September 1st, 2021 paycheck
|Description||Target low percent||Target high percent||Actual percent|
|US equities - small||24||35||18.9|
|US equities - mid||24||35||22.8|
|US equities - large||24||35||42.1|
- Simplified the table and communication of where money lives; based on three allocation blocks.
- Sold all individual stocks.
- Created an M1 Finance pie representing allocations for each Coast FI goal.
- Upgraded interactivity and information available in the spreadsheet.
- Still waiting for the IRS to tell me if I actually owe taxes and fees, so, pausing investments.
Simplified the table
Was recently introduced to Risk Parity Radio via Choose FI and I’m appreciating the ideas there. Specifically this idea of what it is to be diversified in a portfolio. In short:
The "Holy Grail of Investing" is "making a handful of good uncorrelated bets..." It is "the surest way of having a lot of upside without being exposed to unacceptable downside." ~ Ray Dalio, Principles
It’s not just uncorrelated with the stock market, it’s uncorrelated to each other. In fact, in some cases, we want to invest in something that historically goes up in value while something else goes down.
I plan to have a stock-driven portfolio. Therefore it makes sense that the next largest allocation in my portfolio should have a negative correlation to stocks; this is where bonds come in, specifically, long-term US treasury bonds. The smallest part of the portfolio is relatively uncorrelated to cash, stocks, and treasuries.
The equities will typically bring the most growth through capital appreciation and a bit in dividend income. The drawback to equities is they are volatile, which just means they can increase and decrease in value a great deal from day-to-day.
When we talk about risk tolerance, this is what we’re talking about. How likely are you to panic if you see your portfolio or net worth drop 20 to 50 percent in a given day?
In some cases, the overall stock market can be de down 10 to 20 percent compared to its previous all time high and stay there for years. For example, in 2000 the stock market dropped roughly 30 percent and didn’t go back to that previous level until 2007. Then, in 2007, the stock market dropped almost 50 percent and didn’t make it back until 2010. Taken as a single event, it’s basically a decade; a lost decade, if you will.
This is sometimes referred to as risk capacity; how long can you wait for a recovery?
My annual income is greater than my overall portfolio value. My total lifestyle cost is far less than my income. It would take me roughly two years to save up the same amount and I don’t plan on cutting back my hours or income within the next 10 years.
I have a high risk tolerance and a high risk capacity. My portfolio is 100 percent stocks.
When I start hitting those Coast FI numbers in my investment policy, my risk capacity and portfolio allocation will begin to change.
I feel like I’m starting late and playing a bit of catch-up. However, I can’t let that feeling cause me to make un-calculated and unnecessary risks.
Sold all individual stocks
To save for my insurance deductibles I went with individual stocks; mainly to experience owning individual stocks. I’ve decided to step away from that for now. It was working, it was just cumbersome.
I think I’m also starting to understand the difference between saving, investing, and owning for me.
Saving means I have cash; a share in an economy. Investing means I spent cash to buy something else I hope will have greater future value. Owning is a specific type of investing because it comes with other rights and responsibilities.
When I put a dollar in my credit union, I have a share in that credit union. My credit union uses those funds to give loans, part of which they pay me in the form of dividends. I have the ability to vote on who sits on the board and certain other decisions. I’m an owner of that credit union.
My current balances and the dividends the credit union can pay aren’t that high right now and don’t outpace the annual reduced purchasing power of the money saved. I need to invest in something else if I want to be able to pay for my lifestyle in the future and not have to “hustle” until I’m dead.
This is where indexed mutual funds come in. The indexed part of that is the key.
A mutual fund is when a bunch of people pool their resources to invest in something (usually the stock market). There are two flavors of mutual fund: active management and passive management. Active management means someone is deciding what to invest in, when to invest in it, and how often; a portfolio manager. Passive management means there’s an explicit set of rules and changes to any given course of investment are based on those rules; usually these rules come in the form of an index. With this type of investing, I’m not the owner of the individual companies or asset; I own shares of the fund not the stock, bond, or alternatives market.
Right now most of my investments are spread across the entire US stock market. Further, most of that is in index funds. I pay very low fees because I’m not paying a babysitter. I also don’t get to vote on things like budgets and board members for the 3,500 companies traded on the US stock exchange.
I had a small bit of investments set aside in individual companies. I was an owner of those companies. I got to vote on budgets and board members.
Given I’m just starting this journey into investing I want to experience as much as I can while the stakes are relatively low. A 10 percent mistake on 100 USD is 10 USD. A 10 percent mistake on a million is one hundred thousand dollars.
Investing in individual companies wasn’t a financial mistake and I’m grateful for the experience, I may even do it again some time. It just added a layer of complexity I didn’t want to deal with.
If I’m understanding the tax implications around how this works:
- I should not be taxed on the money spent to buy shares. That money was already taxed and the government can’t tax the same dollar twice.
- I will be taxed under the capital gains rules for the remainder of the sale. These will be short-term capital gains, which means I’ll be taxed my ordinary tax rate on around 60 USD; not the over 1,000 USD invested.
Like I said, it was going great and the ride was pretty stable. I also really liked being the owner of the companies I had. Right now I’m just looking to simplify and consolidate things.
Coast FI pies
One of the first things we created was the Coast FI stack in the investment policy. The Coast FI stack creates 5 milestones; one for each Coast FI number. I created what I believe will be the portfolio I’ll want by the time I reach FI. It is still stock-driven and uses the same two funds as the base. From an historical perspective it seems to have the performance characteristics I’m looking for:
- Sharpe and Sortino ratios greater than 1.
- Depending on which dataset I use the worst drawdown is 6–13 percent and that lasts roughly 6 years.
Regarding the drawdown range, the dataset that says the drawdown could be 13 percent is basing it off 3 years of data. The dataset that says 6 percent goes back to the 1970s. Luckily, we have about 10 years before I think I’ll be “all in” on this allocation, so, more data will come in and we can adjust as needed.
With that said, it doesn’t mean we can’t experiment with smaller balances. It also means we can create allocations for each milestone. This is similar to the way a target date index fund would work.
I built pies in M1 Finance, one for each milestone. I put each into a containing pie and will throw 180 USD to be divided equally to the 6 sub-pies; 5 Coast FI numbers plus the 100 percent stock allocation I’m in now. This way I can watch them perform over time and see if I’m comfortable with the swings up and down.
I’ve created two pies for intermediate savings (purchased 5-plus years away); one pie for electronics (computers and cables, not cellphones) and insurance deductibles (what I was using my individual stock portfolio for). These both use the proposed Mark 1 pie, which is what I’m hoping to use as the drawdown portfolio. If I can still buy electronics from the electronics fund and pay insurance deductibles from the insurance fund, we’re probably okay. This will also introduce me to the tax implications of these various holdings.
I created another pie to start saving for a car; thinking in 10 years for the van life thing. I’m estimating 30,000 USD for the car. There will be roughly 240 paychecks between now and then. I want to simulate the Coast FI stack at this smaller scale. I’ll create 6 milestones for the car savings and convert as each milestone is achieved.
The FI Experiments pie with the milestone pies underneath is the control, this pie has no further contributions added to it. We also have two pies testing continued contributions for the Mark 1 allocation; the transition milestones use dot notation with a prefix of 0 (0.0, for example, is where we are now). We also have a pie that should act as something of an accelerated microcosm.
I’ll consider rebalancing once a year using bands. So, on the day, I’ll check each sub-portfolio and, if the spread is wide enough to warrant it, I will buy and sell accordingly. We shouldn’t need to rebalance most of the sub-portfolios because they’ll be rebalanced through contributions; only the control group should require rebalancing, which we’ll only do if they meet the criteria on the day and the bands will be pretty wide. Buy and hold. Buy. And. Hold.
It’s important to note (or possibly reiterate), at the timescale of 10 years and until we hit 100 thousand dollars, we’re not getting much assistance from compounding. Most of the fair market value of the portfolio (and alt portfolios) will be from principal and appreciation of the assets purchased.
These posts use my overall net worth statement, which combines all of the sub-portfolios and accounts. Further, because I’ve essentially used my money to purchase shares of index and mutual funds, most of my money is “tied up” (just like someone who owns a home). Finally, one could argue that my assets are more liquid than a home; however, it still requires someone on the other side willing to pay what I’m charging for the shares.
There are two hopes:
- Between appreciation and dividends, when I sell shares in the funds, the money I receive will have at least the same purchasing power as the principal I put in.
- Alternatively, between appreciation and dividends, if I sell all my shares, I will get the same amount I put in and maybe a bit extra.
A note on M1 Finance is that setting up the pies and selling the stocks revealed something interesting. I was surprised that M1 Finance didn’t sell my lots in a certain fund in order to buy the same fund. It appears the calculations used look more at the lots I hold and not the pies themselves. I don’t know for sure if it works this way, but it appears because more money would end up in the same extended market fund than was already there, M1 Finance only bought more.
Upgraded the spreadsheet
I still use a spreadsheet for high-level planning (and making these entries. I use Apple Numbers, which allows you to add multiple tables to a single sheet in a way I haven’t seen with other spreadsheet apps.
For the tables I use to build these entries I have one where I put the balances and fair market values for all the things. The data in this table is used to update numbers in the portfolio table (more on that later). The data in the portfolio table is used to update some of the percentages used above. Then I export another table to a file I upload to portfolio visualizer, which tells me the percentages for small-, mid-, and large-cap equity investments. The percentages table also has the bands used to determine if rebalancing will occur. I added conditional highlighting to the cells so, if they need more money the cell is green, red if that component needs less money, and plain text if it’s within range.
The portfolio balances table does the same thing while separating the portfolio into four sub-portfolios:
- tax-free, and
- triple tax advantaged.
Each sub-portfolio shows where I’m out of balance.
Another table helps me determine paycheck distributions, saving for known future expenses, and progress toward the Coast FI stack milestones.
Waiting for the IRS
I contacted the IRS to verify if my correspondence was received. They weren’t able to confirm but updated my account noting the call. They told me it could take a few weeks for acknowledgment by mail. And a few more weeks to make a determination.
I will continue to hold back investing in anything except my 401k so I have plenty of cash on hand, just in case. Im still trying to reach the maximum 401k contribution for the year.
When my last paycheck for the year comes in, I’ll reduce my per paycheck percent to something that allows me to hit the maximum each year while still taking advantage of the full employer match.
This year has been interesting as I keep shifting allocation figures around. Next year I’m hoping for more consistent redistribution amounts across the board. I am appreciating that the overall portfolio is coming into balance.