Putting the Personal Back in Personal Finance

Investing strategies are an extremely personal thing.  I started looking at our investment strategy and I wanted to give a little color on what it is and how we think about it.

First things first, we are using the market to do most of the heavy lifting at the moment.  We might diversify into some real estate here shortly, but for the time being we are not concerning ourselves with real estate, for a variety of reasons.

We're also subscribing to the "4% rule" to give us a rough guide as to where we need to get.

I'm sure most of you have heard of this, but if you have been living under a rock, here's the basics:

Save enough income so that your withdraws are 4% of your total portfolio value.  In other words, your portfolio needs to be 25x your spending.

Now, I was thinking about this in respect to how you get there.  Like most folks, we'd like to have a bond shield to help balance out the volatility in the market.  We'd also like to have a little bit of a cash cushion so that we don't have to sell equities at inopportune times.

So, we're thinking somewhere around 80-10-10 split for equities-bonds-cash.

And I figured there are three basic ways to get to that portfolio mix:

Constant Contributions - This means that you take your yearly contributions and you divide them up according to your ending allocation and invest accordingly.  You can see this grow in the simulated chart I have below:

See how the constant contributions build over time.

Layer Cake - This means that you start dumping everything into the highest risk/highest reward.  Then as you get closer to your end date, you shift to the next lower risk/reward class, and then finally right before you leave the workforce, you shift everything to your cash cushion, to build it up.  The thought behind this is, that you are giving your equity portion the quickest build up, and then allowing compounding to work it's magic, while you are layering more stable assets on top of it.  See and example here:

See the Layers adding on as you get closer to your goal.

All In - This is basically shifting everything into the highest risk/reward asset class.  Then once you get to your goal, you shift it to the proper allocation.  Basically, take everything you are saving go 100% equities and to hell with the rest of it.  See here:

100% Equities - To hell with the rest of it!!

The inevitable question then is:

What is the best possible path to take?

And here's where the conundrum lies. When I built the model to get a certain value, all of these different attempts make it there. And the ending balances are within single digit percentages.

Really the difference between them is the assumption return rate on the various asset classes.  And Lord only knows how accurate that is.

So, let's think through this.

Constant Contributions - the Pros are that it has a little less volatility.  It allows you to have a little bit smoother ride to the goal.  And therefore you end up leaving some of the gains on the table.  Is this bad?  Don't know, it depends on your appetite for volatility.  You also have to re-balance your portfolio every so often so that you maintain your allocation.

Layer Cake - The hybrid of the Constant Contributions and the All-In gives you a bit of both worlds.  You get to max out everything going into the riskier investment classes the whole way, until the very end.  Hoping that you hit the right time in the market.  Then you ignore the equity portion of your portfolio and layer the safety on top of it and create your stable assets on top at the end.  This should give your underlying assets a chance to start compounding.  But again, you're losing out on some of gains since you're not investing everything into the highest returning assets.

All-In - Here we get the highest theoretical returns, but we also have the highest volatility.  You also have the simplicity of just throwing your money into one bucket.  Now, that one bucket might spring a leak and you have to just keep throwing money into it.  In theory you can get there quicker, but that's only if the market agrees.  You can always take some of the top once you need access to some cash.

So What do We Do???

I spent a good amount of time building a model to get those beautiful charts up there.  And you know what?  I came to the conclusion, it doesn't really matter all that much how we build it.  The most important part is that we are constantly investing the whole time through all the fluctuations.

And that's where it gets personal.  I can't tell you what you should do.  There's one person that can, and that's YOU.  But, I'll say this, after the last 2 months of activity in the market, you're getting a glimpse of what's possible.  And that's just a glimpse, imagine if this continues for a year or more?  Can you stomach it?

We just watched 10% of our wealth evaporate in the last two months.

POOF!  GONE!

That certainly wasn't easy, but we have faith in the system, and we are still bringing in an income so we can hold up against these current market fluctuations.  While we have the income, we are buying as much as we can each month going forward.  It certainly is a little unnerving to put money into an account to look at the balance the next day and see it go down?!

WTF?!!  Where'd you go?

We talked about this before, we can't be concerned with that.  We can only concern ourselves with what we can control.  And so, we keep feeding money into the fire.  And really, when it comes down to it, that's the most important part.  The allocation be damned, as long as you are continuing to add to it, the allocation is a secondary thing.  So, the choice really comes down to what allows you to sleep comfortably at night.

As for us, at the moment, we're all in.  I've always thought that we would do more of the Layer Cake approach as we got closer to  our goal.  And I still think we might go that route, as it will be nice to have a little cushion on top of our equities, which will do most of the heavy lifting.  But I'm second guessing that at the moment, and thinking about just sticking with all in, then shifting only what we need at the time.  It's easier to keep track of, I have other things that I want to spend my time thinking about.

Don't know, it's personal, so any other considerations we should be looking at?