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Bonds to Reduce Volatility

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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%

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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 bursting.  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 rebalancing.

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.

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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 were 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%


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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 things 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 I 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?  Honestly, 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 panicked 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.

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Meeting the Bogleheads

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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 by highly knowledgeable and experienced investors.

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.

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There were about 30 people who attended the meeting.  They said that it was one of the larger chapter meetings.  Some people were long time 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 on 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 in to 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.

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