December 2022: Update and Full Year Summary

December was a great month. We had family visit us from the US over Christmas for the very first time. We traveled some. We ate some great meals and had a lot of laughs.

However, December was also the first time that our net worth was down in every metric that I track. There are four comparisons at the top of my spreadsheet: USD month over month, EUR month over month, USD year over year, and EUR year over year. For the first time, all of these metrics were negative.

Just like the stock market isn't the economy, your net worth isn't your life. But since this is a money blog, let's focus on the money part of things.

Net Worth Changes

Image: chart of our net worth in USD over time

In December, our net worth fell to $125,071/€116,780, which represents the following changes:

Metric	Percentage
Y/Y USD	-14.23%
Y/Y EUR	-8.79
M/M USD	-2.53%
M/M EUR	-5.71%

Maybe I can assuage my disappointment by creating a new metric: quarter over quarter. How's that look?

Metric	Percentage
Q/Q USD	6.83%
Q/Q EUR	-2.25%

So now one metric shows improvement. I'll take the win where I can I guess.

Our liquid net worth stood at $95,876/€89,521.

So what's up?

Inflation Devours All

The obvious big story is this:

• Due to the war, supply chain, stimulus programs, and energy shocks, inflation rose drastically.
• The Federal Reserve and other major central banks raised their benchmark interest rates to counteract this.
• Since the present value of equities is all future cash flows discounted to the present, both the discount rate and the - assumed - poorer quality of those cash flows put downward pressure on the value of stocks.
• Rising interest rates caused bond prices to fall.

We were not spared from this, and I took some serious hits on the large number of growth companies I had in my portfolio. They weren't the worst growth companies to have owned, but they were hit very hard anyway.

I took some steps to protect myself. In my IRAs, I sold in February due to trend following rules being triggered, which protected us there. I decided to reduce my exposure to individual companies and create the Wiseguy Portfolio, which is a kind of "all seasons" portfolio.

Image: Chart of portfolios in 2022: Green is my IRA, teal is my ETF account containing the Wiseguy Portfolio (started in May), red is S&P 500 benchmark, black is all portfolios together, yellow is individual stocks.

Finally, the effect of rising interest rates has caused a reduction in the estimated value of my pension. Since the pension is discounted at the rate of the 10 year treasury, rising rates reduce the future value. In a sense, this value is both real and imaginary; I'll never be able to pull out all this cash one way or the other, but I do have a guaranteed income stream in addition to government social security. It has value.

Spending

I've created a Sankey diagram that documents the flow of our money. For practical reasons, the numbers are slightly different in some cases compared to our actual budget, but overall this represents money received and spent/allocated well.

Image: A Sankey diagram showing the flow of money from income sources to spending categories.

Excluding tax, social security, and health insurance costs, our largest expenses fall into these categories:

• Rent (warm) (€10956.81)
• Groceries (€5984.66)
• My BLOW money (€4605.97)
• Travel costs (€3532.05)
• Her BLOW money (€3532.05)

A reminder: BLOW is anything we buy that is personal and doesn't require discussing with the other partner.

You can see the mark of inflation on our two largest household expenses. Our rent was raised in August, which was a bummer that upset my equilibrium for a while. Our grocery bill for the year rose from €5,158.22 in 2021 to €5984.66, which is a ~16% jump. Some of that could be carelessness on our part, but some is definitely climbing prices.

Our travel costs included a trip to the US for her, a trip to the US for me, a few weeks of fun in Europe in the summer, and a late year trip with the family who visited us over the holidays. As much as I'd like this number to be lower, there's a reality that an expat who has good relationships with his family will also likely have recurring large travel expenses to contend with.

Image: Chart of the EURUSD price in 2022

Unfortunately, my US trip coincided with a weak period for the euro against the dollar. This made the trip much more painful than it otherwise might have been.

Mindset Changes

There were three major changes in how I view our financial goals in 2022.

Cash

At several points, I felt hemmed in and without options. The most acute phase of this happened when we had our rent raised, but it was a recurring theme in the second half of the year. Yes, we had stock assets, but should we ever actually experience and emergency, our stock wealth would have to be sold off to actually give us flexibility. This increasingly felt intolerable to me, since I was sort of mentally double spending that money: it was both meant as a long term savings but also potentially a bail out, emergency, house, career change fund. It was untenable.

So we are now allocating much more towards cash. Savings accounts both in the US and Germany actually pay something now (though it's still crazy low in Germany). This allows us to pursue opportunities the way a big stock allocation can't.

The Implausibility of FIRE

It is unlikely that we will be able to retire early in any significant way. Perhaps that will change, but it won't change in the next few years, and in acknowledging that reality, I have to ask some questions.

For example, are there other career paths that might be more rewarding? If we have to work anyway, then why not do something that is genuinely enjoyable during that time? Perhaps staying put is the best option, but I should create the space where that's a choice rather than mandatory.

So much of the online financial world is fixated on this idea, that to acknowledge it may never be reality for us feels like a failure. However, my desire is to keep working. It always was, and the FIRE idea was mostly a way to give myself permission to pursue avenues that I find more fulfilling.

Stock Picking

Until this year, I'd exclusively been a stock picker. The US extraterritorial taxation regime has made the purchase of mutual funds tricky, and I'd believed I'd be able to handle individual stocks as the container for all our long term wealth.

It's safe to say that I was wrong.

I've grown as an investor, but I still make silly mistakes that should probably make it clear that stock picking ought not be my primary savings strategy. Yes, I've become less trigger happy, but I'm still too damned trigger happy. Just in the past few months, I sold several securities too early and missed out on rebounds. And my analysis is often rudimentary at best.

I've also discovered that focusing on stocks is not the best use of my time from a "quality of life" point of view. It's stressful and distracting. I have better questions to focus on and better uses of my time than worrying about whether such and such company faces an existential threat or is just going through a rough patch.

My returns thus far - while not catastrophic - align with returns I could more easily achieve by buying ETFs, and so that's what I'm mostly doing now. I just hope that the US/Germany thing doesn't bite me in the ass; if Germany adopts a PFIC type punitive taxation regime again for foreign mutual funds, I'm SOL. But best to save those worries for the future.

2023

The four big questions hanging over me now and likely throughout the year are as follows:

• Do I change jobs and potentially enter a riskier line of work in the hopes of greater life satisfaction and potential long term economic benefits? Or do I remain as I am now: basking in the weird safety of my current position, but potentially plagued by long term doubts around what might have been?
• How do I allocate limited savings for a potential risky life change?
• Do we participate in an expensive vacation that my family has planned out? We participated this year in Europe, but in summer 2023, it's further away and likely much more expensive. This is part of a larger question around family expectations and travel. I should probably write about this, but in general, I feel a lot of pressure to travel to see family, even though the prices are often higher for me, and my income is lower than the other people participating in the trip.
• Does the ticking time bomb of my poor Baby Boomer parent finally explode. There have been indications just in the past month that it might.

One change to the blog is that I will switch to quarterly updates rather than monthly. I find that I repeat myself too often month to month in these updates, and the movements within a month are often noisy.

With that, I leave you for now and wish you a happy and healthy 2023 full of great moments that let you forget about any financial stress you may have.

May 2022 Update: Net Worth, Pension Valuation, Crypto, ETFs

In May, our month over month net worth declined by .73% in USD and 2.31% in EUR to $122,613 and €114,165 respectively. Our liquid net worth was $89,945/€83,747 after closing on the last day of May.

May was a surprisingly busy month. Some major changes:

• I've valued my defined benefit pension and added that to the illiquid part of our net worth.
• I've exited all cryptocurrency positions.
• I've transferred a sizable amount of money away from individual stocks to my so-called Wiseguy Portfolio.

Valuing a Pension

Defined benefit pensions are still a thing in Germany, and since I've been working here, I've been steadily adding value to mine. My employer has never mentioned my pension to me (which is just baffling), but I can see the withdrawals from my paycheck every month, and the pension plan custodian contacted me shortly after moving here. I knew it existed, but it's only been the past few years that I've paid much mind to it.

The pension works like an annuity:

• My employer and I both pay 50/50 into the plan.
• The contributions are payments for promised future income streams.
• The income I can expect from each contribution is the contribution amount multiplied by an annuity rate, which is - I believe - calculated by combining my expected retirement date, current expected returns, and life expectancy. This exact formula is opaque, but they publish their annuity rates regularly.
• If I die before my wife, she's entitled to half the annuity stream until her death.
• The payouts are adjusted by cost of living changes. Theoretically, there's not much risk from inflation.
• I am required to pay into this plan as long as I'm working within this career.

Every year, the pension provider sends me a letter telling me the previous year's contributions and my expected yearly pension. From that I can divine a value of this income stream.

To do that, I first value the income stream as if I were about to enter retirement. That's done by using a present value calculation, which discounts future cashflows to a start date. My assumptions are a 2% discount rate (debatable), and my life expectancy limits the years of payments (also debatable).

That value then gets discounted to today. For that I'm using the years until my legal retirement age as the number of periods, and I'm using the 10-year Treasury bill as the discount rate.

All this adds up to a value that is much less than the value of the contributions that my employer and I have spent on this plan. Since I can't touch that money no matter what, it's only a minor intellectual annoyance. But the value of this annuity only really makes sense if my wife and I live well beyond our life expectancies.

Since I'm using fluctuating Treasury rates as my discount rate, and since that discounting process has an outsized impact on the value of the pension today, our net worth has been negatively impacted by the upward movement of interest rates. Had I been factoring in the pension all along, its value would have cratered these past few months.

This is purely a "time value of money" phenomenon and doesn't mean a loss of current purchasing power. However, I want the net worth calculation to accurately reflect how assets and cash flows sources are accruing over time, and similar to valuing a home - the value of which is at least somewhat fictive - this pension should be included. Otherwise it means that the money spent on it is basically lost, which is not the case.

Leaving Crypto

Image: the collapse of Terra was a scary event for anyone in the vicinity of crypto. I feel bad for all the people who've lost money in that scheme.

Crypto is in a world of pain right now, and since it's so speculative, I didn't want to stick around. It's as simple as that. I took a small loss, and the cash helped me buy a present for my wife.

Using ETFs

As I've written about extensively, I'm going to be adding most of my savings to a basket of ETFs that I'm calling the Wiseguy Portfolio. I sold off some of my stocks to get started on this. Some positions were closed entirely, and some others were merely trimmed since they were outsized positions that were larger than I could actually handle when the going got rough.

It's easy to think you can handle a bunch of risk, but it's harder to actually live with the consequences of taking on too much risk. It's better to underestimate what you can handle. Additionally, is extra risk necessary for your goals? Do you need to hit a home run with a specific investment or are steady gains enough?

Increasingly, I also feel like the time spent analyzing stocks is mostly a waste of time. I've been asking myself a lot recently whether I'm getting much value from it. Does the worry pay for itself? Could my ears be doing something more productive than listening to earnings calls? In my daily/weekly/monthly stress allotment, should I be using so much on this one activity?

I went into stock picking because Germany and the United States both had punitive tax regimes towards "foreign" funds. Germany's system has relaxed a lot, and the worst thing about using ETFs is that I need a U.S. broker to whom I'm lying about my actual residence, and I have to keep track of all tax information myself and translate it back to euros (thanks MiFID ii!). But if that's the worst thing, it sure beats the terror of wondering whether company x will ever regain some high price that I was anchored to.

Spending and EOC

Since it's summer, and since that means a lovely European summer break, we've spent some money on vacations. It hasn't been too much, but it's definitely a cost.

I've been re-listening to the Millionaire Next Door, and it's been hitting me differently this time around. I always learn something from it, and this time it has to do with Economic Outpatient Care. Am I spending more than I otherwise would because I get monetary gifts (usually small ones) from my family? Do I feel wealthier than I am thanks to subsidies from family? It's a question I have to untangle, and if I come to any conclusions, I'll share them here.

Until next time, stay healthy, and give your friends and family big hugs.

The Wiseguy Portfolio

Since I've decided to allocate the majority of my future savings into ETFs, I needed to craft an asset allocation that will:

• Grow enough to meet my future needs.
• Have gentler drawdowns than the overall U.S. stock market.
• Avoid lost decades.
• Avoid bubbles that take down the entire portfolio.
• Allow me to remain sane as the markets bounce around and as different asset classes do better than others.
• Beating the S&P 500 is not the goal, though it wouldn't be unwelcome either.

I've settled on an arrangement I'm calling the Wiseguy Portfolio.

There are two versions. The first is a more aggressive allocation with 75% stocks and 25% protective assets:

• 25% Small Cap Value
• 25% Ex-US Small Cap Value
• 25% U.S. Large Cap Growth
• 20% Long Term U.S. Bonds
• 5% Gold

The less aggressive version is a 60% stocks to 40% protective mix:

• 20% Small Cap Value
• 20% Ex-US Small Cap Value
• 20% U.S. Large Cap Growth
• 30% Long Term U.S. Bonds
• 10% Gold

The Wiseguy name is a crack at myself for trying to out think my emotions. I'm both trying to have strong exposure to factors that the evidence suggests will work over time (small, value, international), while also second guessing that because of my inevitable sense of FOMO around missing out on things like American growth stocks and the occasional big gold move.

U.S. Small Cap Value

Image: the absolute dominance of small cap value since 1972.

There are several reason to include a small cap value tilt in a portfolio:

• Both value and size are factors that tend to lead towards outperformance over time.
• By its very nature, it's unlikely to enter a bubble. If some companies grow more quickly than their fundamentals, by definition, they will leave the small cap factor, the value factor, or both.
• Even when it's not outperforming, its performance is likely to be good enough for my goals.

The downsides are:

• Drawdowns can be nasty. For example, the March 2020 drawdown for the overall U.S. market was 20%, but for small cap value it was 35%.
• There's no guarantee that small cap value outperforms ever again.

However, the bet is asymmetrical: if small cap value doesn't outperform, the likely worst that happens is that it performs well enough for my needs, likely in line with the market over time. The inverse is not automatically true.

ETFs: AVUV, DFSV, VBR

Ex-US Small Cap Value

Everything written above about U.S. SCV applies to ex-U.S. SCV as well, with the added wrinkle that it's not U.S. companies. Depending on your point of view, that's a good thing or a bad thing. Let's take a look at some factors to consider:

• First, like the United States, small caps outside the U.S. tend to outperform the total ex-US combined stock markets.
• Ex-US value tends to outperform the broader ex-US market as well.

Image: a comparison of $10,000 invested in ex-US stocks (blue), ex-US small cap (red), and ex-US value (yellow)

• The world stock market without the U.S. stock market has been under performing for years now.
• In the past it has outperformed.
• It is unlikely that the United States stock market will outperform in perpetuity.

Image found here from Reddit user /u/misnamed

• Some exposure to ex-US stocks, therefore, is a logical bet to make, and within that broader category, small cap value is probably the best place to focus.

Even with this 25% allocation, the Wiseguy Portfolio is heavily U.S. weighted. But if the rest of the world ever does outperform the United States, this portfolio will capture some of that performance.

I'll also add: the dividends from companies outside of the U.S. are often very good. They come in fits and bursts, and it's rough for your taxes, but you can get large cash flows in some years.

Image: shows the dividends from a portfolio with a $500 monthly dollar cost average into Dimensional's international small cap value fund in blue vs the Vanguard S&P 500 fund in red.

ETFs: AVDV, DISVX, VSS (no value aspect)

U.S. Large Cap Growth

Similar to the Weird Portfolio, I was considering sticking with small cap value for my stock allocation. If small-cap value works as it has in the past, it can carry a portfolio, even when adding in heavy allocations to safe assets like bonds.

However, that just didn't feel right to me. Since one of my goals with this portfolio is to avoid feeling FOMO - which I hope will help me hold on in difficult times - having zero exposure to the most high profile stocks feels intellectually possible but practically impossible. In periods where the market does well and beats everything else, I want to at least feel like I'm part of it. Otherwise, I might just give up and buy the S&P 500.

The risk with growth is bubble risk. Investors extrapolate good news to infinity, and no price becomes too high. These bubbles can take years to work out (see Japan and the dot-com bubble). Many argue that we're currently in a bubble, and the poster child for this fear is the growth stocks, many of which have plunged in value over the past year after having exploded higher in price and valuation over the prior year.

That said, there's value to these bubbles if you can rebalance out of them. As the bubble forms, it provides an area of relative outperformance within a portfolio, which can then be rebalanced. When the weaker parts of the portfolio eventually outperform, they are in a good position to take over as the previous winning assets starts to decline.

With both growth and value, there's a timing risk inherent in buying one strategy at any given time. Growth sometimes does better, and sometimes value does better. If you get it wrong, you're going to be looking at major underperformance that may be difficult to recover from. Therefore, mixing the two with a strong tilt towards value strikes me as a compromise. I don't know if we're entering a period of value or growth outperforming, so I'm hedging my bets here.

An obvious question is why not just buy the S&P 500 for this asset? I originally looked at this, but after tinkering, it became clear that it wasn't different enough when compared to a pure growth fund. The S&P 500 is loaded with growth stocks to be sure, and it definitely goes along for the ride on bubble misadventures. But it also has value stocks as well as stocks that aren't really one or the other. Since I'm trying to capture a rebalancing premium, I wanted the factors to be as different as possible. Using large cap growth as opposed to overall U.S. large cap (which is what the S&P500 is basically) was a purer way to capture this difference.

ETFs: VUG, QQQ

Long Term Bonds

Image: a comparison of a 100% stocks portfolio to a 60/40 and 40/60 portfolio. Notice how bonds smooth the ride, and stocks alone have trouble outperforming forever.

I view long-term bonds as serving three goals:

• One, they usually reduce the severity of drawdowns.
• Two, they provide interest income.
• Three, they provide an asset to rebalance into in times of strong stock growth and as a source of funds to rebalance out of during stock drawdowns.

Bonds are not the primary return vehicle in the portfolio, but because they often zig when other parts of the portfolio are zagging, they serve a useful purpose.

The arguments against holding bonds are compelling if not entirely convincing:

• Interest rates are at all time lows. Therefore, the return from bonds will be paltry.
• In 2022, bonds have dropped alongside stocks. Where is the drawdown protection in that?

Both those things are true, but I allay my fears with a few reminders. Yes, interest rates are low, but we have no idea what the future will bring. They might continue to go lower over the long term. Should they rise substantially, the limited 15% position should be protective. Since I'm a net saver over time, future purchases at higher yields are advantageous.

Second, bonds have dropped alongside stocks, but a total bond portfolio (such as ETF:BND) has dropped less. Long term bonds, admittedly, have underperformed the S&P 500 this year, but this is also an outlier drawdown year for bonds. I'm not making this portfolio for 2022 alone. It's supposed to do well enough over various regimes without impacting growth too much. There will come a day when bonds counteract stock drops as they have in the past.

Why long-term bonds (a mixture of corporate and treasuries) rather than just long-term treasuries? In my backtests, a mixture does well. Sometimes a mixture beats treasuries alone and sometimes not. Part of this is my increasing distrust of the U.S. federal government. Despite that, long-term treasuries alone will likely serve just as well.

And why long-term bonds rather than total bonds? Right now, I view my time horizon as long-term. Long term bonds tend to outperform total bonds over the long-term with greater volatility. Big surprise. It may be that as I get older, allocating a larger portion to short-term bonds or a total bond market will make more sense. But today is not that day.

ETFs: BLV, TLT, VGLT

Gold

Image: compares a 100% gold position (blue line) to 100% U.S. stocks (red line) and a 50/50 mix of the two since 1972 (yellow line). Notice the lower drawdowns and more steady rise of the mixed portfolio.

The 5% allocation to gold is a "What if?" allocation. When looking at a performance chart of gold compared to stocks, gold tends to have idiosyncratic performance that makes it an ideal rebalancing vehicle. It can outperform during periods of great financial distress and in inflationary periods. To have no gold at all risks missing out on this performance when the rest of the portfolio may be experiencing extended drawdowns. Since the Wiseguy Portfolio has "keep me sane" as a prerogative, I would hate to leave it out entirely.

That said, I won't ever hold an outsized proportion of my net worth in gold. It is an unproductive asset that requires basic supply and demand dynamics to work in the holder's favor. It will send me no dividends, and gold has no management that is trying to improve it. It is an element that has certain inherent qualities that we humans believe have value. That's why I'm limiting it to 5% in the riskier portfolio and 10% in the more risk-averse portfolio. I personally can't bring myself to approach the heavy allocations to gold that the Permanent Portfolio and the Weird Portfolio have.

ETFs: SGOL, GLD

Performance Characteristics

(Image: a backtest since 1995 using the most approximate funds that I can. In this scenario, the riskier version (red line) has returned 9.99% annually while the risk-averse version (blue line) has returned 9.56% annually. The risk-averse version's max drawdown however was limited to -33.65% while the riskier was down 41.17% in 2008-9. Both had lower drawdowns than the S&P 500's 50.97% and higher than a 60/40 portfolio's -15.06%. The safe withdrawal rate of this backtest is 9.7% and the perpetual withdrawal rate is 6.97%.)

It's hard to get a precise long-term view of how the portfolio will do. Each element will behave differently depending on the environment. In the 90's, the bonds and growth stocks would have done very well, while the international ex-U.S. stocks would have muted growth. In the 2000's, small-cap value, ex-US, and gold would have crushed growth. The 70's were like the latter, and the 80's were a mix, since ex-U.S. stocks were strong then.

Since 2009, the Wiseguy Portfolio has underperformed the S&P 500. So has practically everything else except for some individual stocks or pure growth strategies. That's just the kind of environment it's been, and after you stare at these charts long enough, it becomes clear that environments change. Some day, U.S. stocks and growth stocks won't be the dominant force they've been since the Great Recession, and I believe the Wiseguy Portfolio will do well in those environments while not doing horribly in strong growth environments.

With that, I hope the Wiseguy Portfolio and this article have at least whetted your appetite to consider your options more broadly. Wish me luck, and I wish you luck on your progress.

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.

Applying for Another US Brokerage Account

Today I applied for another US brokerage account. In so doing, I hit one of those pain points for US citizens living abroad.

Right now, I have two brokerage accounts: I have my main Interactive Brokers account, and I have a Robinhood account, which was actually the very first brokerage I opened. When I first opened that Robinhood account, it was years ago when Robinhood was the hot new thing. I was vacationing in the US, and it was no problem to open the account. I began my stock purchases, and when I hit the $10,000 threshold for Interactive Brokers, I moved everything over there. Interactive Brokers has thus far been pretty great.

The problem with Interactive Brokers is they are bound by the laws of the EU as well as the US. Since they have my German address, which means I'm shuffled into their Irish - previously UK - subsidiary, I'm unable to buy any funds that are US-sourced. Under the MiFID II rules, brokers in the EU can't allow EU residents access to funds that don't follow these rules. This rules out all US funds, including ETFs.

Interactive Brokers does allow the purchase of European funds, but this is where my citizenship bites me. If I buy EU ETFs, I'll have to report them as Passive Foreign Investment Companies (PFIC) in my yearly US tax return. It's unfair and ridiculous, but it's the current legal reality, so I can't go that route.

Why now? I've been happily buying individual stocks for years now, but increasingly, I feel like I'm out of my depth. I've saved enough money in these stocks that the risk is starting to feel real. I've also learned a lot about investing, and what I'm learning is that the experts are experts, and even they have a hard time doing this.

Therefore, I would like to begin indexing in some form, but all my outlets in Europe are ruled out.

I could use the Robinhood account for this purpose, but I'm concerned about Robinhood's viability as a company. They also just raised their fee for an ACATS transfer. Robinhood also doesn't offer things like automatic rebalancing. Really, the whole app is very casino-ish.

I'd also like to cut down on the chain of transfers I have to do. If I want to buy ETFs in Robinhood, I'd have to: get paid, transfer the money to Interactive Brokers, convert from euros to dollars, withdraw that money to my bank, transfer that money to Robinhood. Each step can add days of waiting, and since my US bank offers a brokerage, I hope that I could open an account with them just to simplify.

Naturally, though, my application was not instantly approved. For some reason it triggered their extra diligence check. I'm worried that their research into me will not only result in being denied the brokerage but also result in my bank account being closed, which would be bad. Not quite disastrous but definitely bad.

Citizenship Worry

And so I'm once again staring into that bottomless well of worry about my continued relationship to the United States. These rules are unjust and unfair, and citizens living abroad should not have to put up with this. We are punished for living abroad. Congress could fix this at any time: enact Residence Based Taxation (RBT), create a PFIC exception for people living outside of the United States, create a FATCA exception for citizens living outside the United States. But they choose not to out of either inertia or ill will.

What's all the more frustrating about this is that I'm forced to lie. In filling out applications for banks, credit cards, and now this brokerage, I have to use an address where I don't truly live. I also can't name my actual employer, since this employer doesn't exist in the US. So I lie. But what's the alternative?

The United States compels its citizens to use its financial system no matter where those citizens reside, but they don't provide guarantees that the companies there will allow us. We must have a financial relationship with the United States, but when we do exactly that, we're breaking the terms of service or lying on our applications, and from then on, we're worried that we'll be found out and shut down.

In any case, I'll add an update here with the result. Hopefully, my worries are unfounded, and I'll have the new account in a week.

Update April 2022: Net Worth, Rough Month, Indexing, Covid

Rough Month. Ouch.

Our net worth declined by 11.42% in USD and 6.48% in EUR to $110,276 and €104,329 respectively. The euro loss was offset by the appreciation of the dollar relative to the euro. At the same time, our euro debt was reduced in value relative to the dollar.

This was our worst month financially since March 2020.

Stock Decline: Sleep Test and Indexing

Obviously, the main driver was the stock market declines. I wish I could say I bathed in glory and withstood the desire to sell anything. I wish I could say I wasn't scared. I wish I could say that the online chatter didn't influence my decisions.

I sold some stuff. I was scared. I let myself be influenced by noise.

That said, I tinkered rather than dismantled. I knew that at any moment, the whole thing could turn around, so it was unwise to go to cash 100%. So if my tinkerings were mistakes (as they almost certainly were), they will be small mistakes rather than absolute disasters.

One thing that's become abundantly clear though is that my overall portfolio is not passing the "sleep test". I am often worried about it. It is often gnawing at me, prompting me to take action in one way or another.

It's stupid. I'm saving money in order to improve my life, but if I'm stressing over it, then what's the point?

So I'm going to start indexing most of my new money. I'll start with about $7,000 and put most new money into that on a monthly basis. I intend to write more about this decision, but long story short is: I need a pool of money where I don't worry about individual securities. Right now, I have to worry about each individual name in my portfolio. Might this company perform poorly? Have I overweighted this company? Maybe this is a secular decline, and I'm missing it?

I hate all this. This worry is a negative in my life, and so far my stock picking ability has not shown itself to be superior, so it's an emotional negative for not much gain.

Covid Caught

As a backdrop to all this, I've caught the coronavirus. Last Friday, as the worst day of selling was ravaging my portfolio, I was sitting home alone having called in sick to work. I had the sinking suspicion that I'd caught it, but since I'm both vaccinated and boosted, all my self tests came back negative.

Only on Sunday did the test faintly show positive. Now I know why they say the self tests take fifteen minutes: the control line appears quickly, but it takes much longer for the T line to show up. If you just wait for the C line, you might miss the eventual faint T line, which tells you that you're positive.

My employer requested that I get a "Bürgertest" (a free fast test administered by an official testing center) and, if positive, a PCR test. Both came back positive, and so I'm at home at least until next Monday.

Financially, this is a set back. I was set to do some extra work for my employer that would have paid me a fair amount of money. Someone else will do that now. On the upside, at least I can't go out and spend money, but that's little comfort.

Ironically, I caught it at work, where a mini super-spreader event occurred. Restrictions have been lightened in the past few weeks, and we had a week and a half of vacation. Simultaneously, our thrice-weekly testing regimen was changed from PCR tests to antigen tests. Someone must have had a false negative and come to work, where they infected me and around 20 other colleagues. Go team.

Health-wise, this thing was awful. Saturday and Sunday were especially unpleasant with coughing, sneezing, runny nose, body aches and pains, a high fever, and an overall sense of fatigue and foreboding. It's gotten progressively better since Monday, but my voice is still froggy, and I'm still congested. If this is what it feels like with the vaccine, then what the hell does it feel like without it?

So far, my wife hasn't caught it, but unfortunately, it may be just a matter of time.

Final Thoughts

I don't know how to guess about May. But during May I'll be thinking about how to pass the sleep test. What actually worries me during drawdowns? What is so scary?

I'll also try and come up with an asset allocation plan that's simple and effective for my new indexing allocation.

Until next time, stay healthy, and remember that relationships are wealth.

March 2022: Net Worth, Q1 End Portfolio, Stock-Picking?

This is late.

In March, our net worth rose by 2.83% and 3.38% to $124,495 and €111,555 respectively.

Long story short: the stock market rallied in March, and my positions were brought along for the ride. I also sold off some of the camera stuff that I mentioned in February, which brought in some cash.

Here's my portfolio at the end of March:

A few notes:

• Berkshire Hathaway has grown into the largest position in the portfolio, overtaking my tax advantaged IRAs. Berkshire has done very well this year, and it's helped bolster the portfolio against some of the volatility.
• My tax advantaged accounts are still in a money market fund since the Vanguard Total World Stock Index is still below its 10 week moving average.
• A lot of positions are in significant drawdowns from their previous highs.

Do I Want to Keep Picking Stocks?

With all that, I'm considering whether I want to keep picking stocks. I devote a lot of time to this practice, and the results I get are - thus far at least - fine. Not disastrous. Not brilliant. I've basically performed as well as VT has over the past few years, while also spending a lot more time on the project.

At the same time, I have other activities I'd much rather be doing. I have a side hustle I'd like to build up. I'd like to spend more time developing my "hopes and dreams" career. When I listen to podcasts, they're usually investing podcasts. When I do research, it's often stock research. What if I could get rid of those activities and just focus on the stuff that truly brings me joy?

But then I remember I'm an expat and I'd be signing up for tax and reporting hassles. Doesn't mean I won't change this up at some point, but a decision that I could just choose were I living in the US is much more complicated.

This is the dilemma faced by American expats in Europe. I kind of want to get off this train, but the alternative is misrepresenting my actual address to a US brokerage and putting a lot of my assets in it in order to have access to US ETFs. I'm not comfortable with that, but I'm getting tired of waking up and thinking about or worrying about stocks and stock prices and trying to determine where I should put my money every month. I could just buy a few ETFs and be done with it, but then I'd be creating my own tax data and all that crap.

This is stupid. This is all so stupid, and these governments can't be bothered to actually fix the problem for us.

April Outlook

Well, April is almost over, so I have a good idea what's up.

My stocks have performed badly, but basically in line with the overall market.

We've spent some money on travel. We likely won't save much because of it. There's a family medical emergency in the US my wife is attending to, and that kind of stuff supersedes stock investments.

I've made a little money on the side, but I've also spent a good amount, so it's kind of a wash. On the whole, this camera switch has been expensive.

I also went to France for a weekend on someone else's dime. But it felt dishonorable to rely on their money the whole time, so I paid for some of it myself.

Until next time. Stay healthy, save what you can, and remember that your relationships are wealth.