I’ve written in the past about the importance of saving money early and often. By now you know that early in your career your savings rate is way more important than your investment rate. But until now I haven’t told you exactly how I invest, other than hinting that Vanguard is the right way to go.
In the past my asset allocation has been all over the place. I tried to purchase individual stocks. I made some money but lost a lot as well. Chances are good that you’ve experimented with the same. It was only after a few years that I realized I could get a great return by simply trying to match the market. It’s a lot less stressful as well! I rarely check my portfolio. I don’t follow investment news. I keep things simple. The allocation I’ve decided on is:
- 70% US Stocks
- 20% International Stocks
- 10% Bonds
The perfect asset allocation
This is hardly the perfect asset allocation. There are other things you can do to tweak the results. But when you’re building a portfolio like I am, do those margins even matter? Especially when you can’t predict the future? The White Coat Investor has laid out 150 portfolio options he thinks are better than yours. I’m sure mine is better than some of them, but I’m not about to spend hours chasing an alpha that will have a minimum impact on building wealth. Right now is the time to focus on growing income, reducing expenses and saving as much as possible. An extra 1% return at this stage of life (mid-30s) isn’t going to do it.
So how did I come up with this asset allocation? Mainly thanks to the wisdom of Boglehead Taylor Larimore and the three-fund portfolio. Taylor is the co-author of The Bogleheads’ Guide to Investing and someone Jack Bogle calls the “King of the Bogleheads.” With over 90 years of life experience, you know that the man has seen a lot (including the Siege of Bastogne).
The three-fund porfolio is based on fundamental asset classes of stocks and bonds. The core assets in the three fund portfolio are US Stocks, International Stocks and the Bond Market. You can achieve this with the following three Vanguard Funds:
- Vanguard Total Stock Market Index Fund (VTSMX)
- Vanguard Total International Stock Index Fund (VGTSX)
- Vanguard Total Bond Market Fund (VBMFX)
These funds are widely available in most retirement plans and if not, you can substitute a low cost S&P 500 fund for VTSMX in a pinch. Otherwise, I can achieve the three fund portfolio by simply looking at my assets across the various accounts (401(k), Roth, Taxable) and make adjustments where necessary to keep the allocation in line.
I wanted a portfolio that consisted of 90% stock and 10% bonds. Some of you might view that as aggressive, but the truth is that I hope my investment career is long. I’ve lived through the 2008/2009 crash and while I only had a five figure portfolio at the time, I never had a cause to panic or thoughts of selling. I wanted to buy as much as I could. It remains to be seen if I’d feel the same way watching a $1 million portfolio cut in half, but generally speaking I’m not worried about Mr. Market and his mood swings. I’m certainly not going to do something silly like trying to time those swings either.
Splitting the 90% of stocks between 70% in the United States and 20% International is just an arbitrary decision on my part. It might even be too complicated. JL Collins thinks you can skip the international component entirely since United States companies are exposed to international markets anyway. I think he might be right. I’m sticking with the three fund portfolio for now but wouldn’t think it strange if you only wanted to invest in VTSAX and VBMFX.
Adjusting bonds over time
There seems to be two schools of thought when it comes to adjusting your bond position over time. Some say once you’ve “won the game” you should move a larger percentage of your allocation into bonds. Others think that if you want to maintain the 4% safe withdrawal rate, you should keep a healthy allocation in stocks so that your portfolio continues to grow above inflation.
Since I’m trying to build as big of a portfolio as possible, I’m not interested in adjusting my bond position as I grow older. There’s just no good reason to play it safe with a portion of my portfolio. I’d like to get to the point where if the entire portfolio is cut in half, I’d still be able to live on 4% of the withdrawals. To that end, I don’t need the bonds to smooth the ride.
This plan may expose me to unnecessary risk, but when you’re young I think it makes sense to swing for the fences (as long as your definition of swinging for the fences is investing in a low cost index fund that tracks the stock market). I’ll adjust in the future if needed, but I can see some of the stocks I’m accumulating now being around for the next generation. When you’re thinking of an investing career that could last generations, bonds become even less attractive.
While I don’t need an 8-figure portfolio to have “enough”, if I ever get there I’m counting on the portfolio itself to do most of the work compounding on my behalf.
Joshua Holt is a former private equity M&A lawyer and the creator of Biglaw Investor. Josh couldn’t find a place where lawyers were talking about money, so he created it himself. He spends 10 minutes a month on Empower keeping track of his money. He’s also maxing out tax-advantaged accounts like 529 Plans to minimize his taxable income.