We review our investment portfolio allocation and investment strategy annually, as a part of our year-end financial and tax checkup. In this post, we’re sharing our current portfolio allocation and investment strategy for the first time.
Disclaimer: This post contains our personal opinions and portfolio and does not represent investment advice.
Why you need a personal investment strategy
Before you begin investing, it’s wise to create an investment strategy based on your current goals and time horizon.
This plan can be developed using your own research (there is unlimited free information available online) or after speaking with a professional.
The goal is to set a framework for how much and often you will invest, as well as how you will allocate your investments amongst asset classes. Once you have a plan, it’s a lot easier to execute your strategy and avoid letting emotions get in the way.
How should you determine your target portfolio allocation?
There are hundreds of opinions as to what your target allocation should be… too many to get into here.
The most common suggestion is to subtract your age from 110 (or 100 or 120) to determine the percentage of your portfolio that should be invested in stocks. This obviously has to be combined with your age, time horizon to retirement (i.e. will you retire early), and risk tolerance. We tend to invest a bit more aggressively than this model would suggest.
If you don’t know where to start, Vanguard has a great free tool to help determine your ideal portfolio allocation. It also shows the average historical returns for each portfolio, along with best and worst years.
Why should regularly review your portfolio allocation
As mentioned in a previous post, I recommend that investors perform a comprehensive review of their investments once or twice a year to make sure that your actual investments still align with your target allocation.
Rebalancing your portfolio periodically will ensure that you stay aligned with your goals. Following this strategy will also help you lock in gains on high performing asset classes and buy low for underperforming asset classes during the year.
Our Financial Strategy & Investment Portfolio Allocation
Back in December, Mr. RFL and I sat down to have the money talk during our year-end financial review.
Up until this point, we didn’t really have a formal investing strategy or plan. We previously just invested or paid down debt as much as we could, without much thought.
Though we’re in a good financial position, this approach left us without a focus and made it hard to ensure that we were making the best decisions at any given point in time. None were bad, we just could have utilized our money more effectively in many cases.
It was time to create a more formal plan.
Our Current Investment Strategy
After reviewing our current investments and considering our personal money principles, we came up with the following investment strategy.
We pay our mortgage and credit card bills (in full) every month, and already have a robust emergency fund. We also have “fun” money built into our budget, as we are all about enjoying the journey.
The strategy below illustrates how we will deploy extra cash each month.
1. Max out tax-advantaged accounts first
Extra money goes here first since these investments are all tax advantaged in some way and/or offer employer matches. Mr. RFL has a 401k and deferred compensation plan at work, and we have a Health Savings Account (HSA) which all fall into this category.
Additionally, I fund a backdoor Roth IRA since I currently no longer have access to a 401k plan, nor do I have any income. We’ve decided not to make backdoor contributions for Mr. RFL, as we would be required to pay taxes on a portion of each rollover under the IRS’s pro-rata rule, since his Traditional IRA includes both old 401k plan contributions (tax-deferred) and nondeductible contributions (post-tax). Not worth the hassle. NerdWallet has a good article explaining how a backdoor Roth IRA works if you’d like to learn more. However, if we fall below the deductibility limits this year, we’ll both contribute to a traditional IRA instead.
2. 529 Plan (College fund for daughter)
Next on the priority list is to set aside money for our daughter’s 529 Plan each year. We contribute at least $4,000 to get the maximum tax deduction in Arizona. Given the uncertainty of what secondary education will look like in the next 15 years, and fact that we have only one child, we are not currently overfunding this plan. However, we do ask family members to keep physical gifts to a minimum and contribute the remainder of what they want to give to the 529 plan. We’ll continue to reassess this each year.
3. Taxable brokerage accounts
The rest of savings goes into our taxable brokerage accounts. Our after-tax savings rate last year was 76%, though we are budgeting 65% for 2021. This means, that we should still have money left over each month to invest in taxable accounts or pay down debt. Based on our budget, we have a dollar amount that we expect to have leftover each month (though some months will be more, and others less).
Since we refinanced to a 2.5% mortgage rate in November and have run various scenarios which show the benefits of investing instead of paying down low-interest debt, we’ve decided to put all regular monthly savings into the stock market. Previously, we were putting about a third of our extra savings towards the mortgage. However, now that the mortgage balance is below $200,000 and the rate is so low, the decision to invest is easier to make. We have no other significant or high-rate debt.
With regards to any windfall income received, such as a bonus or stock compensation payout, we plan to use 1/3 of the take home amount (after any taxes and retirement contributions) to pay down the mortgage, with the rest going taxable investments.
Our Current & Target Investment Portfolio Allocation
Here is the actual investment allocation of our Financial Independence portfolio, as well as our current targets for each asset class:
| Current | Target Range | |
| Domestic Stock | 58% | 60 – 65% |
| Non-US Stock | 12% | 10 – 15% |
| REITs | 5% | 5 – 6% |
| Total Equity | 75% | 80 – 85% |
| Bonds | 20% | 15 – 20% |
| Cash | 5% | 1% |
| Total Fixed-Income | 25% | 15 – 20% |
| Total | 100% | 100% |
Overall, we’re comfortable with the target allocation for our age, risk level, and time to retirement. You’ll have to make sure your allocation is right for you.
Cash
Cash above excludes our renovation SINK fund and emergency cash. This is primarily maintained in high yield savings accounts, with a small amount held in other investment accounts for purchases.
As you can tell from the table, we currently have more cash than our target allocation. We were comfortable holding more cash last year because of the uncertainties of the global pandemic, fact that we are now a single income household, and uncertainty of remaining budget for our home renovation project. However, we plan to move most of this extra cash into investments over the first half of the year as these uncertainties work themselves out.
Bonds
Our bond investments are mostly held in Total Bond Market Index Funds (or similar), with about 14% in High Yield Corporate Bonds and a small percentage in Municipal Bonds.
We plan to move our bond position down by a couple percentage points this year, since returns are likely to lag for the next few years. We’ll do this by making new investments more heavily in equity than bonds – 90% / 10% within the taxable brokerage accounts, and 85% / 15% within retirement accounts. The bonds purchased within our taxable accounts will primarily be Municipal bonds (non-taxable).
Real Estate
Mr. RFL and I are both intrigued by real estate, especially after building some skills on our own fixer upper, so I think we may venture into this asset class in the future. While the equity in our principal residence is certainly an asset, we don’t include it in our investments. Right now, we hold shares in REITS (mostly through index funds).
Traded REITS are technically stock, though they can behave differently than the rest of the stock market. Because of this, they provide some additional diversification.
Stock
Less than 2% of our investments are in individual stocks. We prefer to have greater diversification and haven’t had as much time to research individual companies as we’d like. I also find trading individual stocks to be more stressful… especially when they are going down. On the contrary, I have no fear that the Total Stock Market will fall to $0. When the stock market is down, my instinct is to always buy more. Just trying to take emotions out of the game.
Most of our investments are in broad-based market index funds, with the largest holdings mimicking the total stock market.
Approximately 20% of our stock holdings seek high dividend yields. While we don’t plan to live only off the income of our portfolio when we retire, it is nice to have an income stream to draw from for when the market is in a down year. However, since high dividend paying stocks are generally more mature companies with lower growth rates, we try not to put too much in this basket.
Only 12% of our investments are in non-US International Stock Funds. I’ve read that most people have “home country bias” in their portfolio, so it’s probably not unusual that most of our investments are in US-listed companies. Though I have recently begun to wonder if 12% is too low. Perhaps it’s not as big an issue as it once was with the increase in globalization. If you have any thoughts on this one, I’d love to hear in the comments below!
