Optimal Asset Allocation

Like many of you here, you’re probably taking advantage of the excellent portfolio tools available for free at Personal Capital. If you haven’t, I recommend you check it out. It is kind of like Mint but with more of a focus on investments.

Once you get more than $100,000 in assets listed under your Personal Capital account, you’ll be contacted by them to see if you want them to do a free portfolio assessment. In the same vein that Betterment, Wealthfront, and Schwab Intelligent Portfolio offer automated investment services, Personal Capital does something similar. The main difference with them is that a human looks over the accounts.

While I really enjoy managing my investments myself and would hate to give up that control, with my new job ahead, I thought it might be kind of fun to see how my allocation compared to the recommended one under the Modern Portfolio Theory, which I’ll talk about below.

So, one day when I was off work in the morning I scheduled the free one-on-one consultation. It actually took place over two days. The first day a very personable financial advisor in Denver, I think, called me and discussed my current investments, income, money needed at retirement, risk tolerance, etc. He had actually worked with Schwab prior to being hired by Personal Capital. He then took a couple days to put together a presentation that I was able to watch online while on the phone with him.

I’ve saved a few of the pertinent slides from his presentation. While the consultation was actually free, their ultimate goal is to have you move some money to them that they can manage and charge a (reasonable) fee. I’m not considering paying someone to manage my accounts at the moment, but it is not because of the fee. I just truly enjoy figuring this stuff out on my own. The excellent tools at Schwab, Personal Capital, and others make it quite easy now.

But first, what is Modern Portfolio Theory? Essentially Modern Portfolio Theory (MPT) is a concept constructed by Nobel Prize-winning economist Harry Markowitz in 1952. Markowitz’s work formed the foundation which eventually evolved in today’s MPT asset allocation model. Simply put, the theory is about maximizing return while minimizing risk. “Diversification can deliver benefits over time at no additional cost.” An example of this (from the Schwab article detailed below):

  • $100 invested in the S&P 500 at the beginning of 1971 would have grown to $8,523 by the end of 2014.
  • $100 invested in gold (as measured by the London Gold PM Fixing) would have grown to $3,226 over the same time period.
  • $100 had been invested in a 50-50 split of both investments, the portfolio would have grown to $9,184 over the same span. This return is 7% more than the stock portfolio alone and more than doubles the return of the gold portfolio, while demonstrating lower average risk.

Past performance does not obviously indicate what will happen in the future. But, isn’t it amazing how diversifying into an asset class such as gold during such a huge bull market period can actually bolster overall results?

For more detailed information on Modern Portfolio Theory, see these articles:
Schwab Intelligent Portfolios™ Asset Allocation White Paper
Chapter 1 – Introduction to Modern Portfolio Theory

What did Personal Capital recommend?

One of my parameters was that I was very risk tolerant. I have a steady job and don’t need retirement money for nearly 30 years. Should there be a market collapse again I’d be more apt to buy more of all the cheap equities than to get caught up in worrying about unrealized capital loss.

Here’s what they suggested:
major class allocation

sub-asset class allocation

And here’s where I am now:

current vs ideal

According to Personal Capital’s suggestions, I am currently overweight in US equities (83% vs ideally 60%), underweight in international equities (7% vs ideally 26%), slightly underweight in bonds (0% vs ideally 2%), and underweight in alternatives (2% vs 11%).

I definitely do want to diverse into international equities. Personal Capital only counted “international” as the companies that are headquartered overseas. BP, Nestle, BHP Biliton, Unilever, etc. They didn’t count the fact that most of the companies I own are international in the sense that a lot, if not the majority, of their business takes place outside the US despite being headquartered here.

However, I still do want to diversify directly into international markets. I already have a lot of large cap companies so ideally I’d want to pick up smaller growth companies. Unfortunately, as hard as these are to pick successfully in the US, I’d imagine it would be even trickier trying to find good small companies internationally. To that end, I will likely invest a portion of my portfolio in ETFs that specialize in small cap international companies. I’ll likely use Schwab’s ETFs for that purpose and may even pick one of the their fundamental index ETFs.

Another way I’m targeting the international market is via direct investment into foreign exchanges. I recently opened a Schwab Global Investing account so that I can have a little of my net worth held in foreign currencies and/or traded on international markets. My first purchase in the resource sector was on the Toronto Stock Exchange in Canada. I’ll soon have a few posts about these purchases as well as my opinion on Schwab Global Investing (hint: some good things, a lot that could use improvement).

As far as the Alternative sector, Personal Capital considers that to include real estate, gold, energy, food, and metals. Currently the only “real estate” I own is through a couple REITs, Realty Income and Ventas. I currently only hold those in my Roth IRA since their distributions are not taxed as qualified dividends. However, according to my advisor at Personal Capital it may actually make sense to invest in REITs in my taxable brokerage account as well.

As far as other alternatives go, I’m not so sure. Rather than being invested in physical gold or silver, I’d rather be invested in the companies that mine these commodities. But, maybe investing a little in gold via an ETF might not be a bad idea. It seemed to work well in the Modern Portfolio Theory portfolio that I discussed above.

Another alternative is Bitcoin. For fun I did create a bitcoin wallet and added a few buck just to see how it works. It really is a remarkable currency. The technology behind it is amazing. I also had nearly a two hour discussion with Johnny on the phone last night. We didn’t talk about Bitcoin the entire time but for much of it we did. I might just for fun buy a couple bitcoins and hold on to them to see what happens. I remember reading about bitcoin on Slashdot a number of years ago when I could have mined a few bitcoins a day with ease. I could be retired already if past me had actually done that!

I am really looking forward to Johnny’s next blog post in his bitcoin series. I can see the underlying blockchain technology being used as the underpinning for settling USD transactions. Currently there’s a three-day hold before funds are settled…blockchain technology could make the settlement nearly instantaneous!

Back to the discussion about diversification…

I’m not a super big believer in bonds and think that equities are the way to go, especially for someone my age. However, Personal Capital didn’t quite have all the information about my investments. In April 2015 I opened a small account at Lending Club. I contributed $2,000 in total and have since been logging on occasionally to purchase new notes with the interest and capital repayments that I’ve been receiving. I try to have as little cash sitting in my account as possible since that doesn’t earn any interest.

Unlike traditional bonds, Lending Club notes can be purchased in as small increments as $25 per note. In fact, small notes are recommended as this allows one to diversify the risk and leave as little un-working cash as possible.

I keep track of my Lending Club interest in the monthly income updates but haven’t yet dedicated a post to how my Lending Club account is performing. That will be coming in another blog update.

I’m excited that I will be receiving my first paycheck as an attending radiologist at the end of August. Much of that paycheck will have to go to rent and a rather large credit card bill (I purchased some new tables and furniture for my apartment), anything leftover will be going to stocks. I’m looking forward to finally making some purchases and getting that dividend income increasing once again!

Thanks for reading this long post. I’ll be getting back to my usual more regular blog updates. Hopefully Johnny will be joining me too!

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