Fifteen Months Into Early Retirement Q&A

A few weeks ago I asked for ideas to blog about now that I’m coming up on fifteen months into early retirement.   I received a number of great questions and decided to post these as a full Question & Answer.   The top question I answered in a separate post, Working After Trying Early Retirement.   Here is the second part of the Question and Answer section:

How has your strategy/investment strategy changed post COVID?

Yes. There’s two parts to the strategy/investment strategy changes after COVID:  Fully understanding our risk tolerance and what I plan on changing in the future.

Risk Tolerance:  

We lost just over $750,000 from the peak of the market to March 23rd and at times trailed a 100% VTSAX portfolio at anywhere from 5-15% through most of the decline and recovery.  This prompted some frank discussions about risk tolerance between myself and Mrs Shirts.  I’ve always been comfortable with more risk, primarily because the worst case scenario was always I could just get a job.  Unfortunately risk doesn’t end there.  We no longer carry life insurance since our assets always covered what we needed.  At the bottom of the market, would that be enough if something happened to me?  

Investments: 

I had a recent “reader” leave a comment on an old portfolio update with something along the lines of “Market timing and stock picking?  Good luck with that”.   I don’t have a lot of room to argue today, but waiting until the moment someone is behind on the market is nice timing on that comment.   Here’s a few comments about where the investments sit.

1. Asset Allocation 

Our portfolio is currently tilted towards the small cap index and emerging markets.  I knew we were late in the market cycle and my primary concern was high valuations and likely low returns from the S&P 500 and the technology sector.  Instead of valuations becoming an issue, a pandemic has pulled forward years worth of digitization in the span of months and high value technology stocks have performed exceptionally well.  Smaller companies and foriegn stocks have been the most sensitive.  The lesson out of this is not all indexes are created the same. 

I’m still bullish on the smaller companies and international for the next decade (and Vanguard agrees), but have to accept some volatility with this.  Once the portfolio gets back to its highs, I will likely segregate out a meaningful portion (50-75%) into a lower risk/lower return/lower volatility 60/40 stock & bond portfolio.   I’ll either buy an S&P 500 Index and the bond index or just turn over a chunk of that money to the Vanguard Wellington Fund and enjoy professional management for 0.17%.  The downside risk matters more to us now than the fear of missing out on some returns.

2. Individual Stocks:

I will always buy individual stocks because I enjoy the process, but the biggest lesson from this pandemic is to pay attention to position sizes.  I don’t get much incremental enjoyment from owning $5,000 or $50,000 in an individual company, but it can expose me to individual risk.  My biggest mistake in this pandemic was not necessarily buying on the dip, but increasing my position size in certain companies as they dropped.  There were other assets with similar risk profiles I could have bought, but instead I added to some of the same companies I owned.   A few of these companies had far greater pandemic risk and I suffered two consequences:  Higher losses in these companies and missed opportunities in other targets.   My performance on things I bought on the way down range anywhere from Amazon (up 61%) to Markel and Exxon (still down 25%+).  It’s easy to say in hindsight I should have just gone all in on Amazon!  As of this writing, I am just under 50% in mutual funds and 50% in individual equities and want to trim down the individual company risk and increase the percentage in mutual funds.  

3. Buying the Dip:  

In a prior investment policy statement, I had a target of moving more of my bond allocation into stocks once the volatility index reached 30.  This has worked for the last ten years, until it didn’t.   The last 10, 15, or 20% of the bond allocation is incredibly valuable and must be protected.   It only requires a 25% gain to recover from a 20% loss, but it requires a 67% gain to recover from a 40% loss!

I will likely have to see the market go down at least 25% before I “buy the dip”.   I have a few *very small* positions I was able to buy between March 20th and April 15th that I’ll hold for a long time as a reminder of the missed opportunity.   I believe we get one opportunity or so a decade where great companies can be purchased at panic prices.   I did not have the patience to wait for the panic and missed a significant opportunity.

4. Roth Conversions vs. Capital Gain Harvesting vs. Cares Act Distribution

I am attempting to target a taxable income of just over $100,000 for 2020 so I can take advantage of the 0% tax rate for capital gains and dividends.  I have been debating this year between the value of the Roth Conversion or Capital Gain Harvesting.   The Cares Act Distribution brings a third option into play.  I meet the requirements as a qualified individual due to being laid off from a small W-2 arrangement.   A Cares Act Distribution would allow me to boost my percentage of after-tax assets this year and realize the tax burden over the next three years.   Over 60% of our assets are in pre-tax accounts and this option is becoming more attractive.

Are you trying to avoid pulling money from investments?

Our withdrawal plan post-COVID has changed a little.  Here are the sources of our monthly spending funds:

#1:  409A (Non Qualified Plan) – We get just under 1/3rd of our monthly spending from this plan’s distributions and it was invested in 50% stocks/50% going into the decline.  The payout on this plan is set and it sells assets and distributes money monthly without an option to stop it.  The plan is now 35% bonds and 65% small cap stocks and the balance is roughly where it was in January, even after five months of distributions.  Keeping this account conservative was one of the few good investment decisions of this pandemic.

#2:  I invested a good portion of our cash allocation on the way down and then decided “We should really have more cash on hand” and sold some shares of Costco between $305 and $315.   Costco stock was close to an all time high when the news was showing massive lines at their stores and it was a growing concentration in our portfolio.   This provides a nice cash cushion to pull from without selling any other stock.   It also means part of our taxable income in 2020 will be dedicated to Capital Gain Harvesting.

#3: Close the gap between our monthly spend and how much cash we’re pulling out.   Our spending is down 10-15%, I’ve cut off automatic dividend reinvestment, and had the pleasant surprise of finding Instacart during the shutdowns.  I’ve also become disciplined at working through bank account signup bonuses that can be found on Doctor of Credit. All three of these have reduced the gap between the money coming in and money going out.

Would you have done anything different if you knew a pandemic would be part of 2020?

Outside of investments, which I would have done a number of things differently, I’m actually thrilled about two decisions we made:

1. Moved to a vacation area.  The rent was more expensive but I’m happy we are paying the“paradise tax”.   Outside of a 3-4 week window, we’ve had access to our outdoor recreation even though the state clamped down on short term rentals.

2. Take a big trip with your parents:  We returned from a three week stay in Hawaii in early February and invited my in-laws to go with us.  They were getting older and the window to be able to do this was closing.  Now with Covid I don’t know when travel will be allowed again.  

This has further reinforced my thoughts of living where we want to live and not relying on a vacation or trip to take us where we want to be.  Life’s too short not to live somewhere that you completely love.  I’m hopefully we can keep exploring the United States and decide if this is our long term location.  The money part can be figured out.

Do you have any fears about market drops?

Now that I’ve experienced a 35% drop in the span of forty days, I’ve gotten my fears out about a second drop.  If it happens, it happens.  I’m sticking with the more sensitive asset allocation until the portfolio gets over a certain target, then I’ll pull back on a portion of it to a more conservative allocation.  Doing that now would limit how much I could participate in the eventual recovery of the world economy.

Crop Circles?  

Uhhh…a little creepy thanks to two scary movies that included corn fields.  That’s about the extent of my knowledge.  

Minimalism?

I’m a fan.   Moving four times in the last six years and reducing our total square footage trimmed a lot of the stuff we own.  There’s still a few opportunities, but it’s tough to get into Marie Kondo mode when it’s been forced on us repeatedly.   The toughest thing to part with is furniture as everything about furniture is expensive:  Buying it, moving it, or storing it.  I’ve also never had luck getting much money for it when I sell it.   That plus there are still too many “junk drawers” that need to be trimmed back.  I am proud to be one of the few houses in my neighborhood that uses its garage to park two cars, so that’s a plus!

Do you have any questions you’d like to ask?   Please leave a comment below or send me a message and I’ll either answer them directly or include them in a future post.