My Money Blog Retirement Portfolio Update – January 2013

Here’s a belated 2012 year-end update of our investment portfolio, including employer 401(k) plans, self-employed retirement plans, Traditional and Roth IRAs, and taxable brokerage holdings. Cash reserves (emergency fund), college savings accounts, experimental portfolios, and day-to-day cash balances are excluded. This is the portfolio that we are depending on to create income and thus financial freedom.

Asset Allocation & Holdings

Here is my current actual asset allocation:

The overall target asset allocation remains the same:

Put simply, I pick asset classes that are likely to provide a long-term return above inflation, as well as offer some historical tendencies to be less correlated to each other. I don’t hold commodities futures or gold because I am not confident in them enough to know that I will hold them through an extended period of underperformance (and if you don’t do that, there’s no point). Our current ratio is about 75% stocks and 25% bonds.

For the last decade, I have stuck to buy, hold, and rebalance. I also keep costs at a minimum in terms of fund expense ratios, commissions paid, and tax-efficiency. A list of specific holdings is below.

Stock Holdings
Vanguard Total Stock Market Fund (VTI, VTSMX, VTSAX)
Vanguard Small-Cap Value Index Fund (VBR, VISVX, VSIAX)
Vanguard Total International Stock Market Fund (VXUS, VGTSX, VTIAX)
Vanguard Emerging Markets Fund (VWO, VEIEX, VEMAX)
Vanguard REIT Index Fund (VNQ, VGSIX, VGSLX)

Bond Holdings
Vanguard Limited-Term Tax-Exempt Fund (VMLTX, VMLUX)
Vanguard High-Yield Tax-Exempt Fund (VWAHX, VWALX)
PIMCO Total Return Institutional* (PTTRX)
Stable Value Fund* (2.6% yield, net of fees)
iShares Barclays TIPS Bond ETF (TIP)
Individual TIPS securities

The only significant change from last time is that I have moved some money over to the Vanguard High-Yield Tax-Exempt Fund. If you look at the holdings, it’s actually a relatively high-quality, intermediate-term municipal bond fund. Over 80% of the bonds are rated A-AAA, and the duration is only 6 years. Compare this with the popular Vanguard Total Bond Market Index Fund that is 90% A-AAA (tons of US government-backed debt at very low rates), and a duration of 5 years. I like mixing this fund with the Limited-Term muni fund to replace a Total Bond fund for my bonds in taxable accounts as my income tax bracket is high. I admit that I am reaching for yield, but I don’t think I’m reaching very much overall and I’m getting enough incremental yield in return. Inflation-linked bonds and the rest are in tax-deferred accounts.

A future change that I am looking to implement is to swap out Vanguard Small-Cap Value Index Fund for probably the iShares Russell 2000 Value ETF (IWN) as it holds even smaller, more-value oriented stocks than the Vanguard ETF. Also, I want to swap out Vanguard Emerging Markets Fund for the WisdomTree Emerging Mkts SmallCap Dividend ETF (DGS) as if focuses on small, dividend/value-oriented stocks in emerging countries. Why? The whole point of those small 5% allocations is to add some spice and risk to my portfolio while reaching into areas not well-covered by the broad index funds.

The overall expense ratio for this portfolio is in the neighborhood of .20% annually, or 20 basis points, which is much lower hurdle to overcome than the average mutual fund expense ratio of over 1% annually. PTTRX and Stable Value fund are the best of limited choices in a 401k. This is all DIY, so I don’t pay portfolio management or financial advisor fees.

Personal Rate of Return

I usually don’t bother calculating the actual rate of return because doing it properly involves accounting for the dates and amount of all new contributions. In addition, most of my investments are passive so you can find the performance easily by looking at individual index and/or fund returns. But doing some rough calculations for 2012:

Total US +16.4%
Total International +18.2%
US Small Cap Value +18.6%
Emerging Markets +18.8%
REIT +17.7%
Total US Bond +4.0%
TIP +6.8%
————
Weighted average = 14.5%

Early Retirement Progress

To measure our progress towards total financial independence, I use a 3% theoretical withdrawal rate and compare that with our expected future expenses. This is lower than the common 4% withdrawal rate because we intend to retire early and our money may have to last much longer than most (50+ years). This results in a goal of 33 times our expected annual spending. Currently, our portfolio would theoretically cover 66% of our expected expenses.

The 3% withdrawal rate is simply a rule-of-thumb, although I’d like if the dividends and interest payments from our holding would create a 3% yield. Currently, our overall income yield would be somewhere between 2-3%. We may also add a rental property to the mix which would increase yield but also increase potential headache.