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.
Why 70/20/10?
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 practicing 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 Personal Capital keeping track of his money. He's also exploring real estate crowdfunding platforms like Fundrise which are open to both accredited and non-accredited investors.
Yeah, you probably don’t need that 20% international. Nearly every company in the S&P500 has huge international exposure. The global economy is so connected now it’s probably not worth the trouble.
That said, the US dollar is near an all-time high I think…that might mean good value for your dollar internationally.
Thanks Mr. Tako. I think you and Jim Collins are probably right. It doesn’t add much to the portfolio, particularly given that adding real dollars is the most bang for the buck right now.
I run a very similar portfolio, except take the 10% to bonds and move it to international. Over the long term I think equities will out perform bonds, so the 10 or 20% tilt to bonds doesn’t seem worth it in my case. I’m not an emotional investor. My money goes in every payday whether the Dow is up 400 points, down 400 points or flat. I also have no intentions of selling my investments for quite a while, so can deal with the volatility of equities. Lazy portfolios are the way to go in my book. Take care.
Well according to William J. Bernstein of “The Four Pillars of Investing” fame, a portfolio with 20% bonds is not only safer than a portfolio with no bonds, its actually more profitable over the long run. He does not believe that a portfolio with less than 20% bonds ever makes sense. That’s because of portfolio theory. When stocks dip, as they will 1 out of every 3 years, and sometimes by a lot, people will flee stocks and move heavily into bonds. This ‘negative correlation’ will cause your bond allocation to increase and after some time you will rebalance the bond gains back into stock gains. People always think that bonds reduce risk but drag down long term profits. Not true!
In the real world I’ve only seen a slight increase in my bond and commodity funds (commodity also has a negative correlation to stocks) but at least they aren’t going down like a leaky faucet, and you will have some assets to rebalance your stocks.
FWIW, my 401k plan at my firm has Vanguard LifeStrategy Growth in it (which is 80-20 stocks to bonds, including a proportion of international stocks/bonds) as one of its lowest expense ratio offerings. I just roll with that (which keeps it pretty simple/rebalances automatically).
Taxable investing accounts are still relatively small and all in Vanguard ETFs (Total Stock, Total International, with a small amount of Small Cap Value) — eventually, when those get larger, I will probably move the 401k to LifeStrategy Moderate Growth (60-40 stocks bonds) and keep the taxable 100% stocks to maintain tax efficiency.
I use LifeStrategy Conservative Growth to hold my “emergency fund” which I call my “Biglaw Eject Button”. It’s great. The expense ratio is slightly higher than it would be if you built the allocation yourself, but it’ll do just fine for now.
On the taxable investing account, asset location is definitely an advanced investing topic. Keep in mind that you should pay attention both to the tax efficiency of the asset as well as the expected returns. It may be better to put your tax inefficient asset in the taxable account (assuming it has a low expected return) and to put your tax efficient asset in the tax protected space (assuming it has a high expected return).
I’d be interested in an article about the topics you mentioned in your reply to chadnuj! (Or if you already have a post, please point me to it) I don’t really categorize my money but I’ve struggled with where to put my “emergency fund” as well as funds for short term goals like house down payment. The conventional wisdom says to put it in something conservative like a high yield savings account but it’s tough seeing all that money earning so little…this is especially true in high cost of living area where emergency funds/house funds probably hold a decent chunk of change.
I also see your point about paying attention to tax efficiency AND expected returns. Many just focus on tax efficiency. I was considering a tax-exempt bond fund for tax efficiency but will I pay a higher price in lower returns? Maybe I should just max out my Roth before I even consider investing in taxable accounts…
Definitely max out your Roth before a taxable account. That’s a no brainer. You’re only going to need a taxable account once you’ve maxed out all your tax-advantaged space. Given that you can buy/sell Vanguard funds in a tax-protected account with no commissions and no tax consequences, it isn’t a problem to keep your asset allocation inside the tax-protected accounts until they spill out into a taxable accounts on the account of saving too much money (a good problem to have).
I haven’t written any posts yet about the location of assets. In the grand scheme of things, it’s a pretty advanced topic and in terms of tweaking the portfolio it comes after maximizing your tax-advantaged accounts and figuring out an asset allocation. I will definitely write about in the future though. Consider the topic on the list!
I did cover where I keep my “emergency fund” here:
https://www.biglawinvestor.com/is-an-emergency-fund-necessary/
Thanks I will check out that link. You’re right, I should max out my tax-advantaged space first. Even with the Roth I can access the funds for a house purchase (though there is a $10,000 restriction which is pretty low for NYC housing purposes) but you can also withdraw contributions if necessary. I was a little uncomfortable using the Roth as an E-fund or housing fund but the benefits might outweigh the negatives.
What are the negatives since you can withdraw contributions at any time?
You got me there…I guess there are none. I’ve just never withdrawn from contributions before. One time when I called asking about that the rep said that I would have to go through my statements to add up the contributions to determine how much I can withdraw. But what if I transferred the account from a different investment firm and didn’t keep good records? I don’t know…just didn’t want it to be an issue when I needed to access the money. I’m probably just overthinking it.
Yeah, way too much hassle to stick a house downpayment in a Roth IRA. But for an emergency fund, it doubles as a nice vehicle (at least until the point that you have a taxable account which could serve as an EF anyway). I make one contribution a year, so I think the record keeping is pretty easy. I wouldn’t worry about it too much though either. As far as I’m aware, it’s not like Vanguard is going to stop the transfer until you prove to them you should have access to the money (for all they know you’re over 59.5 years old). It’s more of a tax reconciliation problem at the end of the year, right?
I’d always leave an emergency fund (or, at minimum, 3-6 months of expenses of an emergency fund) in cash or CDs that could be broken with very little in the way of cost. There is ZERO substitute for having cash when you truly need it (and trust me — as a lawyer, even at big firms, you could lose your job stunningly fast).
For a house down payment, I’m a bit more flexible, because (frankly) my timing is more flexible. I may WANT to buy a new house in 3 years, but I COULD stretch that to 4-5 years (or longer!) if needed. Maybe a safe bond fund (generally speaking, while they may suffer losses in a time period, those losses tend to be minimal – i.e. less than 10%), or if you’re really fine with delaying if necessary go with stock index funds. That’s the approach we’re planning on going with for our next home (we currently own a condo, but we’d like to move for better school districts for the kids when they get school age in a few years….but, if we had to, our kid(s) could easily start kindergarten or elementary school in our local school…and that ignores the fact that we should have some equity from selling our current place to play with).
And BigLawInvestor — I’m not sure I entirely understand your theory on putting high return assets in tax-advantaged/deferred and low return assets in taxable. Generally speaking, high return assets (namely stock index funds) should be in your taxable account because (a) you would only realize capital gains if you sold them, and (b) they pay less in dividends/income (which are taxed higher when you’re making big law money), and bonds should be in tax-advantaged/deferred since they pay more in dividends/income — by doing this, your total returns on your portfolio will be higher because you’ll be avoiding tax drag.
Now, that’s not to say you should NEVER hold bonds in a taxable account, or stocks in your tax-advantaged/deferred accounts; obviously you may have investment goals for your taxable account that require the “safety” of bonds, and everyone will need some amount of stocks in their tax-advantaged/deferred accounts just so that they grow enough to pay for retirement, etc. But generally speaking, as much of your bond portion as possible should be in tax-advantaged/deferred, and your taxable account should be almost all stocks.
On the emergency fund, I tried to tackle the questions you raised in my emergency fund post. I can’t think of any situation where I would need cash in the 2-3 days it would take me to liquidate securities at Vanguard. We just don’t live in that world any more. I think the idea of a “cash” emergency fund is more appropriate for people that are struggling to budget appropriately and build up savings, where the EF serves as a buffer keeping them from incurring credit card debt. Lawyers (not just Biglaw lawyers) should be able to handle unexpected expenses through cash flow or, if you lose your job (happens all the time in Biglaw, as you mentioned), you can then adjust as necessary and sell the securities to cover living expenses. But I recognize that this comes down to people’s comfort level. Some people want a big cash reserve. There’s no harm in that, I just don’t think that there’s no requirement to keep it in cash if you’d prefer to have it invested. As you build up more and more assets all of this becomes moot anyway since you have access to plenty of funds in case of a disability/job loss.
On the asset location question, thanks for the valuable comment. I really appreciate the discussion you’ve generated. I’ve got a post in the works that lays out my thinking. I’ll be sure to leave a link here once it’s been posted.
@chadnudj Good point about being flexible with the house purchase…I think we’re in the same situation and also considered a bond fund. I’m currently in a co-op but it’s a junior 4 (converted 2 bedroom) with a toddler and newborn. It’s getting a bit tight and it would be nice to have a backyard. In any case, we’re actually in a good school district but a bigger co-op in the area is going to be too expensive…a house…definitely out of my price range. Also, I’m in the public sector so job is more secure, although there were some layoffs during the last recession.
As for the asset allocation, I guess it can be argued that due to higher returns of equities, holding that in your tax-advantaged space may result in high tax savings later when you are in the stage where you’re withdrawing the money.
The post I promised on how asset location is not always black and white is up:
https://www.biglawinvestor.com/bonds-in-a-taxable-account/
I currently have my portfolio at 95% US stocks and 5% bonds. I personally don’t like where bonds are in this environment plus I fairly young so I don’t think I need that much exposure. Like you I didn’t worry too much when the market dropped in 2008/2009, if anything I wish I had more money to buy stuff. I’ve built up my cash portion so during the next bear market I can buy a bit more.
Interesting. Why do you have any bonds at all? I guess you could ask me the same question. With both of us holding 5%-10% in bonds, it’s a pretty insignificant amount. A 100% equity portfolio does have a higher expected return, so we could reach for greater returns by dropping our bonds which aren’t doing that much to “smooth the ride” for us anyway.
On the cash position – don’t you feel like you’re trying to time the market?
That’s not a horrible position….but long-term efficient portfolio theory tells you that you should experience nearly the same returns with less volatility with at least 20% bonds (hence why I love Vanguard LifeStrategy Growth Fund, which is 80-20 stocks-bonds).
I guess in my head I don’t think of it as timing the market as much as having cash available to buy when things are cheap. I still remember during the great recession how I wish I had more cash available to buy cheap stocks.
Since then I was able to deploy cash in February when the market dropped by 10% and since the market on average drops by 10% every 11 months I like to have a little extra cash available when it happens.
So I guess theoretically I time the market but while I’m not Warren Buffett I do try to evaluate having a cash position available to buy something if it’s on sale.
I understand the struggle. In 2008/2009 I wished I had more cash available to buy cheap stocks. I’m not convinced it’s worth keeping cash around for those opportunities though. Better to have the money earmarked for investments actually in the market in your desired allocation and then if a recession comes along figure out ways to reduce spending to increase investments.
What % of your net worth does your investment portfolio represent and what is your plan for saving money to eventually buy a place? For example, is your future down-payment part of your investment portfolio or do you have that in cash. (I am assuming you don’t own since you are in NYC).
My net worth and investment portfolio are one in the same. I look at all assets holistically, so the answer to your first question is 100%.
As for a down payment, it’s part of my investment portfolio. I don’t have anything in cash set aside specifically for a house, but I’m also not planning on buying property in the foreseeable future. If I were to change my mind, I’d probably divert cash flow that’s being poured into equities in a taxable account to cash in order to build up the down payment. I have been playing with starting to build a small cash position for a down payment, but I’m not that excited about home ownership.
I’m at 95% stocks and 5% bonds and cash alternatives. I’m way behind in a reasonable investing timeline. Hopefully this will change the outcome in 40 years.