Asset allocation is one of the tent poles in building a productive portfolio. In the past, we’ve discussed 3 main ways to build up a portfolio. But, let’s take a look at how we have our assets currently allocated. And then we’ll walk through what our strategy is going forward.
Current Allocation
Equities (92.5%) – This is currently where we have most of our money, and still where we are putting most of our money. Almost everything gets dumped into equities at this point. We have it split 80/20 domestic US/International with the international portion split 50/50 developed markets/emerging markets.
Bonds (2%) – This is mostly left over from our stint with Wealthfront. It can sit for the time being, but seeing how we are still building our assets, we’re not concentrating on this at the moment.
Alternatives (4.5%) – This includes all sorts of fun things that got roped in through Wealthfront. Recently, we gathered up some losses on individual stocks and bought a Vanguard REIT fund (VGSLX). So, yes, we actually do own real estate, despite our affinity for renting in our current location.
Cash (1%) – Because cash! It comes with these index funds. We also have an emergency fund that’s not included in the chart up there, and makes up about ~2%.
South African Brewery – Yeah, you read that right… remember this?
Allocation By Account Type
401k (35%) – A large portion of our income currently goes into this bucket. it’s helping offset our income so we don’t owe so much in taxes.
Roth IRA (24%) – This is handy as we will have access to the principle as we move forward.
Traditional IRA (0%) – This solely exists as a pass through for backdoor Roth Conversions. There’s really no other reason to have this, as we get no tax advantages from it.
Taxable (37%) – This is the catch all for money after we’re done maxing out our Roth’s and 401k’s. This is also where most of the variety of allocations mentioned above lie.
529 (2.5%) – But wait, we don’t have kids?!? Well… we had a bunch of money returned from compliance testing at an old 401k, so we took it and dumped it in here, so that it can slowly compound, should we decide to have kids in the future.
HSA (1.5%) – Again, this is mostly to shelter some of our income since we can put it into this account tax free. As we incur expenses we will keep cashing it out and investing it elsewhere.
So where do we go from here?
So far this article has been nice and boring, the way asset allocation should be. There’s not much to it. Push as much as you can into index funds, and let them do their magic.
But going forward is where it is going to get interesting. As we transition from the accumulation phase to the sustainability phase, we are going to have to make some shifts in our thinking and our allocations.
Current Contributions
As it stands at the moment, our contributions to our taxable account, are split evenly between the REIT fund mentioned above and Old Faithful (VTSAX). All our 401k & IRA contributions go straight into Old Faithful.
Within the coming months, we are going to shift our a good portion (~30%) of our portfolio to some combination of bonds (specifically High Yield Bonds, something like VWEAX and your standard bond funds). The new contributions from our income will continue to be invested heavily in the REIT fund but we will shift the VTSAX to the combination of the bonds mentioned above. WHY?
Dividends of course!
We want to guarantee* ourselves more income. There’s a shift in priority once you get closer to pulling the plug on your main source of income (READ: job). Appreciation is great and all, but cash flow is king when you are looking to survive a little uncertainty. And we don’t want to be caught having to sell some of our assets at reduced prices should a downturn happen during that vital period that is the first couple of years.
Most of this change will happen in our taxable accounts, so that we have direct access to the dividends. We’ll keep mostly equities behind the tax shield of the 401k/Roth.
Once we reduce our earned income, we’ll also start converting our 401k’s into our Roth accounts to give us access to the money, and allow it to grow tax free. This will simply be a shift of account, we’ll maintain the asset allocation with in the buckets.
Our strategy will shift a little in other respects, we won’t rebalance for the purposes of keeping the allocation at a certain level. We’ll rebalance for cash flow over the short term, and leave the equities to grow in the background over the long term, where they can do a lot of the heavy lifting on our portfolio. Over time, the thought is that they will slowly over take the bonds/REITS and push our assets closer to their current distribution.
So, if you followed along last time, we’re going through the “layer cake” path of asset allocation. We’ve been stacking our deck with equities the entire way through, now we’ll start padding on the cash flowing assets, finally ending with filling our emergency cash reserve.
We do have some other assets, namely over 1MM in Chase Reward points. That we’re starting to spend and use for travel among other things. So that should help offset some costs as well as we start to hunker down and make some of these transitions.
That’s it. That’s the basics of our plan as we go forward. It’s not super complicated, as I believe in the K.I.S.S method.
* There is no such thing as a guarantee in investing, this is just a way to hedge our bets. *
good idea to gain some liquidity and cash flow. we did something similar as we got closer to pulling the plug. instead of high yield bonds we own preferred stock etf’s. one is SPFF that has a yield over 7% but a higher expense ratio than vanguard people usually enjoy. i just wrote about the up and downsides of those preferred shares a couple of days ago. one advantage of preferred stock etf’s over bonds and reits is the payouts are largely considered dividends and taxed at the forgiving dividend tax rates while the bonds and the majority of reit income is taxed as ordinary income at your w-2 income rate. oh, that etf also pays out monthly which i consider nice although we’re still reinvesting it at this point. those are just some things to consider but cash flow is always a good thing. i’m looking forward to seeing how it turns out for you.
That’s a good call on the preferred stock fund. I’ll have to look into that some more as well. Really, we want to optimize for the cash flow off the top of the balance and not concern ourselves with the appreciation. So if that’s going to provide us another version of cash flow, I’ll have to dig into that as well.
Thanks for the heads up!!
Adding a brewery to your portfolio was a smart diversification strategy. Because if everything else goes to shit, you’re going to need somewhere to drink for free.
Yup… free booze and cheap living. When all else goes to shit, we’re going to the Cape of Good Hope!!!!
The preferred shares sound good. It’s just another form of loan, right?
I like your strategy. Having more cash flow would be good. Later, you can adjust if you have income from other sources.
I’d move to bond sooner rather than later. The market is making me nervous.
Yeah, I like the idea of diversifying some into a preferred stock fund, I hadn’t really looked into it, but I think I’m going to look into it more. Makes sense. Loans are always good. And yeah, I think we’re gonna move some of this stuff around here shortly, it’s making me nervous as well. But that’s why I try my best not to look every day.
Good reading and well thought out. Like your international allocation which will have its day in the sun. Way too many folks ignoring international at their peril. Men Faber has some great podcasts on global asset allocation.
Hmmm I’ll have to check that out. Thanks for the compliments, I like the idea of having some preferred stock funds in the cash generation bucket. I’ll have to dive into that a little more. But yeah, yours looks great as well. Cheers to asset allocation!!! More boring, more better!
Next time you’re in CT checking out your investment, you should take a detour via Zambia! Though not sure the Zambian stock market would be one you should invest in too heavily just yet….
We most certainly would love to stop through Zmabia, there’s a place that we’ve never been, but are always game for new things! Don’t know about the stock market as yet, but really… a couple bucks makes life interesting, it’s a bit like betting on horses!!
The CT brewery investment is great! Any investments in Zambia?!?
None is Zambia as yet! We’re always on the lookout, and we’re always game to try a new place, especially when breweries are involved!
Me like this post a lot!!! I especially like that over 50 percent of your portfolio is in Roth and brokerage accounts. That will put you in a wonderful place should you retire before 59.5. No need to hack access to your money. Well done, my friend. Cheers.
Hey Thanks!! Yeah, we’re trying to keep most of it accessible. That way we can hopefully access it without a ton of hoops to jump through.
Thanks for the thoughts!!
Great post Mr. WoW, and congrats to you and Mrs. WoW on being at the point in your FI journey where you are starting to transition your portfolio towards sustainability! My family is a year into our FI journey and will hopefully be debt free (student loans) in the coming months, so we’re still really working towards getting to the starting line. I am a novice when it comes to shifting assets and always get confused by tax implications, so I was wondering what your strategy is for shifting the 30% of your portfolio to bonds specifically regarding tax implications.
Thanks, love your blog!
Hey Thanks and congrats on getting started that’s the hardest part.
Couple things:
1) The taxes are only on the growth of the various assets. So, you aren’t taxed on the entire value of the part of the portfolio you are moving, just the growth on it. And you’re also taxed on that growth at a lower rate. So, taxes, while somewhat of a concern, shouldn’t be a determining factor in what you want to do.
2) Also, Depending how much control you have of your income, you can actually design your income to be under the capital gains limits. So then it’s irrelevant.
3) You can also stockpile tax loses over the years of building your portfolio. Those will then apply to any capital gains that you realize during your portfolio shift.
So, all that being said, we have some loses that were harvested over the years, that we intend to apply to anything we have gains on. When I did a transfer recently I sold some individual stocks that were at a loss to move them into these other bond/dividend producing assets.
And, once we pull the plug on our income, we’ll have complete control over how much we shift to be under the various limits. And we’ll continue to “tax gain” harvest as well when things go well, to up our cost basis, we just haven’t yet, since our income is too high.
But, given #1, that’s a lot of dancing around to avoid what may turn out to be only a minimal tax burden anyway.
Love the realization that income is key! I feel like most main stream financial media completely ignores the fact the fact that the underlying stocks you need to sell may have taken a nose dive.
You are probably way too young but have you given any thoughts to annuities (like a deferred income annuity or similar product)?