KevinVolatile

Is this 2008 all over again?  Have we just transferred liabilities from banks to governments?  And so on.

I’ll leave the post-downgrade economic analysis to the far more capable Russ Koesterich on our team, but I would like to weigh in on some financial planning considerations for volatile times like these.  Let me start by sharing how I evaluate my own portfolio choices, and some changes I’ve made over the past year.

I’ll warn you upfront: My personal portfolio is not very sexy, and there’s no “market-beating” formula below.  But I do take risks at times when I think I will be compensated for them.

Like most of my friends and colleagues who are also in their forties, my biggest savings goal is retirement.  As I’ve blogged about previously, getting your retirement assumptions right is both critically important and a bit tricky.  I opt to be more conservative on assumptions, so I’ll hopefully end up saving more than I need for retirement.

With 20 plus years to go until I retire and then (I hope) 30 plus years enjoying retirement, I have a long time horizon.  Normally, planning for a longer retirement would encourage me to tilt toward riskier assets like stocks, which are more volatile in the near-term but have historically produced higher returns over longer periods.

On the other hand, given my profession, I would also like my asset allocation to tilt a bit toward bonds to help balance the volatility of future income which tends to rise when markets are doing well and fall when they are doing poorly.

Lastly, we’re in this highly unusual extended period of zero interest rate policy (ZIRP).  Shouldn’t I do something to improve on the 2.2% the US government is offering to pay me for holding its bonds for the next ten years?

The short answer to all of the above is yes: I do think about all of this when reviewing my asset allocation, and I occasionally make adjustments as a result.

My “default” allocation the last few years has been 60% equities / 30% bonds / 10% alternatives (mostly real estate and gold).

In terms of how I implement this asset allocation, it’s pretty straightforward.  I use mutual funds and ETFs.  I’m more of a passive investment type of guy, but I do have a few favorite active managers and have owned their funds for many years.  Since I still have a few investing scars following the dot-com era, I rarely invest in individual stocks, but I do own one—BLK— the firm where I work.

So, what changes have I made in the past year?

  • Equities: I usually prefer broad market exposure both domestically and internationally without any long-term preference to size or style.  I have been favoring US large caps recently, partly for their tax-favored dividends (might as well take advantage of qualified dividend income (QDI) while we have it; who knows how long it will last) and partly based on Russ’s thoughts on relative value.  I’ve been pushing past my own home country bias the past few years and now hold 60% US equity / 40% international.  I was overweight to EM for many years, but am now back to market weight as both valuations and correlations to other markets have risen.
  • Fixed Income: No great options in a ZIRP environment, but remember bonds are in most portfolios primarily to balance equity risks and even at very low yields, government bonds have historically done that better than higher yielding bonds, as we’ve been reminded the past few weeks.  With that said, I have reallocated half of my previous aggregate bond exposure (AGG) to a combination of high quality corporate bonds, munis and a stable value fund (unfortunately, only available in 401(k) plans, but at 3% yields, a handy option in the current environment).
  • Alternatives:  The only change I’ve made here recently was to significantly reduce my allocation to REITs (consistent with the rationale Russ discusses here) and also because unusually strong market appreciation had taken them far above the original allocation target.

At work, I’m surrounded by a lot of very smart people with very interesting investing strategies, but I know my limitations in terms of the risk I’m comfortable with and the amount of time I have to review my portfolio.  So I try to stay pretty disciplined on this and not fiddle with it too much.  My aversion to paying capital gains taxes usually keeps that impulse in check!