Hello folks! Hope you are doing well today. It has been a while since I’ve written about my investment portfolio. Since a few things have changed or evolved in terms of my investment philosophy, I thought I better explain. Sorry for interrupting my series on the RISMAT, but part 3 will resume next Monday, 8/21.
First, let me give a little background and context to help you understand how my portfolio has evolved.
The Road to Financial Independence
I haven’t always been on the road to financial independence and early retirement. When I got out of school I began investing right away and that was with the plan of working a long and full career before I would tap those funds.
I stumbled on the Financial Independence Retire Early (FIRE) crowd around the time my first cygnet (baby…) was born. I was giving life insurance a deep look and trying to determine what my wife would need to cover living expenses in case I was gone (and vic-a-versa).
In the process I began to formulate a better sense of what it would take to live without both our salaries and reach financial independence. Shortly thereafter my wife and I were fully on board with the FIRE movement.
Initial Investment Philosophy
Back when I was initially constructing my investment philosophy, financial independence wasn’t on my radar. As such, I went about building my portfolio with diversification in mind, and that meant by geography (US and international), by company size (large, mid and small cap companies), by management style (index and actively managed funds), and by management company for my actively managed funds.
I was all about asset allocation and buying many mutual funds to balance the load.
A lot of folks frown on actively managed mutual funds because of the high fees compared to their index fund counterparts as well as their general under-performance compared to their benchmark index, but there is a story to be told.
By definition, actively managed funds have a team of managers that are hired (and paid by your administrative fees) to hand pick a wide variety of investments that match the funds strategy. In theory, the active managers are more in tune with the market and various individual companies and can identify the winners and avoid the losers.
While it can be hit or miss, that is the strategy and if you can pick the right management you can do well. As I analyzed about a year ago, the actively managed funds I owned have done well for the most part.
Where I see this being a particular advantage is in certain sectors that are more risky or require more research, such as small cap companies, international and emerging markets. As you may recall, this is how my portfolio looked a year ago:
Shift Toward Index Funds
While historically I’ve had a large reliance on actively managed funds, my tune has been changing lately. For folks seeking financial independence and early retirement, I’m now a firm proponent of index funds.
Why? Because your early retirement is being driven primarily by a low cost of living and saving the majority of your income. Your investments will grow mostly by contributions, not gains from your investments. That’s because you are retiring early…so you aren’t allowing your investments to compound much before retirement. Therefore you don’t need actively managed funds to try and fuel above average gains, you just need average gains to keep the ball rolling…the ball that is being fueled by contributions.
Take my portfolio as an example. I’ve been investing for over a decade now and Lucy and I have built our portfolio to over $1.2 million. The composition…67% is attributable to contributions and the remaining 33% is from gains from the stock market. And here I am nearing financial independence already.
Chasing some extra return on investment with actively managed funds just doesn’t move the needle, even with the best performing actively managed funds. If I’m hoping to reach financial independence in let’s say 15 years, having actively managed funds won’t meaningfully reduce that time. Therefore it isn’t worth the risk of under-performance to me. Nor is it worth the stress, anxiety, and time to monitor and choose actively managed funds.
For the early retirement crowd, shoot for average market returns and use index funds!
The other change I’ve made to my portfolio is related to the class of index funds I invest in. Chalk this one up to another mistake I’ve made along my path toward financial independence, but until this year I didn’t fully appreciate the difference in Vanguard Admiral Funds and their standard investor shares.
I’ve always used Vanguard as my go to for index funds based on their lower fees relative to other index funds, but I used their standard share class. Admiral shares are a separate share class of Vanguard mutual funds that were created to pass along the savings via even lower fees that result from larger accounts. On average, Vanguard admiral funds have expense ratios 41% lower than their standard investor share class!
What do you need to qualify for admiral shares? Not as big of an account as you would think. For the three index funds I’m interested in (S&P 500, small cap, and international) you only need an initial $10,000 investment in each.
So…ooops. I have now swapped out all my VFINX, NAESX, and VGTSX for the identical version in admiral shares which are VFIAX, VSMAX, and VTIAX, respectively.
As I outlined last year as a short term goal to change my target allocations, my plan has been to reduce the concentration of employer stock in my investment portfolio.
Yes, a good chunk of my investments is held in a singular company’s stock…risky, but let me explain. 🙂
First of all, remember that I am a banker. And bank stocks hit it hard during the crisis. Remember the whole fear that the federal government was going to nationalize the banks. Yeah, that killed the stock price. In general, it drove bank stocks to very low lows, irrationally low! How many more times can I say low…? The markets were in chaos and acting very, very irrational. Bank stocks were low…:)
So being acutely aware of what was happening to bank stocks, I took a very calculated risk and put a whole lot of my 401k into my employer’s stock. Very risky bet at the time, but it paid off.
I have ridden the wave for a good couple years now and have been slowly de-risking that position and actively selling since last year. In 2008, my employer stock represented 33% of my entire investment portfolio! In 2016 and so far in 2017, I’ve take steps to opportunistically sell this investment and get it near 5%, and eventually 0%.
New Investment Philosophy
With this change in investment philosophy, spurred by my realization that I can reach financial independence and early retirement at a very young age, I’ve simplified my portfolio to a few index funds.
All I rely on to reach financial independence is average stock market performance. No super fancy investment will make a meaningful difference to me since the majority of my portfolio will be constructed from contributions.
Once in retirement, however, my portfolio will rely entirely on investment gains going forward. My retirement will be supported by the premise of a 3.5% safe withdrawal rate (with plenty of conservative estimates) making reliable average stock market performance all the more important. So I plan on continuing to be 100% invested in the stock market in retirement, and primarily invested in index funds.
Here is a snapshot of my portfolio today by type of mutual fund (active vs index vs employer stock) and also a snapshot in terms of asset class (large cap, small cap, international, etc.)
I’ve kept emerging market and some international active management exposure. Having more exposure to active management in international is fine as that I believe is a sector that can really benefit by more research intensive active management. While I also want more direct exposure to emerging markets, I’ve held on to those funds.
No huge amounts will be attributed to this sector, so it probably doesn’t matter much either way. And while emerging markets are considered higher risk with more volatility in performance, it is my plan to keep this within 5-7% of the total portfolio.
I use Personal Capital to manage and track my expenses as well as my investment accounts, allocations and performance. It is absolutely free to sign up and use and has some fantastic features when it comes to investment management. I highly recommend it to everyone. Note, if you sign up to Personal Capital by clicking the image below I may receive an affiliate fee (no cost to you). But rest assured that I would not recommend this tool so highly if I didn’t use it myself and love it. It adds so much convenience to managing personal finances. Plus it’s free!
This is one thing I love about personal finance. You don’t have to know all the answers to start and you can continue to evolve your strategy as you learn more and your situation changes. That’s my personal finance story and this is the latest evolution.
Let me know your thoughts in the comments below.
Thanks for taking a look!
The Green Swan