“I want to learn how to invest like you. What do you invest in?”
I get this a question a lot. And I usually answer with a curt “You know…stocks and bonds.” In the off chance that this curious person follows with, “Yes, I want to invest in stocks and bonds too. But how do I know what to choose?” That’s when I share what I’m about to share on this post.
Portfolio Allocation is really what the question is about: how I allocate my dollars across the seemingly infinite options out there. And people get PhDs and win Nobel Prizes for theories that guide portfolio allocation. But that’s not what this post is about.
You don’t need a MBA or even a Finance class to learn a few important things about investing in stocks and bonds. But there’s something to be said about getting to the simplicity of things – having spent over two decades investing in the market, reading all of these investment books, talking to CFAs and financial planners, and yes, getting my MBA and taking Finance classes. And the simplicity of things is where I’ll start – principles of how I allocate my portfolio – before I give you the percentages of my allocation.
Principles
Before I show you how I have invested my nest egg, let me first share a few principles that I picked up in all my research and experience in investing:
1) No singles – I have been burned one too many times in chasing the perceived upside of a single stock. I remember how bullish I was with biotech stock AstraZeneca after a college course I took studying this company, or how as a high schooler, I put some money into Compaq computers because I wanted one. But investing in single stocks is a young man’s game. The risk-reward tradeoff is not worth it to me – especially in my forties and in mini-retirement. There’s too many factors that can influence a single company: timing, poor management, overvalued, etc – on top of the macro factors that impact an entire sector. I am happy to forgo the low likelihood of superior returns gambling on Tesla or NVIDIA when I can get higher likelihood of moderate returns to, as Buffet puts it as his #1 rule to investing: don’t lose money.
2) Low-fee index funds – There’s two reasons why Buffet recommends index funds for non-professional investors and why he specifies how 90% of his trust, upon his death, would be invested in a low-cost index fund for his (ex) wife. First, I’m not a professional – nor do I pretend to be. I don’t have any unique insights in a growing trend like Artificial Intelligence or Clean Energy that’s not already baked into today’s prices. I trust in the long-run returns of a well-balanced portfolio. Second, I don’t think mutual fund managers have any unique insights either. The 2-3% that such a manager would charge me annually ($40,000 – $60,000 of a $2 million portfolio!) – I would rather invest back into my portfolio than pay a ‘professional’ to make trades with. Plenty of research suggests that the market consistently outperforms the average mutual manager – and while I can’t guarantee any one fund would be an exception, I can guarantee that the fund will take my 2-3%!
3) Frequent balancing – like tires on my car, balancing regularly prevents disasters. Imagine re-investing all the S&P 500 gains back into the 2006-2007 market and then seeing all the red when the bottom fell out with the 2008 housing crisis. Balancing helps hedge against the risks of the Gambling Fallacy: that because the market has been “hot”, it will continue burning hot. I re-balance every quarter – and it doesn’t take too long especially given the value it helps preserve. Also, in mini-retirement, I don’t have any other income source outside of my portfolio returns (i.e., I use 100% of my SERP to pay for my costs of living), so I do not have the benefit of dollar-cost averaging in investing into the market (i.e., putting in money every pay check into the market) and falling into the illusion that I can ‘time’ my way to superior returns. I believe frequent balancing helps keep me honest about market timing.
My Portfolio Allocation Mix
I’m not going to get into complicated financial theory here. What I did was quite simple. I read Tony Robbin’s book Money: Master the Game (excellent book, by the way). That book introduced me to the portfolio allocation of David Swensen, the Manager of the Yale Endowment Fund. Mr. Swensen’s allocation is in a handful of ETFs:
- 30% Bonds (IEI, TIP)
- 30% Domestic Stocks (VTI)
- 20% Real Estate (VNQ)
- 15% International Stocks (VEA)
- 5% Emerging Markets (EEM)
I adapted Swensen’s mix to have a long position on Tech (10%), because I believe in Tech’s long-term returns as a sector, and then called it a day. I didn’t want to overthink the asset allocation; I mean you can’t really go wrong with many of these and it’s hard to predict whether it’s better to put funds into, for example, Gold versus Emerging Markets. I put my trust in my principles (above) and focused simply on execution; so long as I’m frequently balancing, in the long-run, the portfolio will deliver returns in good years, weather through bad years, and preserve the nest egg I worked so hard for.
My asset allocation mix is:
- 30% Bonds (VTC)
- 20% Domestic Stocks (VOO)
- 20% Real Estate (VNQ)
- 15% International Stocks (VPL)
- 10% Technology (VGT)
- 5% Emerging Markets (VWO)
Like I said, pretty simple. But let’s see how well this allocation has done since I mini-retired in 2022.
Returns of My Portfolio Allocation
For this back test, I used this simple online tool. I assumed a $2 million portfolio invested at the start of 2023 with quarterly rebalancing and dividends re-invested.
My back-tested portfolio generated a 17% return, very close to the 18% I actually generated (because of some vested stock options I still had in my prior company). Not bad, right?
Keep in mind, though, that the benchmark was the S&P 500. If this were, instead, 100% of my portfolio, I would have generated over 30% returns! But as I mentioned earlier, the market could have gone the other way, and the risk-return tradeoff would have been a lot worse in that scenario for me, i.e., would be hurt more by losing 30% of my portfolio than gaining 30%. I am happy with the 17% back-tested return – and would gladly take that (to the bank!)
Closing Thoughts
Investing, for me, is test of composure. I’m reminded of the opening lines of one of my favorite poems, If by Rudyard Kipling:
If you can keep your head when all about you
Are losing theirs and blaming it on you,
If you can trust yourself when all men doubt you,
But make allowance for their doubting too;
Yes, it’s easy to give way to panic – to over-react and sell when the market is falling, or double down when the market is just too hot. And while I am on the other side of the world from my American friends who talked much more frequently about how much money they made on crypto or how much they lost with European and Middle Eastern conflicts occurring, I still hear this talk occasionally from my expat friends here in Thailand. It’s been important for me to simply remain calm, trust in the principles that I laid out above, and just keep executing against my portfolio allocation. I’m neither boastful about the 18% I generated since mini-retirement or regretful about not putting more into the S&P. I remain composed.
I believe this mindset is worth far more than the portfolio returns. And this is, dear reader, what I hope for you. I hope you also keep your head when all about you are losing theirs. I hope you can trust yourself when all men doubt you. I hope you maintain your composure.
~ Lester T