Q2 2018 Net Worth and Asset Allocation Update

Net Worth and Asset Allocation Update

We are already halfway through 2018!   It has been a much wilder ride in the market if you’re listening to the financial news than the 2.85% YTD return on the S&P 500 would suggest.  Our household net worth crossed $1,600,000 this quarter and we will stop updating this numbers going forward.   Why?  We’ve already “won” the first stage of our working career.  This is more than enough to execute on an early retirement plan and anything else we do above this is completely voluntary.   This also isn’t a competition, we make the decision to trade time for money and the definition of success is unique to each individual.   There are also plenty of debates as to what *exactly* should be included in that net worth calculation at higher amounts, including the tax drag out of retirement accounts and future pension values.

Asset Allocation:

It wouldn’t be a normal quarter without a little tinkering in the portfolio.   Some of it was just because I can’t avoid the temptation, but other moves were positive, like finally getting some better investments options in our company provided HSA plan.   The allocation information discussed below is as accurate as I can get today, as a large portion of our assets are inside employer retirement accounts without great reporting.   Once these are all rolled over to Fidelity in 2019, the data available will improve.

Individual Stocks:  16.11%, down from 16.87% in Q1.   There was little change in our individual stock asset allocation for the quarter and the decline in holdings was  mostly from new contributions all going into index funds.  I’ve turned off automatic dividend reinvesting to accumulate some cash for some higher expected spending, which reduced net new purchases.

I sold a small holding of Nike stock (right before it went up 10%) after earning some nice gains, while buying a small holding in SRE (follow the activist), and re-opened a position in Starbucks at a 52 week low.    Starbucks was a long time holding of mine that I unloaded due to valuation a while back.  Now the company pays almost a 3% dividend and I believe they have the cash flow to double that payout.   We’re planning on living off a 3-4% withdraw rate and there’s a company with the ability to payout 5% and selling a highly addictive product.

REITs:  9.53%, up from 9.11%:   This was by far and away the best performing asset class of the quarter.  Real Estate Investment Trusts were hated by the market from mid 2017 through Q1 of 2018.   I started adding to my position too early, but then continued to add through the decline and bottom.  The best purchases have resulted in a 25%+ gain in four months.   These are concentrated in two holdings, Entertainment Properties Group and Stag Industrial.

I prefer to own individual names in this asset class because there are wild variations in the amount of debt and property types a REIT can hold.  They are already a diversified fund-style investment, owning 300+ properties leased to many different tenants.  I would rather own a couple of companies I view as low to moderate risk instead of an index which includes mortgage (double leveraged) REITs.

The percentage of our asset allocation to REITs could have gone up more, but I had an opportunity to tax loss harvest a couple of lots and did so to offset some other gains for the year.

Passive Index Funds:  64.95%, up from 63.1% in Q1.    The breakdown of these passive funds is as follows:

Large Cap/ Total Market: 33.53%

International: 13.96%

Small Cap:  9.18%

Mid Cap: 8.28%

The biggest change for the quarter was my HSA account added a mid-cap and small-cap index fund, which I immediately moved into from the S&P 500 fund.  There are a couple other opportunities to move out of the large cap index funds to small/mid cap funds that I’ll be executing on in the 3rd quarter to get closer to my target 15% asset allocation..  The international funds are the lagging asset class this year, down on average 3.8% YTD.

Active Mutual Funds:  8.5%:  I trimmed 1% out of this asset allocation in Q2 and am considering reducing it again in Q3.    7.5% of our invested assets are in the Vanguard Wellington Fund, their flagship actively managed fund that’s closed to new investors.  The expense ratio is less than some of the passive funds and the Wellington Fund provides our only exposure to Bonds, both reasons we haven’t parted with the fund.   Finally, this holding is inside the one account we would consider doing a 72t early withdraw strategy fund.  A lower volatility holding is critical to making the 72t work.

Thoughts for this Quarter and Going Forward:

Liquidity management:   This will be important in early retirement and I’m starting to get a taste of it now.   I’ve always been “fully invested”, leaving minimal cash.    I’ve also always been of the mindset that when a market decline makes the front page of the newspaper, throw cash at it until you stop seeing those headlines.   Who doesn’t like a good sale, whether its on toilet paper or stocks?

Now that our deferral rate is so high on the deferred compensation plan there are months where we need to pull from the regular account, which is giving us a taste of liquidity management.  There will also be some bigger expenses  over the next year with a retirement and geographic move.  This has me thinking about looking for opportunities to generate cash in the portfolio while avoiding the temptation of investing it in during the next “sale”.

Consolidate Funds:   Did I mention I can’t wait to do a rollover and have 80%+ of my investments with the same discount brokerage?  We have too many different mutual funds trying to accomplish the same thing.   The self directed option inside my 401k is one of the complications and I am slowly divesting myself of holdings in that account and transferring funds back into basic index funds.  It was originally opened when the options inside the retirement account were pretty bad with the intention of just buying Vanguard Small and Mid Cap ETFs.   There are a few other opportunities to consolidate two funds into one that I’ll execute on this quarter and the big opportunity comes next year during the rollover.

Tax Efficiency:   The portfolio just isn’t tax efficient.  I shouldn’t hold REITs in a regular brokerage account, but this was where the funds were available when the asset class went on sale.  I also have individual stocks throwing off dividends in a regular account while holding some of the most efficient index funds inside retirement accounts.   Its awesome the market has been going up, but then you have to manage the tax obligation if every holding you sell is sitting on 25%+ unrealized gains.

Today the tax obligation this is creating is a rounding error compared to the tax obligation on earned income, but this will require close examination and planning this time next year and going forward.   I have to remind myself that a 20-25% gain on all holdings is #successproblems

Parting thoughts:  It’s true what many say, the first million is the hardest.   Well, unless you’re T Boone Pickens and decide to blow up the internet with this reply.   The quarter and year has been pretty mediocre with investment returns, but the dollar returns for the year are still exceeding our base level of expenses.  The power of compounding has really taken off and its nice to see that we could live off our investments in a mediocre year.