a taxable account = $350,000

20 Year Performance

5-years = 8.16%

10-years = 6.82%

15-years = 6.88%

20-years = 7.18%

Best Year = 23.93%

Worst Year = (23.32)

$1,000,000 grew to = $4,188,631 (Rebalanced Annually)

Average Expense Ratio = 0.06% (Admiral Shares)

Conclusion

Dr. William Bernstein wrote, “that if you won the game, quit playing”.  While a million dollars might not be enough to declare victory for everyone, it is a nice lead to have.  For me, I recommend holding on to that lead by running the ball and playing great defense.  To translate that football analogy into financial advice would mean to shoot for a nice conservative return of 6.8%.  That would enable you to double your money about every decade.  

This post was entered into the “How to invest a million dollars” contest.  

Please visit www.howtoinvestamillion.com to check out all of the sample portfolios. 

Please remember to check with a financial professional before you ever buy an investment and to read the Disclaimer Page.

 

How the Mob Influenced My Asset Allocation

“Behind every great fortune there is a crime”.  – Honore de Balzac

I have recently been doing a good amount of research on Peer-to-Peer Lending (P2P) and have written about it in a recent blog post.  Yes, Peer-to-Peer Lending (P2P) is legal in most states, but is it ethical?   While I was researching more about Peer-to-Peer Lending (P2P), I felt a strange nostalgia.  This type of investing caused me to reflect on the town I grew up in and the people I once knew.

I grew up in a small town located in Northeastern, Pennsylvania.  Like myself, most of the population was made up of people who were Irish, Italian, Polish, and from other Western European heritage.  Many of my friends would say that their grandparents were “right off the boat” at Ellis Island.  These were hard-working people, some might say salt-of-the-earth.  Many of those first-generation Americans performed back-breaking labor.  The men worked in coal mines and the women worked in dress factories.

Not everyone in this region shared the Protestant work ethic.  Like my parents, most of my friend’s parents also had square jobs.  Some, however, did not seem to work at all, yet lived very well.

This had me perplexed.  I remember asking my friend Sal what his dad did for a living since he always seemed to be home and never at work.  He told me that he worked as a billiards supply salesman and spent his evenings working at pool halls.

I asked my father if he knew how lucrative being a billiards supply salesman was.  He frowned at me and explained that even though it was socially acceptable in our town, Sal’s dad was not a billiards supply salesman.  He explained that Sal’s dad was a loan shark, bookmaker, and organized illegal high-stakes card games.  It was even rumored that people lost the deed to their house at these card games.

My dad was not being judgmental.  Sal’s dad was a legitimate criminal.  He did time at the Allenwood Federal Prison Camp for racketeering.

My parents raised me with high morals.  Never the less, I was young and impressionable.  I just saw that Sal’s dad seemed to live a great life.  He had a big house with a kidney-shaped swimming pool.  He drove a brand-new black Jaguar.  The whole family had the best of the best.  Plus, they were always nice to me and a very popular family in the community.

It was not until many years later that I realized why my dad was so critical about Sal’s father.  Sure, I understood that he was not paying taxes, but I was in denial about the scale of corruption that infected this region.  I thought that nobody was getting hurt.  Two books and a documentary changed my whole outlook on the area where I grew up and some the people who I grew up with.

The first book that blew my mind was I Heard You Paint Houses by Charles Brandt.  This book is about Frank “The Irishman” Sheeran.  Sheeran was a hitman from Philadelphia who worked for Jimmy Hoffa.  He also worked for the mob boss Russel Bufalino who was from Kingston, Pa.  What was truly shocking about this book was that it states that the plan to murder President Kennedy was hatched at Brutico’s Bar & Grill in Old Forge, Pa.  I have eaten dinner at that restaurant on countless occasions.  This book was adapted into the movie The Irishman that will be released in 2018.  The movie stars Robert De Niro, Al Pacino, Joe Pesci, and is directed by Martin Scorsese.

The second book that was shocking to me was The Quiet Don by Matt Birkbeck. The Quiet Don was about the history of organized crime in Pennsylvania and how powerful Russel Bufalino was with the New York crime families.  What floored me was that people who I knew as a teenager were mentioned in this book.  I used to casually talk to Frank Pavlico at Golds Gym in Scranton, Pa.  I did not know that he was the driver for mob boss William D’Elia.  He told me that he owned a car detailing business.  After William D’Elia was arrested, Frank was identified as an informant.  Shortly after that, Frank was found dead and his death was labeled as a mysterious suicide.

Thirdly, what truly was disturbing was the Kids for Cash Scandal in 2008 that was made into a documentary.  Kids for cash was a scandal involving a real estate developer who was also the owner of a for-profit juvenile correctional facility and two corrupt Luzerne County judges.  Basically, the owner of the for-profit jail was paying off Judge Marc Ciavarella and Judge Michael Conahan to send children to his jail for minor offenses such as not completely stopping at a stop sign or truancy.  The arrangement between the owner of the prison and the two judges was allegedly brokered by William D’Elia.

How does this tie into the ethics of Peer-to-Peer Lending (P2P)?  Maybe I am just not anti-establishment, but I see Peer-to-Peer Lending as being very much like an online loan shark.  It seems as shady as the payday loan stores or cash-for-gold outfits that you see in strip malls.

Some might say that Peer-to-Peer Lending (P2P) helps people who do not have the credit to get a traditional loan from a bank.  Some might even feel that they are sticking it to the man by taking business away from big banks.

In my opinion, it is not altruistic for an individual to loan money to other people and charge them a high-interest rate.  I would not do that to a friend or relative, so why is it alright for me to do in on an anonymous level?  Also, the lending practices of P2P companies are equally as manipulative as big banks based on advertising one rate and offering a higher one.

While I am socially conscious, I do not generally take on a socially conscious approach to investing.  My largest holding is an S&P 500 index fund.  Some of the stocks in the S&P 500 have questionable business ethics.   There are energy companies that pollute the environment and clothing manufactures that pay slave wages to employees in third world countries.  Yes, all of that might be true, but I do not feel like the pawnbroker who Raskolnikov murdered in Crime and Punishment by Fyodor Dostoevsky when I contribute to my Roth IRA.

Don’t get me wrong, I am an investor.  Never the less, I believe that is important to be honest to yourself and have principles.  If a business transaction or investment opportunity does not seem ethical, it should be examined further.

Just because I can use a sterile online platform to issue loans to people with shaky credit, am I not just shylocking?  Sure, nobody is going to get their finger broken or have the vigorish increased for defaulting and failing to pay back their loan on time.  It still feels like the same basic concept of taking advantage of people who are down on their luck.

For some time, I was considering opening an account and to participate as a lender. Upon further review, I have decided against opening a Peer-to-Peer Lending (P2P) account.  I am comfortable with my balanced-growth portfolio and do not see the need to add alternative investments to my holdings.  There is no need to go beyond a portfolio of a few index funds and to make my investment portfolio more complex.

What is your opinion on Peer-to-Peer Lending (P2P)?

Do you think that this type of investing is ethical?

Please remember to check with a financial professional before you ever buy an investment and to read my Disclaimer page.

Early Retirement Portfolio & Plan

Thank you for reading part-4 in my series on asset allocation.  In my last post, I wrote about our current balanced-growth asset allocation.  That is the asset allocation that we plan on maintaining until we retire in 2028.

In this post, I will be considering the future.  This post is about how I foresee our assets being allocated at the time of retirement.  I use the word foresee because it is what I am anticipating.  As I stated in my previous post, I don’t have a crystal ball.  Nobody can predict the future, but this is what I am optimistically forecasting.

At the time of retirement, I will be age 52 and my wife will be age 60.  At age 60, my wife will draw a Pension equal to 70% of her last annual salary.  The Pension technically has a cost of living adjustment (COLA), but there has not been an adjustment in over 15 years.  Moving forward, we are not going to count on any COLA adjustments.

By 2028, we plan on having about 50 years of annual living expenses in investable assets.  To come up with that amount, I have run our figures on many different financial calculators including AARP, Charles Schwab, and Fidelity that take the future projected growth of different asset allocations into account.  The 50 years of living expenses are based on what we currently have saved, the amount we plan on adding to our savings, as well as projected market performance.

The asset allocation that we plan on using at retirement will be 50% invested in stocks and 50% invested in bonds/cash:

S&P 500 Index Fund – 32%

Extended Market Index Fund – 8%

Total International Stock Market Index Fund – 10%

Intermediate-Term Bond Fund – 32%

TIPS Fund – 10

Cash – 8%

At retirement, we are planning on withdrawing only 1.8% per year from our portfolio.  Based on the Vanguard Monte Carlo Nest Egg Calculator, our success rate is projected to be 100%.  We also have a greater than 100% projected success rate on Firecalc.com and the Trinity study.

Between the pension and withdrawing 1.8% from our portfolio, we will have $112K per year to live on.  Just based on simple math, if we are taxed at 25%, we would have $7K per month to live on.  That would be more than double of what we live on now with fewer expenses.

For the first 10 years of retirement, we plan on withdrawing from our taxable account.  When my wife is age 70, we will be forced to withdraw from her Traditional IRA because of Required Minimum Distributions (RMD).  At that point, we will still be 8 years away from having to withdraw from my Traditional IRA.  We might never have to touch our Roth IRA accounts.  If we do use our Roth IRA accounts, it might just be to withdraw extra money without causing us to go into a higher tax bracket.

We are currently planning on being flexible when it comes to Social Security.  Our goal is to take it when my wife is 70 and I am 62.  We are, however, keeping the option open to taking it early based on retiring during a prolonged market correction. Otherwise, the amount that we will collect will compound 7% annually for every year my wife waits between age 62 and 70.

For some people, this plan might seem too conservative.  For me, being a little on the conservative side is important.  That is because I am retiring at a young age.  I have to plan on being able to fund a retirement of at least 35 years for both my wife and myself.

For me, I don’t see it as being overly conservative.  I see it more as being flexible.  By only planning on a 1.8% withdrawal rate, we have a great amount of flexibility.  If we had to increase it to 2.8%, our success rate only falls to 98% on the Vanguard Monte Carlo Nest Egg Calculator.  If my wife had to work two more additional years, her pension would jump to 80% of her last annual salary.  Also, I will most likely still work part-time because I want to continue to take advantage of my catch-up contributions in my retirement accounts.

That is how our future plan looks.  It is over 11 years from now.  I don’t want to get too excited.  Between now and then, we will work hard, save, invest, take care of our health, and enjoy every day.

Also, please check out the following links from some of the top personal finance blogs to learn about the #DrawdownStrategy Chain:

Anchor: Physician On Fire: Our Drawdown Plan in Early Retirement

Link 1: The Retirement Manifesto: Our Retirement Investment Drawdown Strategy

Link 2: OthalaFehu: Retirement Master Plan

Link 3: Plan.Invest.Escape: Drawdown vs. Wealth Preservation in Early Retirement

Link 4: Freedom is Groovy: The Groovy Drawdown Strategy

Link 5: The Green Swan: The Nastiest, Hardest Problem in Finance

Link 6: My Curiosity Lab: Show Me The Money: My Retirement Drawdown Plan

Link 7: Cracking Retirement: Our Drawdown Strategy

Link 8: The Financial Journeyman: Early Retirement Portfolio & Plan

Link 9: Retire by 40: Our Unusual Early Retirement Withdrawal Strategy

Link 10: Early Retirement Now: The ERN Family Early Retirement Captial Preservation Plan

Link 11: 39 Months: Mr. 39 Months Drawdown Plan

Link 12: 7 Circles: Drawdown Strategy – Joining The Chain Gang

Link 13: Retirement Starts Today: What’s Your Retirement Withdrawal Strategy?

Link 14: Ms. Liz Money Matters: How I’ll Fund My Retirement

Link 15: Penny & Rich: Rich’s Retirement Plan

Link 16: Atypical Life: Our Retirement Drawdown Strategy

Link 17: New Retirement: 5 Steps for Defining your Retirement Drawdown Strategy

Link 18: Maximize Your Money: Practical Retirement Withdrawal Strategies Are Important

Link 19:  ChooseFI:  The Retirement Manifesto – Drawdown Strategy Podcast

Please remember to check with a financial professional before you ever buy an investment and to read my Disclaimer page.

Balanced-Growth Portfolio

Welcome to Part-3 of my series on asset allocation.  In my last post, I wrote about Adding Bonds To Reduce Volatility in the portfolio that my wife and I held for the past ten years.  In this post, I am going to write about our new asset allocation.  This is the allocation that we will hold until we reach early retirement (FIRE).

As a Financial Independence (FI) blogger, I have always been a portfolio nerd.  The Lazy Portfolios made popular by Paul B. Farrell on marketwatch.com and his book The Lazy Person’s Guide to Investing have always been something that I have enjoyed following.  It is interesting to analyze the performance of famous portfolios like the Coffeehouse Portfolio, Yale’s Unconventional Portfolio, the Second Graders Starter Portfolio, as well as others.

The portfolio that I would like to introduce to you is what I call The Sweet Dreams Portfolio.  The portfolio is named after what it provides for us.  It is a portfolio that allows us to sleep well at night in spite of all the scary headlines that can easily cause nightmares from the sensationalized financial and political media.

This portfolio has a balanced-growth asset allocation.  Based on the Vanguard portfolio allocation model, a portfolio that is made up of 60% stocks and 40% bonds is classified as a balanced portfolio.  Vanguard classifies a portfolio of 70% stocks and 30% bonds as a growth portfolio.  The Sweet Dream’s portfolio is 65% stocks and 35% bonds.  The Sweet Dreams portfolio is made up of the same funds that we used in our previous asset allocation.

The Sweet Dreams Portfolio:

S&P 500 – 38%

Extended Market Index Fund – 11%

Total International Stock Market Fund – 16%

Total Bond Market – 35%

You might be asking, why not just use the total stock market instead of using an S&P 500 and an extended market fund?  The answer to that question is that these are the options that my wife and I have available in our 403B accounts.  A total stock market fund has the same market weighted allocation of a 4:1 ratio and can be used in place of those two funds.  There are many different ways to approximate the total stock market with a combination of other funds.

Our Roth IRA’s and taxable funds are invested with Vanguard.  My 403B has index funds from Fidelity.  My wife’s 403B plan has index funds from Charles Schwab.  This asset allocation can be created with index funds from any of those companies.

In my first two posts in this series, I wrote from a position of experience.  In those two posts, I was able to look back at how my asset allocation performed over long periods of time.  Those posts were also about how I responded to different market conditions.

The Sweet Dreams Portfolio is a brand new asset allocation model for us.  There is no such thing as a crystal ball that I can use to see into the future.  We can only look backward at how an asset allocation performed during different market conditions.

Over the past 10 years, The Sweet Dreams Portfolio returned an average of 6.34% per year.  The largest one-year loss was in 2008 with a -24% loss.  An initial investment of $10K would have grown to nearly $20K if rebalanced annually.

Over the past 20 years, The Sweet Dreams Portfolio returned an average of 6.91%. The worst one-year loss over the period of 20 years was still in 2008.  An initial investment of $10K would have grown to more than $38K if re-balanced annually.

At the age of 40, I still have a long investing horizon.  It is not as long as others because of our goal to retire in less than 12 years.  We are comfortable with the 65% invested in equities for growth.  We are also comfortable with the 35% invested in bonds to use as a re-balancing tool during market corrections.  Ultimately, we are comfortable with the thought of having restful nights and sweet dreams as we work toward our next goal on this financial journey.

Please keep an eye out for the 4th and final part of this series.  The final post in this series will be about how we plan on structuring the asset allocation of our retirement portfolio when we reach early retirement (FIRE).  The final post will also include how we plan on funding our retirement based on investment withdrawal rates, pensions, and Social Security.

Please remember to check with a financial professional before you ever buy an investment and to read my Disclaimer page.

Bonds to Reduce Volatility

During the first ten years of my investing career, my asset allocation was solely invested in stocks.  From 1997 until 2007, my portfolio returned 8.5%.  I wrote about that period in my first post of this series 100 Percent Invested in Stocks.  In this post, I will write about how adding bonds to my portfolio reduced volatility during the decade that followed.

By the year 2007, my portfolio had five years of positive returns.  At that time, I was reading a good amount of Jack Bogle’s writings on asset allocation.  He suggested holding (100 – your age) in stocks.

After investing for 10 years, it made sense for me to reduce the volatility of my portfolio.  However, I still was focused on aggressive growth because I had the goal of retiring early.  I felt an asset allocation equal to my age in bonds was too conservative.

Another factor that I had to consider was that I was newly married.  Prior to getting married, my wife and I decided to manage all our finances together.  We sat down and evaluated how we wanted to invest our money after we were married.

At that point, I was 30 years old and my wife was 37.  We decided on adding 25% of our portfolio to bonds.  It was close to equaling (110 – our average age) in stocks.

This is how our new asset allocation looked:

S&P 500 Fund – 43%

Extended Market Index Fund – 13%

Total International Stock Market Index Fund – 19%

Total Bond Market Index Fund – 25%

My second decade as an investor was equally as volatile as my first decade. In 2007, our portfolio was off to a solid start by returning over 10%.  Then 2008 came.  That was the beginning of the great recession that resulted from the subprime mortgage bubble burst.  In 2008, our portfolio had a loss of more than -30%.  If I had my original asset allocation of 100% invested in stocks, we would have lost more than -40%.

Just as during the dot.com bubble and the three years of negative returns that followed, we just kept investing and moving forward.  We stuck to our normal schedule of dollar cost averaging.  We also stuck to our plan of semi-annual re-balancing.

Fortunately, the market bottomed out in March of 2009 and one of the greatest bull markets began.  By the middle of 2010, we had recovered all of our losses. From 2009 to 2016, our portfolio averaged over 10.5% annually.

That 10.5% return did not occur without volatility.  During this period, there were peaks and valleys along the way.  There were budget crises, polarizing politics, debt-ceiling debacles, federal government shutdowns, and threats of austerity.

Over the course of those ten years, our portfolio had an average return of 5.24%.  If we were invested in 100% stocks the average return would have only been 5.58%.  By adding 25% in bonds, there was almost zero impact on growth.  The bonds did help to reduce volatility.

If you are not comfortable with having 100% of your portfolio invested in stocks, consider adding some bonds to your allocation.  Bonds are susceptible to interest rate increases, currently have low yields, and do not hold up as well as stocks during periods of inflation. Bonds do, however, reduce volatility when the stock market is in decline.  That is the main reason why they have an important role in our asset allocation.

Please keep an eye out for Part-3 in my series on asset allocation.  In Part-3, I will write about the balanced-growth asset allocation that we will hold until we reach early retirement (FIRE).

Please remember to check with a financial professional before you ever buy an investment and to read my Disclaimer page.

100 Percent Invested in Stocks

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Do you think you have the risk tolerance to invest 100% of your portfolio in equities?  I had an asset allocation of 100% invested in equities for over 10 years.  At this stage in my life, However, I no longer have the need or desire to have that asset allocation.  That was how my portfolio was invested when I reached my first milestone of Saving $100,000 by age 30.

This is the first of a 4-post series about my asset allocation.  This series on asset allocation is about my asset allocation at different points in my investing career.  The series is based on where I started, what happened, where I am at now and where I will be heading based on age and risk tolerance.

My investing career began in 1997.  This was a time Alan Greenspan referred to as a period of irrational exuberance.  The stock market was soaring.  The S&P 500 had an average return of over 15% per year from 1989 to 1999.  If a person invested $100 in the Vanguard 500 Index Fund (VFINX) in 1989, it would have grown to $692 by 1999.

In 1997, I purchased my first mutual fund.  My first fund was the Vanguard 500 index fund (VFINX).  This was the only investment that I owned from 1997 until 2000.  I would purchase at least $500 worth of this funds shares per month.  Over that 3-year period, the Vanguard 500 averaged a return of nearly 20% per year.

In 2000, as the result of my savings and market returns, my portfolio was large enough to add more funds.  To improve my diversification, I wanted to add small caps and international stocks to my asset allocation.  I added the Vanguard Extended Market Index Fund (VEXMX).  By adding the Vanguard Extended Market Index fund to my portfolio, I could replicate the total stock market because I already owned the Vanguard 500 Index Fund.  The third fund that was added was the Vanguard Total International Stock Market Index Fund (VGTSX) for international exposure.

My asset allocation was:

Vanguard 500 Index Fund – 60%

Vanguard Extended Market Index Fund – 15%

Vanguard Total International Index Fund – 25%

As far as equities are concerned, my new portfolio was diversified.  It contained every major publicly traded U.S. and international stock.  In my mind, I was ready for the new century and another decade of 20% annual returns.

It did not take long for the economy to change for the worse.  In March of 2000, the dot.com bubble burst.  On September 11, 2001, New York City and Washington D.C. were attacked by terrorists.  By 2003, the U.S. was fighting two wars in Afghanistan and Iraq.  Those unfortunate events drove the U.S. economy into an extended recession.

As the result of those events, the stock market posted losses for three consecutive years.  The average annual return on my portfolio was a loss of -16%.  In other words, if you invested $100 in January or 2000, it was worth $61 by January of 2003.

How did I handle the prolonged recession and market contraction of the early 2000s?  I stayed the course.  I dollar cost averaged the same amount of money into my investments every month.  My goal was to reach financial independence, so I rode out those volatile markets and took advantage of buying equities at a reduced price.  I would, however, feel unnerved when I paid attention to the media.  Fortunately, I was too busy working and going to college to become obsessed with the media.  I honestly do not remember ever feeling overly fearful during this period.

My patience did ultimately pay off.  By sticking with my allocation, I was rewarded handsomely between 2003 and 2007.  Over the course of those next five years, my portfolio had an average return of more than 16% per year.

During my first 10 years as an investor, my portfolio returned slightly more than 8.5% per year.  This asset allocation, however, was extremely volatile.  The best year returned 34% and the worst year had a loss of -20%.

An asset allocation of 100% invested in stocks is not suited for every investor.  It worked for me because I was young and able to dollar cost average when the market was both up and down.  This type of volatility does cause many investors to sell low and buy high.  That is a losing game if you want to reach financial independence.  If you cannot honestly handle a -40% drop in the value your portfolio, then a portfolio made up of 100% stocks might be too aggressive for you.

There is a simple solution if the volatility of a portfolio invested in 100% stocks causes you to feel insecure.  Add a percentage of bonds to your portfolio that matches your risk tolerance.  In my next post, I will write about how adding bonds to my asset allocation reduced the market volatility of the next decade.

Please remember to check with a financial professional before you ever buy an investment and to read my Disclaimer page.

Stocks: Buy Low, Sell High

When it comes to investing, the one saying that most investors have heard countless times is to buy low and sell high.  In other words, buy stocks when they are selling at the bottom of the market and sell them when they become overpriced.  In theory, this is great advice.  In practice, it is very hard for professionals to do and almost impossible for individual investors to do.

Many investors try to base their approach to buying low and selling high to where the economy is in the business cycle.  When the economy is in a recession, stocks tend to be priced low.  As the economy improves, the indexes that track the prices of stocks go up in value.  They tend to continue to increase while the economy expands.  This continues to occur until the economy falls into another recession.  A recession is generally based on two consecutive periods of negative GDP growth.  This business cycle historically runs its course about every decade.

The stock market has been making steady gains since March of 2009.  Many people have grown wealthy as the result of those gains.  That period of recovery and expansion has been going on now for over 8 years.

Many economists, professional investors, and members of the financial media are calling for a market correction based on where we are in the business cycle.  Unfortunately, based on how the economy works, they are correct.  Odds are, it will happen.  The problem is that nobody knows for sure when it will happen.  It could occur tomorrow or it might not occur until many years from now.

How can an investor buy low and sell high? To do so, an investor must buy investments that are priced low in relation to what the business is truly worth.  Not only is this hard for individual investors to do on a quantitative level, it is hard to do on a psychological level.  This requires investors to buy when the media is screaming to sell their stocks, people are losing their jobs, businesses are filing Chapter-11, and there is little hope on the horizon.

The best approach an individual investor should take is to not make investment decisions based on the current state of the business cycle.  An investment plan should be created for all economic conditions.  An asset allocation should be selected based on age and risk tolerance.  When most investors try to buy low and sell high, they end up doing the opposite.

If it is that difficult to buy low and sell high, what should an investor do?  A good starting point is to not try to time the market.  Ignore the noise coming from the financial media.  If you want to read about investing, go to my Resources page and select a book, blog, or forum that is recommended there.

As for buying low & selling high, there is a way for individual investors to do this.  It is quite simple. It is called rebalancing.

Rebalancing is realigning the asset classes of a portfolio.  Over time, a portfolio asset allocation will change because asset classes will perform differently.  Small cap stocks might perform well, while international stocks might have negative returns.  That will change the asset allocation of a portfolio.  Rebalancing is performed by buying or selling asset classes periodically based on the performance of those asset classes within a portfolio.

For example, let’s assume that an investor has a portfolio that is made up of 3 mutual funds.  The portfolio has 40% of its holdings in a bond fund, 20% in a total international stock fund, and 40% in a total U.S. stock fund.  One year later, the investor reviews their asset allocation.  Based on market performance the bond fund is still at 40% of the portfolio, but the international fund has dropped to 15%, while the U.S. stock fund grew to 45% of the portfolio.

To return this portfolio back to its desired asset allocation, the investor must rebalance the portfolio.  They must sell off 5% of the U.S. stock fund and exchange or buy 5% in the international fund.  That is simply selling the U.S. stock fund high and buying the international fund low.

How often should rebalancing occur?  Most experts suggest at least once per year.  I review my portfolio twice per year and rebalance at that point if it is needed.  Some investors do it quarterly.

When do you know it is time to rebalance?  A very simple approach is to set up rebalancing bands.  I follow a +/- of 5% rule.  As in the previous example, if an asset class is off by 5%, I will make the needed exchanges to sell high and buy the lower priced asset class.

Even though this is more structured than trying to know when to make a trade based on the headlines in the media, it is still difficult.  It is difficult because of psychology.  It requires an investor to sell an asset class that is performing well and exchange it for an asset class that is performing poorly.  It is hard for the brain stem to realize that the poor performing asset class of today will be a market leader in the future.

If an investor struggles with pulling the trigger to rebalance their holdings, there is a solution.  Many investment companies have an automated rebalancing feature.  Today, most 401K plans have an automated rebalancing feature.  It is as simple as selecting the percentage bands and frequency.  This allows investors to bypass the psychological barrier of selling off the asset call that is growing for the asset class with recent negative returns.

If you want your portfolio to have high returns while reducing risk, buy low and sell high.  The simplest way for the individual investor to do this is to periodically rebalance their portfolio.  Based on percentage bands an investor should exchange shares of the best performing asset class for those that are lagging in performance.  If an investor is struggling to follow this process, set it up where it is performed manually.

Please remember to check with a financial professional before you ever buy an investment and to read my Disclaimer page.

Meeting the Bogleheads

In February, I attended my first Bogleheads chapter meeting.  It was a long drive.  I drove over 100 miles to the Philadelphia meeting in King of Prussia, Pa.  I have been a follower of the Bogleheads.org forum for many years and have spent countless hours reading the Bogleheads.org forum.

The Bogleheads take their name from John C. Bogle who founded Vanguard in 1975.  He created the Vanguard 500 Index Fund (VFINX).  The Vanguard 500 Index fund (VFINX) was the first index fund available to individual investors that tracks the S&P 500.  John C Bogle has also made a career of being a champion for small investors.  His approach to investing is to build a portfolio of low-cost index funds that are tax efficient and to stay the course during all market conditions.

The Bogleheads are a group of people who follow the investment teachings of John C. Bogle.  They have a forum Bogleheads.org.  They also have written The Bogleheads Guide to Investing and the Bogleheads Guide to Retirement Planning.  The Bogleheads are an altruistic group.  They help others learn about investing at no cost and have donated the proceeds from their books to charity.  A person can post a question about investing, education, careers, consumer goods, as well as other topics related to personal finance on the forum.  Most questions receive many answers from highly knowledgeable and experienced investors.

The Bogleheads’ Guide to Investing

The Bogleheads’ Guide To Retirement Planning

I did not know what to expect since it was my first meeting.  Everyone was friendly and welcoming.  They were happy to see everyone who was in attendance.  Even though I did not know anyone, it was like a meeting with old friends.

There were about 30 people who attended the meeting.  They said that it was one of the larger chapter meetings.  Some people were longtime members.  Others were first-timers, such as myself.  There were people in attendance from Philadelphia, Maryland, New Jersey, Washington D.C., and the Poconos.

It was nice to put a face to some of the avatars that are regular contributors to the forum.  It was a pleasure to meet “Lady Geek”.  If you follow the forum, you know her as the moderator who regularly monitors the posts.  She makes sure that the rules are followed.  If someone strays from following the rules, the post will be removed or the thread will be locked.  The Bogleheads forum is as close as it comes to being a perfect online community.  That is due to the hard work that the moderators put into keeping it positive and educational.  No politics, religion, trolling, or solicitation is allowed.

The topics that were discussed over the course of two hours were:

  • Retiree Portfolio Model, a highly informative lecture on Roth conversions (think MBA level).
  • Social Security tax impact calculator, how a Roth Conversion can impact your Social Security taxes (think Ph.D. Level).
  • Asset allocation, Lady Geek gave a great lecture on asset allocation based on risk tolerance (think undergrad level for newcomers).

It was truly an intense 2-hour lecture.  It was almost information overload.  I left the meeting feeling stimulated and exhausted.  I cannot wait to attend the next meeting in May to listen to the lectures on tax loss harvesting.

The Bogleheads have chapter meetings in most major U.S. cities.  They are free to attend.  I highly recommend attending if you are into reaching FI and FIRE.  If you are interested, there is a local chapter section on the forum to find a meeting near you.  Also, if you are interested in the calculator and more detailed notes from the February 2017 meeting, they can be found under the Philadelphia chapter meeting section on the Forum.