2023 First Quarter Update

When I decided to move to a quarterly posting schedule for these updates, I did so out of fear that I was getting repetitive. How many times could I write, "Net worth was up/down a bit... Mostly it was thanks to stocks one way or the other"?

Pretty dull.

The first quarter of 2023 was not dull, however. The consequences of one conversation rippled outward and touched all areas of our financial lives.

The Texts That Launched 1,000 Ships

One Sunday in January, I got a series of texts from my sibling (hereafter Sib) regarding my poor parent (hereafter PoorParent). It was a horrible conversation full of disagreements.

I've thought about writing more details about this, but it's much too personal. Long story short, the worries I laid out in My Baby Boomer Parent is Poor are threatening us much earlier than I had anticipated. The reality for me and Sib is that supporting PoorParent right now is only possible by severely limiting our lives in other ways. It would also make it more difficult to help PoorParent in the future when more dire situations arise.

Sib agrees with me now, but getting there was an unpleasant path.

Enter Dave Ramsey

I went to YouTube and looked up advice for people in my situation. There's hardly any, which is shocking, and the only person out there really talking about the duties or lack thereof of children when it comes to supporting their elderly poor parents is Dave Ramsey. So Dave Ramsey re-entered my life for the first time since I read his book Total Money Makeover back in 2009.

Although I'm not a pure Ramsey-ite, Dave's thinking has deeply influenced mine. Many of my money concepts can be directly linked to The Total Money Makeover. I've been budgeting for that long because, well, he told me too. I've become a true budget believer, and so has my wife. Even our "Blow" category is directly taken from his budget outline. Suffice it to say, I was primed to listen to what he had to say.

One thing that became clear was that I'm allowed to say no. To use his metaphor, I'm allowed to put on my own financial oxygen mask before I help other people, and that includes my parents.

Additionally, I now suspect that Sib and I had been enabling PoorParent. We can only take so much responsibility because we were much younger, but I can look to specific choices that PoorParent made that were emotionally and/or logistically supported by us. Had we gone along with fewer of these choices, we might currently have a better situation on our hands.

Tchüss, Debt

I was taking too much risk. That giant loan I took out in August 2021 was dumb. Sure, the interest rate was rock bottom, but so what? The monthly payments were annoying, and they limited our actual choices.

In February, I mostly paid it off after selling off a bunch of my individual stock positions. There's a pre-payment penalty for nearly all German debt, so I left slightly more than three scheduled payments to avoid that trap. You'll see a big change in the assets and liabilities of our net worth chart.

My thinking about the loan was wrong from the beginning.

FOMO

Reflecting, I got the loan after visiting America and feeling FOMO. I had this sense that I should do something, which is not a great emotional place from which to make decisions.

Most of the time, as I'm learning, the adult choice is just to keep on doing smart stable things. As Dave Ramsey describes it, his baby steps 4 and onward are pretty boring. Saving for retirement takes time, dedication, and patience. It's exciting in terms of the power of compound interest, but otherwise, it's a boring process. I've listened now to many calls into his show where someone has had a windfall and wants to do something to maximize their return on that money. For most people, the correct answer is to simply pay off any debt and their mortgage, and invest in mutual funds. This advice is often unsatisfactory for the caller, however.

Since I've become much less tolerant of holding individual stocks, the cognitive dissonance of being in debt while holding individual stocks became unbearable for me. I have no idea if I'm any good at picking stocks. For someone like me, borrowing money while owning individual stocks is especially dumb. I've learned in the past that my thinking goes crazy when I leveraged a position, and sure enough, I felt perpetually crazy.

The risk I had taken was:

• Job loss risk and risk that I couldn't make the future payments
• Increased risk of emotional volatility leading to poor decisions
• Currency rate risk (borrowed in euros to buy in dollars)
• Opportunity cost since that income was tied to monthly payments

It also bothered me philosophically that I was in debt. I liked being out of debt, and it was a point of pride that I'd paid off my student loans early. Along the way, yes, I had some installment plans, but there was never any interest attached. But now, I was in debt and paying interest. Yuck.

But even those installment plans need to be a thing of the past. Making choices for future me to pay for stuff is a mean thing to do to myself. It also assumes that the future looks like the present, which is not guaranteed.

Re-enter the IRA

During my Dave Ramsey rabbit hole, I listened to the Chris Hogan book "Everyday Millionaires" and read Ramsey's "Baby Steps Millionaires". One of the statistics was that most millionaires did it by steadily adding to their 401k plans. I hadn't added to my IRA since 2012, which was my loss because the money I'd put in between 2008 and 2012 - a total of $1,750 - had quintupled.

Therefore, after a decade of avoidance and fear, I've decided to continue adding to my IRA. For expats, this is tricky but doable. I'll have to use the Foreign Tax Credit rather than the Foreign Earned Income Exclusion to prevent tax payments to the US. This is more work, but having tax-sheltered investments is too important.

Wiseguy 2.0

I'll continue adding to the Wiseguy Portfolio allocation across my various accounts. Using Portfolio Performance, this is relatively easy to do with the Asset Allocation feature.

I've made an adjustment to weightings, however, which I'm thinking of as Wiseguy 2.0. There's now a 10% weighting to REITs, now that there's a tax-sheltered place for me to put them. REITs in a taxable account are dumb dumb dumb, which is why I left them out before. Within the REIT basket is a 25% allocation to ex-US REITs, so 2.5% of the total portfolio. That may seem paltry, but the fees on the Vanguard ex-US REIT fund are high. I'd like exposure, but until the fees come down more, I can't justify a heavy weighting.

To make space for the 10%, I've reduced the bond allocation to 10% from 20%. I'm taking more risk, which means that any future drawdowns will likely be more stomach-churning. However, I'm hoping this will also lead to long-term greater returns. I can't access my IRA money for another 30 years after all.

So Wiseguy 2.0 is this:

• 25% US Small Cap Value
• 25% US Large Cap Growth
• 25% ex-US Small Cap Value
• 10% Long-term bonds (both Treasury and Corporates)
• 10% REITs (75% US/25% ex-US)
• 5% Gold

Net Worth

Image: A stacked bar chart of our net worth over time. Click to enlarge.

As of March 31, 2023, our net worth rose since December by 8.22% in USD and 6.83% in EUR to $135,357 and €124,753 respectively. Liquid net worth is $99,747.

This new chart is meant to simplify viewing. The previous style was pretty difficult to read, and this new iteration makes it clearer. It also, perhaps a bit pretentiously, uses typical business accounting terms for some items, such as "Cash and cash equivalents". "Accounts receivable" at this point means strictly dividends for which the ex-dividend date has passed.

Stock Performance

Stocks have more or less been in an uptrend. Of the Wiseguy components, US large-cap growth, gold, and bonds have all done very well. Small-cap value has performed poorly, likely as a result of banking industry volatility. The purchase of the REIT funds accidentally corresponded with a bounce for that asset class, which wasn't intentional but worked out in my favor.

Spending

In addition to the big macro money moves, we've also re-committed to following our budget. We reined in our grocery spending, cut down on subscriptions, and otherwise made choices that resulted in lower spending overall. I'm also turning reward points (classified as "intangible assets") into groceries or money as much as I can.

We did buy a plane ticket for my wife to visit her family in the States. That was necessary. However, we've declined to go on a big vacation this summer in the US. This was a secondary set of conversations with my family that were difficult, but I'm at peace about it.

Simultaneously, the elimination of the debt also eliminated the lifetime interest cost, which I had added to the liabilities side of our balance sheet. That was about €2,000.

Second Quarter Forecast

Considering how much activity there was in the past three months, it's hard to consider what might happen in the next three. Here's some of what we know:

Our heating bill has gone up a lot. We'll have to eat a big upfront cost in April, and our monthly warm rent will rise. That's a bummer, but it's the situation Germany finds itself in.

My wife and I will likely plan some modest trip for the two of us. We'll probably pay for it before the end of June.

I'm going to aggressively add to my IRA until I hit the max for 2023. $6500 is a doable number, and I hope to never miss hitting the max ever again. I doubt I'll get there by the end of June though.

The last debt payment will be gone at the end of May. Good riddance.

Until next time, stay healthy and avoid FOMO.

VTSAX and No Chill

As I've been debating my ETF allocation, a regular suggestion has been to buy the Vanguard Total Stock Market Index Fund (VTSAX or ETF:VTI) - which holds all the publicly traded stocks of the United States - and buy nothing else.

Aka, VTSAX and chill.

To be sure, this is easy to implement, and it would be exceedingly tax efficient. Buying one fund and never selling is the height of simplicity. And since you're never rebalancing, you don't have to worry about tax costs eating into your gains over time (aside from pesky dividend taxes). Those are real benefits that I'd be stupid to dismiss.

It's also been difficult to beat. The U.S. stock market has been on an amazing run, and while I've been running backtests of different asset allocation strategies, it's been very hard to find strategies that outperform the market cap-weighted U.S. market. Especially in the years since the Great Recession, buying any asset other than the U.S. market has been an exercise in frustration. You have likely underperformed year after year after year. Value has been crushed. Ex-US stocks have gone mostly nowhere. Small caps have had mediocre returns.

Modern FIRE

During this period, the modern FIRE movement got its legs. Obviously, it existed before this great bull run, since the term comes from 1992‘s Your Money or Your Life. However, I believe this modern version with the blogs and internet forums has been aided by this incredible period of somewhat easy returns. Both Mr. Money Mustache and J. L. Collins began blogging in 2011, which was an amazing time to be buying U.S. stocks.

Both recommend VTSAX/VTI as the singular vehicle for investment. As the blue line in the above image shows, they've been 100% correct. Anyone who recommended anything else has been wrong.

But what about now?

Valuation

First, in the early part of the long bull market (interrupted occasionally by short and intense drawdowns), the U.S. stock market was fairly inexpensive.

For one, the S&P 500 had fallen to below its 200 month moving average. I repeat: below its 200 MONTH moving average. This had only happened before after the second crash of the 1970's and (if you extrapolate backwards) in the years following the Great Depression, both of which were incredible times to be loading up on stocks.

Secondly, in 2009-2011, it was possible to buy the U.S. market for CAPE ratios between 15 and 20. Today, however, it's near its second highest ever level:

An easy rebuttal: using the CAPE ratio for the past few years has been dumb. It's been warning for years that the market was expensive, but buying the U.S. market has been the winning trade. Admittedly, that's a fair critique. CAPE is an awful timing tool.

However, for anyone with a "buy and hold" mindset, stocks are long duration assets. That means that we stock investors shouldn't be focused on short term results. And focusing on a few years of outperformance is focusing on short term results. We need to look over time.

Over Time

In that vein, here's a chart that shocked me:

This is a comparison of three portfolios' performance since 1972 with a starting balance of $10,000. Dividends are reinvested, and the portfolios are rebalanced quarterly. The yellow line is U.S. Stocks, blue is a 60/40 portfolio (60% U.S. stocks, 40% 10-year Treasuries), and red is a 40/60 portfolio.

What do you notice?

For one, up to the end of April 2022, U.S. stocks have outperformed the more balanced stock/bond portfolios. Since 1972, U.S. stocks have returned 10.52% annually. 60/40 has returned 9.49%, which is clear underperformance. And when I see comparisons of the 60/40 portfolio to a pure stock portfolio, that's the framing I usually see.

However, that might not be the best framing. If you look at the box over the chart, that's the performance at the bottom of the 2008/09 crash. Notice that at that bottom, the pure stock portfolio had worse performance than the more balanced portfolios. That's 37 years of holding on to a volatile asset class only to be beaten by a much more conservative mix of stocks and bonds.

This makes it clear that we have to question our assumptions about the relative outperformance of one asset class vs. another. If you read my Update posts, you should know that I value my net worth at the end of the month, and I subtract out my freshly received salary. To me, I'm measuring what I've accumulated after all expenses are paid. It doesn't make sense to inflate my net worth if I'm about to spend it down.

I'm starting the view the stock market the same way. There's clearly some kind of cycle that happens over time, and measuring outperformance based on the results in the middle or peak of a cycle leads to lofty expectations. Yes, as of right now, U.S. market cap-weighted stocks are trouncing everything else. But that has been true in the past as well, and it didn't automatically mean that it continued into the future.

Will a pure U.S. stock portfolio's returns fall below a 60/40 mix after two decades ever again? I have no idea. Going back to the beginning of the 20th century, it appears that a pure stock portfolio does eventually pull away from that more diversified stock/bond portfolio. However, we don't know what time scale that requires. And we have to consider the specific events in the early 20th century that might have influenced that result, which we might not be so glad to repeat.

Market Cap Weighting Downsides

Part of the inescapable issue with VTSAX and all such indexes is the market cap weighting. The most valuable companies get the most dollars allocated to them. However, since market caps are driven by more than the business results, this can mean money allocated to the wrong companies at the wrong time. Looking at the largest S&P 500 holdings over time makes this clear: they were darlings for a time, and then they weren't.

Yes, yes, the indexes are eventually self-cleaning, and those companies will eventually become smaller and will get efficiently de-emphasized. Valuations eventually get sorted.

Without a second asset class, though, you just have to wait for that to happen, and you have to live with the volatility and year or decade long reshuffling to correct these imbalances. An upside of even a simple stock bond mix is that you can sell off the stocks as they get too expensive to put into something else. This makes the overvaluation of the market a benefit since it can be sold to buy something else.

That leads to the so-called rebalancing premium, whereby two assets together can outperform either one individually. You can’t do that with one asset all by itself.

We're All Making Bets

If you're buying VTSAX and chilling, you're making a series of bets:

• You are betting that the U.S. stock market is more or less efficient.
• You are betting that the U.S. is the best place to invest.
• You are betting that large cap stocks are basically where the majority of your money should be.
• You are betting that the downsides of rebalancing (taxes and complication) are significant enough to warrant putting all your money into a single asset class rather than diversify.
• You are betting that other asset classes aren't worth bothering with.
• You are betting on positive returns coming from earnings growth that justifies the current valuation.

It's easy to wave this all away by using words like "passive" and "efficient" and "indexing", but you're kidding yourself. You're making a very aggressive bet on one asset class.

It's one I'm not comfortable with. It is possible that I'm wrong. But since the future is unknowable, we have to consider a variety of future scenarios. You pays your money, and you takes your chance.

That’s a long post to say: I won’t be putting all my money into VTSAX. It's too concentrated in one style for my taste.

If you are, then you'll probably be ok. Just realize that the returns you're hoping for won't be smooth, and there may be long long periods of no growth or sideways choppiness that will be no fun. You'll probably also have times where other markets do better, which will tempt you to bail on your strategy.

If you're cool with all that, then enjoy your very simple tax-efficient U.S. stock allocation.

Asset Allocation Conundrum

When I decided to focus on a diversified ETF strategy, I hoped asset allocation questions were settled science.

Nope. Not even close.

Accepting Lower Returns

One aspect of this that's a hard pill to swallow is that it will likely force me to accept lower returns. When I buy an individual stock, my hope is that it will appreciate by 15% a year for the foreseeable future. Naturally, volatility won't make that a smooth ride, but generally 15% is the goal.

Expecting a 15% CAGR when you're allocating to a basket of assets is foolish. After backtesting various portfolio types, it's probably wise to expect a 4-9% CAGR. Some years will be better, but due to overvaluation and volatility, sometimes there's no escaping bad returns. There might be an extended period of 0 return.

If I can get 15% on a stock but only 4-9% on ETFs, then why get the ETFs? Well, it's because the stocks aren't guaranteed to work. Additionally, they expose me much more to my own thinking errors, behavioral mistakes, and biases. Perhaps my analysis is simply wrong or under-baked. Basically, I need some money set aside into broad buckets that will perform well enough in case my stock picking doesn't work out.

That's where asset allocation comes in, and - even accepting lower returns going forward - it's tricky.

Why Not Just Do Something Lazy?

So what would be the, you know, "Ah, screw it" portfolio?

As a baseline, there's J.L. Collins 100% allocation to VTSAX (ETF: VTI). Lazy and easy, and you won't feel a lot of FOMO (fear of missing out) since it's the whole U.S. stock market. It's also very hard to beat:

But what if you want some "hold onto your butts" assets for the scary times? Something like the Bogleheads' 3 fund portfolio fits:

For sure, lazy has a lot going for it. It would be easier for me to manage, and should I get hit by a car, it will be easier for my wife to manage. There are some portfolio varieties that just have too many funds in too many strange percentages. If it requires a computer to manage, then it's probably not the best choice.

And the lazy portfolios don't perform strangely. If you spend years envying the S&P 500, how long can you reasonably hold out before you just buy the S&P 500?

That said, are there ways to achieve slightly better risk-adjusted returns without it becoming too complicated?

International

I should have been prepared for difficult questions since I've been an active listener of Meb Faber's podcast. He has idiosyncratic views about asset allocation. For example, he argues effectively that a global allocation is not only valuable but even dangerously underutilized in many modern portfolios.

To make a long story short, being concentrated in one country in a market-cap weighted portfolio leaves you open to major country risk as well as valuation risk. There will be periods of underperformance, and there's the risk of a total country disruption that leads to a total loss.

What's hard to get over, however, is that international additions to a pure 100% US market allocation have been a performance drag in recent memory. It's one thing to know that allocating all your assets to a single country (even the US) can be risky, and it's another to actually allocate money to underperforming geographies:

Adding international exposure looks like a leap of faith based on the following ideas:

• The US is likely overvalued relative to international markets, which may lead to sustained international outperformance during times when the U.S. is working through overvaluation.
• The existential risk of single country concentration is high enough that putting up with potential lower returns is worth the risk. Countries don't stay on top forever, and whole country's stock markets have gone to 0.
• Adding international adds even more diversification.

With those ideas in mind, I will probably add an international component.

Drawdown Protection Portfolios: 60/40, Weird, and Permanent

If I want lower drawdowns in a lazy way, there's not much lazier than the 60/40 or 40/60 portfolio:

One of the accounts I follow on Twitter is ValueStockGeek. While occasionally, he'll put out some information on a specific company he's interested in, the most surprising content he writes is about his Weird Portfolio. I encourage anyone interested in this stuff to read what he's written on it, but long story short it's:

• 20% US Small Cap Value
• 20% International Small Cap
• 20% Gold
• 20% REITs (divided between US and ex-US)
• 20% Long term treasuries

It's his variation on Harry Browne's Permanent Portfolio, and it's more aggressive than Browne's risk-averse allocation (25% US stocks, 25% Long Term Treasuries, 25% Gold, 25% cash).

Notice the slow and steady return of the blue line (the Permanent Portfolio) vs the more jagged yellow line (the S&P 500), with the red line (the Weird Portfolio) somewhere in the middle.

Both alternative portfolios are trying to consider inflationary and deflationary environments, and how those periods impact the various components. When both portfolios succeed, they leads to lower but steadier growth with much gentler drawdowns. The Sharpe ratios are considerably higher than a pure stock allocation. The Permanent Portfolio's returns are low but with much lower risk, while the Weird Portfolio has more acceptable total returns.

Backtests point to something like an 8-9% return for the Weird Portfolio. In the Great Recession, the drawdown was higher than the Permanent Portfolio's, but it was much lower than a 100% stock allocation. Combine that with a 9% return, and it feels like a revelation.

My concerns with it however are:

• Small cap value outperforming over time is necessary for the growth to be satisfactory. It hasn't out-performed during this last decade, though its longer term record is very good:

• The drawdown protection via gold and treasuries has to actually work.

Nevertheless, I find it compelling despite my concerns and will integrate some of this into my own approach.

Other Compelling Portfolios and Final Thoughts

Look around enough, and you'll see all sorts of smart portfolio constructions. Take a look at the Ginger Ale Portfolio for one idea. For my taste, it's too many ETFs, but to each their own. Or stroll through the Boglehead forums to read intelligent debates about portfolio construction.

Nothing is guaranteed, and we have to make best guesses about our own psychology and how best to navigate an unknowable future based on the available research and how assets have behaved in the past. Avoiding blunders is paramount.

The strongest takeaways for me are:

• U.S. Market exposure is basically good enough on its own. It prevents FOMO and will probably perform well. It has risks though.
• Some "hold onto your butts" assets make sense.
• A tilt towards small cap and value makes sense.
• Too many assets gets unwieldy.
• Some international exposure is likely worth it despite recent underperformance.

This only begins to scratch at the surface of asset allocation decisions that someone could obsess over. I think I have a basic plan, when I make a decision I'll write more.