Investing in Early Retirement: Q3 2019 Update

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The third quarter was an eventful past three months for the Shirts retirement portfolio. I was able to extract my old 401k into Fidelity and slowly deploy the funds over the duration of the quarter. This allowed me to purchase a number of individual stocks, get our cash/bond target allocation right, and learn all about investing in US Treasury Bonds. We have been following the Equity Glide Path for our stock/bond allocation to reduce sequence of return risk and ended the quarter right on target. So how did our portfolio shake out at the end of the third quarter?

Asset Allocation As of 9/30/2019:

Stocks: 63.97%, Bonds: 21.68%, Cash: 13.60%.

Our Equity Glide Path Target as of Quarter End: 64%

The Equity Glidepath we decided on started at at 60% equities and 40% bonds, with the plan to slowly increase this to near 100% equities over the next five years. Six months into a sixty month plan means we should now be at 64% equity – getting within 0.03% of that number is a victory.

The 401k rollover expanded our investment options. There are two remaining employer based accounts limited to their investment choices, but otherwise 75% of our funds are with Fidelity and it opens up all the investment options a discount brokerage provides. I momentarily thought I may need to change firms when Schwab and TD Ameritrade announced free trades, but fortunately Fidelity followed in the next week. Anything that reduces transaction costs in the investment process is a win for everyone!

Investment Highlights for the Quarter:

Investment Reading: This past quarter I finished two books on investing/business, Peter Theil’s Zero to One and Howard Marks’ Mastering the Market Cycle. Theil’s book opened my thought process to technology investing, even though valuations today seem completely insane. Howard Marks’ read was more psychology based combined with properly understanding risk adjusted return. Marks along with some other reading and people I follow on Physician On FIRE’s FatFIRE Facebook group opened my eyes to understanding treasury bond investing.

I’ve picked up a copy of Marks’ other book, The Most Important Thing and have been taking in many of his lectures available on YouTube. There’s a level of intelligence from listening and learning from a billionaire investor that you can’t get from a “market strategist” on a business news channel.

This Quarter’s Moves:

Related Post/Disclosure: Can I Give You Investment Advice?

#1: Bank stocks, Long Term Bonds, and Interest Rate Volatility:

Howard Marks talks a lot about risk adjusted return. His writing/philosophy similar to Warren Buffet’s quote of “be greedy when others are fearful, and fearful when others are greedy”. Reading through his work led me to understand risk adjusted returns and treasury bonds. Sometimes it may be okay to have a good cash allocation and wait and if you’re waiting, the lowest possible risk asset is the United States Treasury Bond. These bonds also can come with the secondary benefit/risk of price changes if you invest further out the interest rate curve.

Here is a live example of something I’m doing going back and forth with a sector that is out of favor and the US Treasury Bonds.

Bank Stocks: I’ve been “playing” around with financial stocks since December of 2018. These stocks have been stuck in a viscous cycle of panic, drop 10-20%, then slowly grind back to their highs. There two underlying issues with Banks – shrinking net interest margins and the potential for increasing problem loans. This has caused these company’s price to earnings ratio to drop from around 15x to 10x, effectively a 33% discount because of business concerns.

I am bullish on banks at their current valuation because share repurchases are outpacing flat to declining earnings, which results in near double digit earnings per share growth. If a Bank stock trades at 10x earnings and pays a 4% dividend, it still leaves 6% available to add to loss reserves of buy back shares. At these prices that means the banks are buying back 6-8% of their outstanding stock a year. This increases my ownership in the company by 6-8% per year without me buying a single additional share. Less shares outstanding on flat to slightly declining earnings will still equal positive earnings per share growth.

Long Term Bonds: I’ve been following US and global interest rates and expect these rates to keep falling. The United States is probably the lowest credit risk in the world, yet a 30 year US Treasury will pay around 2.15% while a German 30 year bond (for a country just entering a recession) pays 0.04%. The US Economy seems to be okay, but not exactly setting the world on fire. All buyers are looking for yield and central banks are “providing liquidity” which debt yields lower.

When the 30 year treasury reached 2.20%, I bought more than six figures worth of both individual 30 year bonds and long term treasury ETFs such as TLT and VGLX. I get paid more than 2% on my money and obtain some appreciation in the bonds when interest rates continue to fall. In my opinion, this is one of the best risk adjusted returns I can have in an uncertain world.

The Trade: Bank Stocks and Treasuries: The interesting thing about owning both bank stocks and individual treasury bonds is how their prices move in opposite directions. Higher long term rates increase the bank stocks and hurt the treasury prices. Conversely, when interest rates fall, bank stocks drop and treasuries rise. I’ll use the benchmark 10 year treasury, which has been trading between a 1.5% yield and a 1.9% yield and here’s what my investing thesis looks like.

10 Year Treasury: 1.5% to 1.7% – Buy Banks

10 Year Treasury: 1.7% to 1.9% – Buy Long Dated Treasuries/VGLT/TLT

If something gets to the edge of the range, I’ll sell some of one and buy more of the other. At a 1.9% 10 year treasury, I sold banks and bought treasuries. When the 10-year hit 1.5%, I sold some treasuries and bought bank stocks. This rotation between the two has been a productive quarter. I am bullish on the risk adjusted return of either, so I am agnostic as to which one I end up holding when this pattern breaks. Until then its been a nice way to pickup some additional return in the portfolio.

#2: Tiptoeing Into Emerging Markets:

I purchased my first emerging markets mutual fund late in the 3rd quarter. This asset class is notoriously volatilize and has under performed the S&P 500 over the last decade. A quick review of valuations pointed out that the average Emerging Markets Fund was trading for around twelve times earnings per share while the S&P 500 trades at twenty two times earnings per share. All things being equal, an investment in an emerging markets fund is 45% cheaper than an investment in the S&P 500.

All things are NOT equal when it comes to emerging markets as the risks go beyond business. There’s political risk, the rise of populism (Argentina’s market crashed 70% recently and the country’s perpetual experiment with democratic socialism has equaled seven defaults in its two hundred year history), the seemingly endless march higher of the US dollar, and challenges with transparency and corruption in third world countries. Emerging markets still have faster income increases and a growing population leading me to make my first purchase.

#3: The Technology Stock “fliers”:

In what was my worst investing move of the quarter, I decided to buy some small chunks of a couple of technology companies after reading Peter Theil’s book. He had insightful commentary on looking for companies that have a near complete monopoly on their business. I put around 0.5% of our net worth in four companies that I saw as meeting these parameters. Unfortunately three of them have monopoly businesses but are not valued on traditional metrics due to their high (Etsy, Match Group, and Pintrest). The result was probably what I deserved, 10-15% declines and some price volatility.

#4: Continuing to Follow the Activists

I picked up two stock positions with activist investors involved, one intentionally and one unintentionally.

ATT – AT&T was a purchase I made around $32/share, predicting lower rates will help them work out of their debt load while boosting the stock given its dividend. Even if they had to cut the dividend some, I saw this as undervalued. The cable/direct TV business is a trash fire, but this company also controls the means of high speed Internet to households and owns a lot of content. I’m not thrilled about how the activist’s involvement has been politicized, especially in a heavily regulated industry, but AT&T likely knew what they were signing up for when they decided to keep CNN.

AMRK: Aramark is a name you’ve probably seen in arena concessions (and now uniforms). This company is a near monopoly in outsourcing food services for large organizations but has under performed the market since going public. Their CEO was earning nearly $15mil a year, which was near criminal eight figure salary for a company with a market cap of $8bil. Fortunately activist investing is the free market solution to excessive CEO compensation and Mantle Ridge Capital acquired a 20% stake in the company and promptly replaced (retired) the under performing leader.

Speaking of activism, in a story that’s gone largely unnoticed, it has been a great year for shareholder activism and corporate responsibility. CEO departures on pace for a record 2019. These business leaders are paid like professional athletes and coaches and this is a performance based business: Either perform or the board should find someone who can.

Individual Stocks or Index Funds? Value or Growth?

My 401k rollover opened up more investment options for our portfolio and I had the debate of continuing to own VTSAX (or equivalent), or go a different route. This opinion isn’t popular in the FIRE space and meant more for people like me preserving their portfolio instead of early in the building stages (ie: Phase 2 Investors), but I have some concern about the composition of the Total Stock Market Index in 2019. This index sits at 21% technology stocks and the fund trades at a 20x Price to Earnings Ratio. In comparison, the Vanguard Value Index Fund (VIVAX) trades for 15x earnings and limits technology exposure to just under 8%.

Our investing goals involve achieving lower volatility and are okay if the returns are slightly lower. We’ve made the decision to buy more individual stocks and focus on places we can find value instead of continuing to plow money into a total stock market index at these prices. I have concern around the 21% weighting of technology stocks in the total market index, especially when many of these companies barely make money. We are looking to reduce risk at this stage in life and are shying away from a mainstay mutual fund for that reason.

Dividend Income

Now that 75%+ of our investments have been consolidated, I can provide an update on monthly dividend income and various dividend ideas going forward. Since the majority of our accounts are tax deferred and we are below the income threshold for taxes on qualified dividends, dividend income is a great form of cash flow for us as investors. Dividends & interest in the month of September was $5,746 against budged expenses of $6,000. September is a big month with many mutual funds paying quarterly distributions. I would love to see every month have 95% of our early retirement budget funded by companies paying us a portion of their profits in dividends and interest!

So What Happens Next?

Tax management will be the primary focus of the portfolio over the next fifteen months. I will work through taking any capital losses I can for 2019 since this was my last year earning a high income. 2020 will be focused on capital gain harvesting since tax laws may change as early as 2021 with another election cycle looming. 2020 should be a low-income year now that we’ve both left full-time work and we can begin the Roth IRA conversion ladder. There may be some other investing opportunities that show up and I wouldn’t mind adding a rental property or two to the portfolio (even if I’ve had a terrible history with personal real estate), but patience and price discipline will be key in any investment decision.

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5 Replies to “Investing in Early Retirement: Q3 2019 Update”

  1. Great to see your investing strategy in treasuries. To clarify, you’re buying individual bank stocks, and not an index like Vanguards Financial ETF VFH? I have long followed Robert Kessler and he has always been a strong proponent of treasuries.

    1. I’ve owned some of the regional bank etf, KRE, but I’ve been buying individual ones. I mainly bought a bunch of individual ones to be able to manage some taxes and do a little trading of them. So many things can spook bank stocks down, then they just keep earning money and retiring stock.

    1. As long as you’re okay holding it, I see nothing wrong. I don’t like the political football it’s become – it’s already a heavily regulated industry and it’s a bit more difficult to measure that risk

  2. I like hearing alternative ideas to plowing everything into the total stock market index. I am still following that strategy with most of my portfolio, but certainly starting to think outside of the box with the technology stats you mentioned. September is always a great dividend month.


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