Welcome to Rich Frugal Life’s 2023 year-end investment portfolio update, including a discussion of the changes we’re making to our investing strategy in 2024.
Last year was a great one for our investment portfolio!
Mr. RFL and I were both surprised and thrilled to watch our investments increase by 53% during 2023. About half of that increase came from contributions we made (including company matches) and the other half came from organic market growth. From these investments, we also earned a record $29,368 in dividend and interest income during the year.
The market is at its all-time high and bond yields have recovered from historic lows. In fact, we’re expecting to surpass our “Fat FIRE” goal sometime in 2024!
Given where we are on our financial independence and early retirement journey, Mr. RFL and I have been discussing whether it’s time to reduce risk and make some updates to our investment strategy.
Remember, we like to keep things simple and boring, so we won’t be selling off a bunch of investments or making any drastic changes. Rather, we’ll gradually and prospectively adjust our portfolio allocation by changing how we invest new money going forward.
But before we get into our investing strategy changes, let’s pick up where my last blog post left off and take a look at where our investments landed for 2023.
2023 Year in Review – Investment Update
Our Financial Independence portfolio includes all cash and investments, with the exception of our daughter’s 529 Plan. We do not include home equity or any other non-investment assets in this balance.
Here is the current investment allocation of our Financial Independence portfolio:
| Dec 2023 | |
| Domestic Stock | 70% |
| Non-US Stock | 7% |
| REITs | 3% |
| Total Equity | 80% |
| Bonds/Fixed Income | 18% |
| Cash | 2% |
| Total Fixed-Income | 20% |
| Total | 100% |
Cash & Bonds
Our bond investments are primarily held in Total Bond Market and Total Corporate Bond (or similar) Index Funds.
Approximately 20% of our bond investments are in high-yield bond funds, which payout at higher interest rates because they invest in lower-rated investment grade bonds, as well as some non-investment grade bonds (a.k.a. junk bonds).
As our income has grown, we’ve also been adding more tax-exempt municipal bonds to our portfolio, which are exempt from federal taxes. The percentage of our bond holdings that are tax exempt is approximately 20%.
After purchasing approximately $50,000 in I-bonds during the periods of peak inflation, we’ve since sold off all but $20,000 of these bonds.
The rest of our cash is primarily held in CDs and high yield savings accounts to receive the best rates possible.
Real Estate
We continue to be interested in real estate investing. However, given our shortage of time these days, we invest through home ownership of our primary residence (though we don’t count this in our “investments” balance) and publicly traded REITs.
Traded REITS are technically stocks, but they sometimes behave differently than the rest of the equities market. Because of this, they provide additional diversification.
We fell below our target allocation of 5% last year when my old 401k plan eliminated its REIT investment option, which is where the majority of our REIT investments were held. It’s more tax-efficient to hold REITS in retirement accounts, so we haven’t invested our brokerage account in any REITs. As the value of our home has gone up (and thus our exposure to the local real estate market), we’ve decided to hold our investment allocation at 3% for now.
We also have around $10,000 in real estate crowdfunding with Fundrise (referral link).
Stocks
Most of our investments are in broad-based market index funds, with the largest holdings mimicking the total stock market.
Individual stocks made up 9% of our investments at year end, with the majority representing vested options from Mr. RFL’s current employer. This percentage is roughly in line with our goals, albeit on the higher end of our tolerance. We prefer to have greater diversification so try to keep our exposure to individual stocks pretty low.
Currently, 8% of our investments are in equities that seek high dividend yields with another 7% of in non-US International Stock Funds.
Updating our investing strategy: Is it time to shift our focus from growth to income?
As our portfolio grows and we’ve well surpassed our original FIRE goal, we’ve decided that it’s time to de-risk and shift our investment strategy from a growth to income focus.
Investing for Growth vs. Income
Whether you choose to focus on growth or income-generation should depend on your risk tolerance, timeline to retirement, and personal circumstances.
Growth investments are focused on capital appreciation, and typically experience higher returns over long periods of time than other investments. Index funds tracking the NASDAQ Composite, which is heavily weighted in tech stocks, are an example of growth-focused investments. Higher returns are great, but these investments are typically more volatile over shorter investment horizons and you won’t see much income (if any) unless you sell.
Income investments focus on earning income while you hold the investment. Examples of income investments are bonds, CDs, and stocks that pay out dividends. These types of investment generates income each year and are less volatile, but their capital appreciation and total returns tend to be much lower. While S&P 500 and total stock market index funds pay some dividends, the payouts are low (<1.5%), so I include these in the growth category when evaluating our own investments.
I personally believe that everyone should include some level of diversification in their investment portfolio. There are trade-offs to each type of investment. The ratios and asset classes you choose are up to you, but they should evolve as you move along in your journey.
Novice investors or investors who want to “set it and forget it” can accomplish this by choosing one of the many low-fee Target Retirement Date funds available through Vanguard and other popular brokerage firms. Target Retirement Date funds shift their allocations from growth to income over time based on the stated retirement date. You just have to pick the one that aligns with your values. For example, if you prefer a more aggressive portfolio but want the benefits of this option, you can choose a target date further out from when you intend to retire, which will keep equities higher for longer.
Updating our investing strategy
We’ve always felt reasonably diversified for our age, but have primarily focused on growth (and equities) up to this point. Focusing on growth early in our journey has helped our investment portfolio grow to the size it is today.
As we approach our “Fat FIRE” target and get closer to full early retirement, we are realizing that it may be time to take our foot off the accelerator and focus on other things… like income generation.
We earned almost $30,000 in passive investment income during 2023, which was enough to cover half of our expenses for the year (excluding income taxes).
We’ve never planned to live only off the income of our portfolio generates in retirement, but it’s nice to have an income stream to draw from when markets are down. I find comfort in this income. And wouldn’t it be even nicer if we could increase this percentage and further reduce the risk in our portfolio? I think so.
Now that our portfolio has grown to a balance that we believe could cover our retirement needs, we’re looking to reduce risk a little bit by shifting our investments going forward towards income (vs. growth).
We’ll still invest in both types of investments, and we’ll make these changes gradually, but here are the changes we’re targeting this year.
Our Current Break-out of Investments (Income focused vs. Growth) and Target Allocations:
| Dec 2023 | New Target | |
| Dividend-Focused Stocks | 8% | 15% |
| Bonds/Fixed Income | 18% | 20% |
| REITS | 3% | 3% |
| Cash | 2% | 2% |
| Income focused Investments | 31% | 40% |
| Non-Dividend-Focused Stocks | 62% | 53% |
| Non-US Stocks | 7% | 7% |
| Growth focused Investments | 69% | 60% |
| TOTAL | 100% | 100% |
As you can see, there aren’t any drastic changes we’re making just yet.
On a $2 million dollar portfolio, these small changes will probably only increase passive income by $3,000 to $4,000 per year. But that’s $3,000 to $4,000 per year that we will be able to spend in early retirement without having to sell any investments.
Lowering our sequence of returns risk, reducing volatility and sleeping better at night feels right for this next stage of our FIRE journey.
How did your investment portfolio do last year? Are you making any updates to your investing strategy in 2024?
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Finn
It is an interesting shirt to move to 60% fixed income.
Mrs. RichFrugalLife
It’s 40% income focused vs. 60% growth focused (I think you had it flipped). However, unlike a traditional bond/equity portfolio, some of our income focused investments are still in equities (REITs, dividend stocks). They won’t grow as much as the growth category over the long term, but they’ll churn out decent income as they grow and will should grow more than a traditional bond only “fixed income” portfolio would grow. We’re still pretty young, but since we are only a couple years out from potentially needing income from our investments it’s prudent to make somewhat of a shift at this point. We believe our growth investments will still be enough to cover our traditional retirement years.
Petra
The downside to income-producing assets (in taxable accounts) is probably that you will pay capital gains taxes on the produced income, even if in a particular year you may not even need this extra income. The income could also reduce ACA subsidies or other income-dependent subsidies or tax credits that you might be able to get.
So to me it feels like how much income you’ll have in a year is less under your own control and more under control of the fund managers or the company’s managers who decide how much dividend you’ll get.
Still, if you’re this close to FatFIRE, it is probably a good strategy to reduce risk in your portfolio a bit. I guess sometimes it’s okay to pay a bit in extra tax if that makes your overall portfolio and your overall chances of doing well in retirement much better!
Mrs. RichFrugalLife
Agree, that technically adding income investments in taxable accounts is typically less advantageous for tax purposes. Dividends are fortunately taxed at a lower rate, but bond interest is taxed at marginal rates. We’re still earning income and have maxed out all of the tax-advantaged investment vehicles available to us so have to put the majority of our new investments in taxable accounts to keep it growing. A good portion of our new income based investments are in going into dividend stocks (low tax impact) and Muni-bonds (which are tax-exempt for federal, and we live in a low tax state). So we manage the taxes as best we can, while still trying to manage risk and get closer to the diversification level we’d like and income level we’ll need in retirement.
You make a good reminder point about considering ACA subsidies. This isn’t really a factor in the decision for us. We currently have insurance through work at the moment so earn way too much to qualify. Then when we retire, we will probably still be earning less income from our income-generating investments than we actually need for expenses, so the total income we have would report for taxes will likely be similar. For example, we earned $30,000 last year in dividends and interest, but our current FIRE expense projections are $50-60k. What will shift is the amount of income we get without having to sell off investments (vs. collect a dividend/interest check for the rest of what we need). Last I looked, at our anticipated spending level, we’ll still qualify for a pretty hefty ACA subsidy (if they are still around).
Overall, paying a little more in income taxes now is worth it to us to begin to diversify our portfolio as we are adding to our investments and improve income generation so it’s where we want it by retirement (since any rebalancing in taxable accounts later would trigger taxes owed).
Thanks for reading and commenting!