Changing My Investment Philosophy

Investment Philosophy

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:

Investment Philosophy

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!

Admiral Shares

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.

Employer Stock

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%.

Investment Philosophy

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.)

Investment Philosophy

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!

Summary

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

Save

Save

Save

Save

Save

Save

Save

Facebooktwittergoogle_pluspinterestmail
share on:

27 Comments

  1. Nice JW – I’m not quite ready for the admiral share stock yet in my portfolio since majority of my contributions have been made in my 401(k) as a young gun. Definitely will look to do the switch.

    Have you ever thought of taking some of the money you have in Vanguard Index Funds and creating your own small index funds based on the companies you believe are better investments?

    Joshua Kennon has recommended this before. Example: You don’t think Facebook or Amazon is a great investment right now, but by investing in an index fund it is most likely buying it:

    https://en.wikipedia.org/wiki/List_of_S%26P_500_companies

    You can potentially get better returns by finding the better companies within the SP500, then creating your own index fund using your own weightings, but still utilizing the index.

    Overall it is something I plan on doing in the future, not with my full portfolio but definitely some of it. REITS / INDEX Funds / My own Index Fund / Individual holdings that I buy at value. I’m thinking this is what my portfolio will consist of in the future.

    What do you think?

    1. The time commitment is what holds me back right now but I’ve often thought how I’d like to do that as well. My brother is a fund manager so I’ve had an inside like at it through him. Plus my 9-5 involves continuously evaluating companies so I’d think I’d do alright at it. It’d be fun to have a small piece of my portfolio set aside for that… Just not too big initially in case I fall flat on my face! 🙂

      Thanks for the comment, Master Duke!

    2. i wonder how well one could do by regularly buying individual stocks of the S&P 500 based on market cap (and bad news). just buy and hold until you’ve enough to afford to get into Admiral shares of, say, VTSAX.

  2. JW, I’m a big Admiral shares fan myself, and have essentially all of my investments in Vanguard Admiral share index funds. Interesting to see your shift over time, and I applaud your timely move on riding your bank shares up, and now out. One question: with such a high exposure to equities, how much cash are you planning on holding post-retirement? I’m going to use the Bucket Strategy, with ~3-5 years in cash to ride out all but the worst downturn scenario. I didn’t see a mention of it in your post, and curious how you’re approaching volatility once you FIRE?

    1. Great question, Fritz, and that may be worthy of its own post someday.

      While I haven’t perfectly formulated my plan, I don’t expect to hold more than 6-12 months in cash. I’d like to have enough cushion built into my portfolio that I don’t have to worry about the volatility so much. Or I would consider holding back some discretionary spending temporarily until the market recovers.

      I’ll have to give this more thought though. Thanks for the question!

      1. I’d encourage you to spend some time on it, JW. Think “if 2008 happened, I’d do…..”. I’m presenting my “Bucket Strategy” to a Rotary Club in my community next week, and I’m encouraging attendees to keep 3-5 years of cash in “Bucket 1”. I just put the presentation together today, think it came out well. Don’t underestimate the damage of Sequence Of Return risk, it’s “real” given today’s CAPE ratios.

        1. I have some time to formulate my final decision yet but I lean on Early Retirement Now who’s done significant research on sequence of returns.

          While it is great for the psyche to have the landing pad of a large cash reserve, there is still risk of holding so much cash via loss of value from inflation over time and the opportunity cost of higher return assets.

          That’s why I lean toward less cash while ensuring I have ample comfort in the size of my retirement accounts to endure volatility.

          Check out ERNs piece on it here:
          https://earlyretirementnow.com/2017/03/29/the-ultimate-guide-to-safe-withdrawal-rates-part-12-cash-cushion/

          The other solution to help avoid sequence of return rush is waiting to retire until after a crash but that presents some challenges too 🙂

  3. Good to hear a different perspective on actively managed investments. Most FI/ER people seem to hold the opinion that the higher fees associated with such investment vehicles have no place in someone’s portfolio. I still have the bulk of my investments in actively managed funds (e.g., PRWCX, PRHSX, PRMTX) – mainly through T. Rowe Price. These funds have significantly outperformed their respective indexes net expenses. I do have some index funds and ETFs and I have an old TSP in the S&P 500 index fund that account for maybe 15-20% of my total investment portfolio. While I generally like ETFs and index funds, I have some concern that if too many investors blindly invest in these funds, certain stocks in the index may become significantly overvalued and others significantly undervalued since they are being bought simply for being part of the underlying index. Not sure if this is a problem yet, but if it becomes one, this should be an opportunity for actively managed funds to buy undervalued stocks.

    1. Thanks Chris. I’ve had some good fortune with a T Rowe Price fund as well (PRMSX) but that may be something to do with timing of purchase as emerging markets were down huge when I bought it.

      That’s a very common concern regarding index funds that I’ve heard some experts discuss before on podcasts (can’t remember which one now…) But if I recall correctly they don’t anticipate “price discovery” being hampered unless the portion of index funds was much higher (it isn’t even the majority of investments now!).

      But I could see actively managed funds begin to outperform again as the field is pruned out a bit, especially in a downturn where I’ve seen the good ones come out ahead before.

      Thanks for the insights, Chris!

  4. Well done GS! I do remember reading a couple of your older posts on active mgt funds and employer stock concentration. The data really does not support active funds >99% of the time given costs that are embedded. Your shift to indexing and reducing your exposure to employer stock is a smart move. I guarantee your family will thank you for this big time in a few decades.

    I get a bunch of restricted stock awards from my company each February – based on company, division and individual performance. As soon as they start vesting after 1 year, I sell them immediately…..and buy index funds like VTSAX, VWIAX and VTIAX.
    We moved to a little more international equities late last year and intend to stick with it for the foreseeable future. There is no shame whatsoever in tweaking your investment philosophy.
    Again, well done

    1. Thanks Mr Pie! I’ve always been a proponent of indexing but I’ve definitely come around to being an entirely index investor.

      I hear you in restricted stock awards. I’ve been eligible for this form of long term incentive comp and I wish I had more control over where it was invested (of course that defeats the companies incentive of giving it though…). More reason to not hold any extra company stock elsewhere for me!

      Thanks for the comment and always good to hear from you!

  5. Thanks for sharing how your portfolio is evolving. You will save yourself some money by shifting towards index funds. I agree with you, it is hard to know all of the answers. We just keep learning and growing as we go.

  6. I love how you are allowing your personal finance and investing philosophy evolve over time… haha- I feel like ours changes weekly sometimes! We are mostly in the index fund camp, but have a few investments scattered elsewhere.

    1. It’s something that I feel you can’t wait to take action to invest until you know everything. You have to start somewhere and then as you continue to learn and grow you have to be prepared to evolve.

  7. You sir have balls of steel. Firstly to load up on employer stock in the first place, and secondly to do so at a time of chaos and carnage.
    I look forward to working my way through more of your blog. (time- sigh 😀)

    1. Haha that’s hilarious! Definitely a risky move. I believe it was February of that year where the nationalizing the banks talk really picked up steam. It seemed so irrational to me but I have to admit it as a little nerve racking! Thankfully it worked out well.

      Glad you enjoyed the post! Thanks for the comment.

  8. many moons ago I heard someone say, “take the southbound train.” it was a metaphor. suppose you want to go to Florida. you’re standing in the station and trains are departing right now. sure, you could study maps and timetables and figure out the perfect route. but you’re just standing there and trains are leaving. get moving in the right direction, even if it isn’t the perfect direction it’ll still get you closer to your goal than you are now. frugality and living within your means is the first step in the right direction. you cannot save for FIRE if you aren’t saving. just put the money in a simple passbook savings account until you know enough to transfer to a better train. and when you learn more you may figure out how to transfer to a chartered jet.

  9. Great job selling off some of your employer stock. And riding it up.
    I tried that when I was young, but the timing was wrong. At least, I didn’t lose that much money because I didn’t have much money. 🙂
    I thought actively managed funds do better in a downturn. We’ll see how it goes over the next few years. Good luck!

    1. Yeah it’s a risky bet, no doubt! I was fortunate the way it turned out. Granted I didn’t have a ton of money then either but it paid off well.

      Thanks for the comment, Joe!

  10. I too have been slowly moving to the philosophy of primarily index funds, although I do have one actively managed fund that is about 15-20% of my portfolio. I would move more to Vanguard, but because my retirement plans are with Fidelity I just put everything in house. I wish they had an admiral share kind of item for Fidelity, but c’est la vie.

    1. At least they’re still really competitive on fees. I can’t remember who provides the index funds in my 401k but it is not one of the main three (Vanguard, Fidelity or Schwab). I’m guessing it too is competitive on fees but there isn’t an admiral class either.

  11. Similar story here. Active managed funds are a quite big position in our portfolio. I have downsized them recently with 25pct. I keep them for now. Is it fear, do I want someone to blame when things go wrong?

    What is sure: new money goes into ETFs.

    And I do want vanguard to come to Belgium! I will go admiral as from day one!

Leave a Reply