Offense wins games, defense wins championships.
- unknown
While we're sure to trip at times, the goal is not to fall.
- Todd Harrison
I've been debating today's topic for a few days now. My main worry is not that the topic is controversial, but whether I can clearly articulate my point-of-view. So with the caveat that these are my views based upon my risk tolerance, my time horizon, my investment objectives, and my desire to sleep at night, it's time to introduce the two portfolio's I commonly write about:
- unknown
While we're sure to trip at times, the goal is not to fall.
- Todd Harrison
I've been debating today's topic for a few days now. My main worry is not that the topic is controversial, but whether I can clearly articulate my point-of-view. So with the caveat that these are my views based upon my risk tolerance, my time horizon, my investment objectives, and my desire to sleep at night, it's time to introduce the two portfolio's I commonly write about:
- Retiree portfolio
- Dollar Cost Averaging portfolio
I graduated college in the late 90s to a job with an S&P 500 software firm. Among my benefits was a 401k retirement plan with a generous company match of 50 cents on the dollar up to ten percent of my salary. Knowing a good thing when I saw it, I immediately enrolled into the 401k program for ten percent of my salary. After reading a few investment articles and talking to family and friends, I selected 4-5 stock mutual funds to diversify my fledgling nest egg. My primary screen was fund performance and low cost.
Over the initial years, I have to admit a gratifying satisfaction watching my account balance rise with the stock market. I took up finance and economics as a minor hobby reading the occasional magazine article and watching CNBC. As with much of the nation, I was enamored with the idea of striking it rich in technology or Internet stocks.
However this joy came to an end that I never saw coming. In March 2000, people decided that companies should earn a profit and not simply count how many eyeballs look at them daily. Over the next several months, the stock market crashed and so did my 401k.
During this time, I did what I was supposed to do. I kept on buying, which dollar-cost averaged my nest egg into cheaper shares. Still, that didn't take the pain away. I decided that I needed to learn how to look for warning signs of future market crashes, as well as learn from my mistakes - such as not having diversified into a bond fund those initial years, which would have significantly cushioned the blow.
...
October 2007 was a notable month as I decided to move on from the same software company to the position of stay-at-home dad. It was also notable as I couldn't get my retirement money out of the 401k plan and into a rollover IRA at Vanguard fast enough. While you might think I was in a hurry because Vanguard invented the low cost index mutual fund, you would be wrong.
Since the Nasdaq Crash of 2000, I had become a voracious reader of economic and financial subjects.
...
This time I saw the financial storm on the horizon known as the US housing crisis, and I was determined to save my hard earned retirement nest egg.The Genesis of My Retiree Portfolio
I am a huge proponent of dollar cost averaging. The primary advantage of dollar cost averaging is buying more shares at lower prices should the stock market drop.
However being a stay-at-home dad, I no longer dollar cost average into my 401k as I have no income. In this respect, my 401k resembles a portfolio of a retired individual, which is why I call it my Retiree Portfolio. And like a retired person, my primary objective for this portfolio is capital preservation - I don't want to lose a lot of money if there is a foreseeable crisis.
Although I'm a proponent of lazy investing, I saw no reason to let the storm known as the 2008 Financial Crisis decimate my retiree portfolio. So I tried to protect the portfolio from losses as best as this engineer-want-to-be-investor could by managing risk. Thus what you see in the table below are my Retiree Portfolio allocations.
| Fund/Asset | Percentage |
|---|---|
| Money Market Funds | ~34% |
| Intermediate Treasury Bond Fund | ~14% |
Ginnie Mae Bond Fund | ~10% |
| Inflation Protected Securities Fund | ~17% |
| S&P 500 Index Fund | ~4% |
| Total Bond Market Index Fund | ~9% |
| Gold ETF | ~12% |
Please note that I selected the allocations in table 1 to help me weather the financial crisis. This is NOT a recommendation for your portfolio. Remember that I do not know you, your risk preferences, your time horizon, or your investment objectives. Furthermore you should not change your portfolio based solely on something that you read on this blog (or any blog for that matter). Please review the disclaimer at the end of the article for more information.
As I mentioned in Stay True to the Path or Take the Fork in the Road, cash is a legitimate position. The only risks to cash is inflation and missed opportunities. In order to hedge inflation risk, I chose to buy a gold ETF and inflation protected securities. For general protection in 2008, I thought bond funds would do well as any return is better than the negative return I foresaw in stock markets. The Total bond market index fund provided general protection across short, intermediate and long term bonds. I added intermediate treasuries because they provided a better yield than short term, but less potential risk than long term and corporate bonds. Ginnie Mae bonds are government-backed mortgage securities that also provided better yields.
While I have made few changes since 2008, I may make significant changes any time now as I have considerable exposure to the bond market. While interest rate risk is not yet keeping me up at night, it is something that I think about regularly. Interest rates can only go so low before they begin to rise again. When that happens, bonds will lose money. I'm still formulating a course of action. So if this article causes you to think, "I'm putting more into bond funds" - please understand that I believe that they are no longer the safe allocation as they are traditionally perceived.
In 2007/2008, my goal was simply to make it through the crisis without taking a significant loss. While I'm disappointed to have missed out on the stock market returns since March 2009, I take comfort in the fact that losses I had were minimal and that this portfolio grew better than 15% since October 2007. Though nothing to brag about, I'll take the smooth low returns over the experience of large losses when the stock market dropped over 50%.
Dollar Cost Averaging Portfolio
While I no longer contribute to a 401k, my wife does. Additionally, she recently started with a new company, so I was excited to see what investment options were available. As what has been typical in my 401k experience, there was a dearth of index funds. However, here are the funds that I chose for her along with the overall allocation.
| Fund/Asset | Percentage |
|---|---|
| S&P 500 Index Fund | 15% |
| TRP Blue Chip Growth Fund | 10% |
Fidelity Low Priced Stock Fund | 15% |
| MSIF Small Cap Growth Fund | 15% |
| DFA Emerging Markets Fund | 15% |
| Harbor International Fund | 10% |
| Nuveen Real Estate Fund | 10% |
| PIMCO Total Return Fund | 10% |
Again, table 2 is NOT a recommendation for your portfolio. Remember that I do not know you, your risk preferences, your time horizon, or your investment objectives. Furthermore you should not change your portfolio based solely on something that you read on this blog (or any blog for that matter). Please review the disclaimer at the end of the article for more information.
Looking at the table above, you may be shocked to see 90% allocated to stock funds and only 10% to bonds. Here is my rationale for these selections:
As my wife started recently, there have been minimal contributions to this account. Hence there is no significant account balance to be lost. As there is no significant balance, a large stock market loss means the next contribution very quickly averages the overall cost per share down. Thus I'm choosing funds that are considered more risky, like small company, mid-company, emerging markets, international stocks, and real estate. While this may seem counterintuitive to some people, I experienced the positive results when the stock market rose from the 2000 crash until 2007.
Additionally we have a long time horizon, so we can wait out any downturn. Within this time horizon, small and medium companies should grow. So I have allocated 30% of funds towards these categories. Likewise, I believe that international stocks will grow well as other nations want to be prosperous like the U.S. Thus 25% of funds are allocated to international and emerging markets. Also, bond rates will at some point rise. While bond funds will lose money when that happens, dollar cost averaging enables me to again buy cheaper shares.
By now you've probably realized that I'm treating the dollar cost averaging portfolio on the complete opposite end of the spectrum as the retiree portfolio. Again with regular contributions, my wife's portfolio is managing market pricing risk by buying cheaper shares in any downturn. Even though we're in our mid-to-late 30s, this portfolio illustrates the advantage of a long time horizon, which is being able to weather more risk.
Parting Thoughts
I chose today's quote because much like sports, investing isn't about a single game - it's about the whole season. Championship teams can lose a few games during the season. However in order to win the season, you must have a defensive strategy to manage risks. Dollar cost averaging is one proven method to play defense in your retirement strategy.
In my Retiree Portfolio, I concentrated entirely on defense by selecting bond funds. This worked - though not everyone wants or has the ability to actively monitor and manage risks. This is why lazy investing shines, and one reason why I recommend lazy portfolios. Lazy portfolio's are another defensive strategy. No doubt this is one of several reasons why many investment professionals use them.
For more information on lazy investing, check out:
Or look for the following books at your library:
- The Little Book of Common Sense Investing by John C. Bogle
- Millionaire Teacher by Andrew Hallam
With that said, don’t let your investments keep you up at night. If they do keep you awake, you may be taking more risks than you are comfortable with. Talk to a professional about reallocating to less risky investments so that you can sleep. During your conversation with said professional, ask why they believe that their recommendation is less risky. If you are not convinced by their explanation, don’t invest. Remember:
- It’s your nest egg.
- Opportunities are easier to make up than losses.
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