We have been investing for two years today!* Shortbread’s love of portmanteaus necessitated creating a word.
Recently I’ve been thinking about timelines and long term planning. It’s not something I’ve ever been particularly good at (Shortbread handles this part of our relationship!), but having the new addition to our little family on the way makes it hard not to think about where we want to be in 5 years, 10 year etc. It doesn’t help that we are running out of patience with our current adopted home in Asia and we’re looking at alternatives. Not sure if we want to leave the continent yet though.
In any case, celebrating an anniversary allows me to start really developing a sense of time scale. Two years ago I was obsessionally immersed in personal finance books and blogs, trying to work out a strategy for our money. I opened our brokerage account, deposited about $1000USD and, with Shortbread next to me, bought 14 shares of VUSD at $67.66. I then spent a large amount of the next few hours watching the value fluctuate while, frankly, a bit terrified.
Two years later and we’ve moved apartments twice, and invested more than we ever thought was possible. We’ve carefully considered what is most important to us and weathered a global pandemic. Looking back on what we mark as our achievements it feels like we would never have believed it was possible if we had shown our past selves our current situation. It helps to reflect on this. We didn’t do any single major thing in this time, but instead an aggregation of long term decisions led us to where we are now.
This realisation is making it easier for me to imagine the future and consider what I might actually want from it. It doesn’t seem so impossible as the huge mountains between where we are and where we want to be become are, upon closer examination, a series of manageable steps. The Millionaire Next Door book made it absolutely clear that the most common method of achieving wealth was not inheritance or incredible financial foresight about a particular asset or stock. Instead, the aggregation of small, well considered life choices over a long period of time was most important.
This is a slightly rambling post, but I think what I’m trying to say is that by acknowledging the decisions which led to current success it is easier to imagine and anticipate future success. The FIRE thing is starting to feel real (current market downturn be damned!) and I’m genuinely excited about where this might take us.
*Okay, not completely true. We put money into a high fee mutual fund for a while before we moved to a self managed, low-cost index fund approach. I’m sure we’ll discuss this in a future post about mistakes we’ve made along the way.
The 3 Types of Savings
The terms savings is used quite generally. Putting money into savings can mean different things to different people. Even having to “dip into savings” could carry wildly different implications. Are you spending money in a cash reserve? This is, potentially, absolutely fine and a world away from having to sell off things like investments. A cash reserve is a short to medium term sum of money, investments are for the long term. I think savings should be thought about in three ways: Investments, Piggy banks and funds.
Investments
These are your long term, retirement or F-U money savings. This involves buying assets that will grow and/or generate income in the long term, either in the stock market or in real estate. You won’t be withdrawing from these unless you have literally no other choices! The rest of the blog is more or less about investing, so no need to give it more space here other than to say this should be the first priority when money comes in.
Piggy Banks
Crucially, these have a set end date and end sum of money. Once you know these two pieces of information, you can then work out how many pay periods there are between the current date and the end date. This will give you how much you need to contribute each pay period. If this is too much for your monthly budget to bear (e.g. it impacts on your investments or ability to survive on anything more satisfying than ramen packs), you need to either increase the end date or decrease the price.
A deposit for a house would be an appropriate piggy bank, although smaller items are fine too. My new iPhone, for example, took about 8 months of saving for. It’s possible to hack piggy banks a little for gains by locking money away in a money market account. These usually pay pretty low interest, but the money is secure and you know you won’t need it for the period it is locked away. You’ll get only a little back on the cash you are saving, but it’s better than nothing. If you’re saving for a home deposit over 3 years, once you have the first years contributions you could put them into this style of account, then Year 2. By the end of Year 3 you would have your deposit saved and a little extra from the interest.
Any money that will be needed in five years or less should be put in a piggy bank instead of investments to avoid the fluctuations of the market. Low interest rates are better than the a sudden market decline sapping your money just as you need it!
A piggy bank lasts only as long as the date that is initially set for it. The money is spent entirely on the thing that is saved for. It is not raided (it doesn’t need to be if you have a cash reserve). The nice thing about this approach is there is always a sense of having worked and earned what is being spent on. Piggy banks are absolutely intentional as they are medium to long term goals. Buyers remorse is less likely – you set this path and the money was earmarked for the purpose set out when the piggy bank was created. They are second in line for what you do with money received through wages, just behind investments.
Funds
These have no set end date and can we withdrawn upon as soon as they get to an acceptable level. They are then topped up as money comes in and should be considered short term savings.
For example, we dislike cleaning our apartment (who does?!) and domestic help is generally quite cheap and available here in Asia. However, we do not want this as a regular daily or weekly expense. Every so often it would be nice if the apartment was given some deep cleaning…by someone else. The point is, paying someone seems trivial to justify if small sums are set aside each month for it. If it takes four months or two months makes little difference. We’ll use the money if we have it, we won’t if we don’t. Perhaps you like to go out to an expensive restaurant every so often or splurge in some other way. A fund means you can choose whether to wait a month or spend it all now. It doesn’t matter either way as it shouldn’t affect any other part of your finances.
You can also look at the overall amount you are left with after investments, repayments (if you have any) and piggy banks as a fund. It’s a living expenses fund. It fluctuates every time you spend and it gets topped up when you get paid. Similarly, a cash reserve (or emergency fund) should be looked at in a similar way. The only real difference is that a cash reserve would normally be calculated as a certain amount of expenses (classically somewhere between 3-12 months).
TLDR: When money comes into your account, move it into investments, piggy banks and your funds (in that order!).
Single income family planning…time for some buckets!
Transitioning to a single income household for 18 months is an interesting challenge for Shortbread and I. Aside from having to tolerate her making jokes about becoming a trad-wife (without all the right-wing stuff), we have to have a look at the process by which we earn and spend. We will be losing a huge chunk of income for a while, but we still want to be investing and intentional in how we live.
Previously we covered expenses with our salaries, as considered in our post on financial firewalls of defence. This has always generally worked out fine, with the extremely occasional big expense being taken out of money we put aside for tax and then topped up later. The power of our income is going to be significantly depleted with one earner instead of two, so a bucket strategy is going to have to be adopted.
For those who are particularly financially savvy, this might seem absolutely obvious. However, for us, it’s not something we’ve really done before. We ran down our monthly pay living in the U.K getting to save very little. We also experienced such crazy lifestyle acceleration when we moved to Asia that we tended to save money from our incomes even when we were not trying to be thrifty. I think a lot of our peers are in a similar situation.
The Plan
So the plan is to expand our emergency fund and refer to it instead as a cash reserve. We know that some would critique this as silly and that it doesn’t actually change anything. I think it might. An emergency fund is for…emergencies. What is an emergency though? One of the problems in transitioning to an intentional life is that you can start to over-analyse everything. We are proud of how we exercise discipline in our spending, but we may have gone too far in the other direction! The word emergency is so dramatic! A cash reserve is for use and immediate topping up. An emergency fund is when the world is ending.
The fund is going to be about 10 months of living expenses. This number was arrived at by the very unscientific method of calculating Shortbread’s maternity pay and adding it to the three month fund we keep in our local bank accounts already, as well as the money we keep back home in the U.K.
We have a few large expenses coming up next year (the first trip home and a tax bill – those bemoaning the U.K’s PAYE should count themselves lucky!) and the reserve will be tapped into a little. If it reduces down to six months, that’s fine. We will slowly top it up from month to month if it depletes. I’m also likely to get a bonus next year which would offset all of those costs too.
So that’s the plan. Try to meet all financial challenges with income first, then our cash reserve bucket. We can fill the bucket with income and future bonuses over time if it gets depleted. Not very exciting given that this is largely well trodden financial advice, but its somewhat new to us!
Q3 update – “We have barred the gates, but cannot hold them for long”
“The ground shakes… Drums. Drums in the deep.”
A little melodramatic, but this is what the last month or two have felt like for our net worth. The market has continued to kick our arses and we now have to contend with the value of Pound Sterling (which is what our property is valued in) falling against the US dollar… which is what we measure our net worth in.
Obviously, we have been enjoying The Rings of Power TV series recently!
Back in Q2
Net worth: $719,501 / Portfolio: $213,504
We have contributed $38,881.50 to our portfolio. Shortbread got her bonus at the tail end of Q2, but we didn’t include it in our last net worth update as it hadn’t hit her bank account by the time we posted. While we’re pretty happy with how much we have managed to invest (while simultaneously paying for some extremely expensive prenatal care and budgeting for the birth of our new son!), the markets have continued their brutal slide.
We’re still chipper about it, but it’s testing us a little all the same. The numbers now look like this:
- Net worth: $715,665 (-$3,836)
- House: $419,239 (-$35,461)
- Retirement Accounts: $37,323 ($25)
- Portfolio: $245,244 ($31,740)
- Cash: $13,859 ($-105)
Wins this quarter:
We’re not panicking too much. Our property in the U.K hasn’t actually lost $35,461 of value, it’s pound sterling which is currently taking an absolute pounding. In some ways we feel a little vindicated in our choice to hedge against the $USD for our portfolio rather than trust the lunatics we left the U.K to get away from. We’ll see how all this plays out. We have also been really happy with the plan we have followed over the past few months. We have stuck to our budget and earmarked money for things like pregnancy care. We could never have done anything like this just a few years ago without significant stress and having to stretch ourselves dangerously thin.
We have also snagged some free and cheap baby things from friends and colleagues, which will be saving us a significant amount of money! We have a new cot and baby carrier for almost nothing and a very large bundle of clothes. We’re very grateful to the people who have given them to us.
I’ve also picked up a new iPhone after saving for the last 9 months. This is the first time I’ve had to save for something like this in many years. In typical expat fashion I would just buy the thing I wanted in the past and invest a little less for that month. It’s a minor thing, but sticking with it has made me feel a sense of accomplishment.
Goals going forward:
- Pay for flights back home for summer 2023
This is something that all expats have to deal with eventually. We haven’t been home since 2019, so it will have been four years by the time we visit. We will also have a six-month-old with us. We’ve decided we want to fly business class. I hate flying and the extra cost doesn’t bother me given our situation. We have the money put aside, we just need to buy the tickets.
- Continue to increase our cash allocation
Paying for the aforementioned flights has put a significant dent in our cash reserves we built over the past quarter. We have earmarked Shortbread’s maternity pay for this as well, but we would feel safer with a decent cushion behind us even though we have already budgeted and funded all pregnancy related costs. It doesn’t help that we have kept the majority of our emergency fund in pound sterling…which has plummeted. We will keep the rest of the fund in our local currency going forward. Hopefully we can take advantage of the interest paid by our brokerage on cash balances.
- Being parents
The next quarterly update might see us with a new arrival into our family. If it’s not exactly next quarter, it will be at the very beginning of Q1 2023. We still haven’t decided on a name…
Bring on Q4!
Emergency funds earning interest? Yes please!
I just noticed that our brokerage, Interactive Brokers, offers interest on cash balances. They have an initial tier of currency you have to hold which pays nothing, but then a low rate is paid on the rest. They also have a minimum Net Asset Value (NAV) to receive the full rate. Essentially, if you have a minimum NAV of $100,000 USD and $10,000 USD of cash uninvested any cash you add on top of that will accrue interest.
It’s not a life changing amount of interest, but it has given me an idea regarding our emergency fund. The interest rate for us would be just over 1.4%. This isn’t going to be retire early money, but given that the S&P500 funds we invest in only spit off about 2% of dividends each year, it’s not money to be ignored!
Additionally, it does not come with the withdrawal penalties that something like a money market account might have where you lock money away for 1-24 months. Interest rates on those are ever so slightly higher, but surely if you locking your money away is the opposite of what you want for an emergency fund??
The other upside to Interactive Brokers is the outrageously cheap ForEx fees. This is good for us expat types as we have all our international bank accounts linked to it. The brokerage can be used to convert and move cash to where we need it. We used to split our (admittedly tiny) emergency fund between the U.K and here in Asia. The ease of using the brokerage as a middle man, as well as the potential for earning far more interest than in our regular bank accounts, has meant moving the money to the brokerage is an attractive proposition.
The potential downside
The specific downside for Interactive Brokers is pretty minor – only a single withdrawal is free each month. I guess this just means don’t have two emergencies in a month?? We don’t anticipate or see any reason why this would be a problem for us personally. Even if we did withdraw more than once, the cost is fairly small – less than the fees our banks would charge to move money internationally.
For some, this whole premise may not be a great idea. Swing traders are unlikely to ignore a large stash of cash just sitting in their investment accounts. The market has been so volatile this year that I expect the temptation to spank a load of the cash on cheap stocks in the event of prices tanking to be high. However, as long as a disciplined approach is taken this should be a way of earning at least a little on cash that is otherwise just being eaten by inflation.
We decided recently to increase our emergency fund (from very little) to about 6-10 months of expenses. This is less for emergencies and more because we are encountering some unexpected baby costs. This includes things like flights home and health insurance while Shortbread is on maternity leave. There is some irony in our being quite stressed when we were calculating these costs and wondering if we had enough cash to cover them – we had just written our financial firewalls post!
We will be going down to one income for a while and, given how I obsess and over-plan everything, having some accessible cash to cover anything outside our tight budget makes us feel a whole lot better. I’m sure we’ll write in the future about the system we will use, but it’s absolutely certain that this would be almost impossible without tracking software. Shout-out to the self-hosted Firefly III – perhaps a review in a future post.
Firewalls of Financial Defence
With a baby on the way we are, for the first time, assessing how safe our lifestyle is. What would happen should we be hit with unexpected bills? What would the plan be if something unexpected comes at us?
10 years ago we didn’t consider this all that much – we had been teachers for just a couple of years and were still living in the U.K. We had little in the way of income (who starts a career in education for the money??) and almost no savings. We did have some potential sources of support through our parents. We also had credit cards, although not all would see debt as a viable defence in the face of sudden adversity! We could could be somewhat flexible in our lifestyle, although our mindset at the time put a lot of emphasis on possessions. Moving abroad really affected that mindset (in a good way!). We certainly could not have taken on extra work; teaching in the U.K takes over your life.
In essence, 10 years ago we had very little defence if something unexpected came our way. I remember our first holiday together exemplified how precarious our position was. We had only booked a few days to Morocco. When we arrived at the guest house we had booked, we were informed that we hadn’t paid for it online yet. We had to stump up about half of the money we had with us to pay for the room. This made us pretty anxious for the next few days – not something you want on holiday! On the final day we went to the airport to find that our plane was not scheduled at the right time. We were a bit confused…until we realised that the flight we had booked was the day before! We had completely missed it. I still remember the deep sense of panic which hit my stomach when I realised it might be difficult to get home. I didn’t have the money for a ticket and I wasn’t sure Shortbread did either. I didn’t actually have a credit card at the time so access to further cash was going to be challenging. I wandered if we could ring Shortbread’s parents to get some cash transferred (I couldn’t ring mine – there was no way they would have it!).
Shortbread had a couple of credit cards and we managed to grab two seats on a Thompson holidays flight back home. I remember their staff being helpful despite us not being on a Thompson holiday. The thing is, we spent the next couple of months seriously broke as a result of that holiday. Obviously a lesson learned for the future, but that feeling of panic is memorable. Ten years later we have worked ourselves into a different position, although I’d be lying if I said it was a direct result of the aforementioned story.
We see our defence as being a bit like firewalls – each form a barrier to protect us from ruin! Writing them out like this has been quite therapeutic given how anxious we have been at times following the news that baby was on the way. Here they are:
Level 1 – Income
We are both employed and live on considerably less than we earn. Thus, our first firewall of protection is our earned income. We have tracked our spending using Firefly iii for a few years now which has allowed us to accurately see how much money we need every month. We didn’t start with a budget based on a vague notion of what we thought we should be spending to live. This has allowed us to be really intentional and realistic with our incomes. Every dollar gets a job! Being in control of our spending has made it far easier to ensure there is slack in our finances.
Level 2 – Cash reserves
Further to our first firewall, we have an emergency fund for anything that our incomes can’t take care of. We have kept this quite low in the past compared to our portfolio (it’s about 5% held in cash). However, we felt that the liquidity of ETFs combined with the fact that markets tend to be up more than they are down meant we could just sell a few shares if needed. We’ve changed our minds a little now with a baby on the way. Cash reserves are hugely important if you have few other firewalls (or just get really anxious). For us it makes sense for a couple of years while we figure out how much babies cost. We will be targeting six months to a years living expenses for now.
Level 3 – Lifestyle flexibility
This is one of the FIRE superpowers. Should this firewall be reached we could slash our budget (well, a bit anyway. We’re already pretty frugal), we could find a cheap apartment, we could leave our current employment or even pick another expat destination. By combining lifestyle flexibility with, potentially, some geographic arbitrage we would be fine. We eat more locally and cheaply than many fellow expats, but we could go even further with this if we wanted to. Food and rent are our biggest outlays each month and it would be absolutely possible to address these if we needed to.
Level 4 – Relatively liquid investment in low cost index fund ETFs
Our portfolio currently includes property for family to live in, but the rest is in Vanguard ETFs. These were chosen not only for the indices they track, but also their liquidity. They are relatively high volume investments, so unlocking value from them is a straightforward and rapid process. If we have reached this firewall something quite drastic has happened in our lives! During the accumulation phase of our financial journey we do not wish to sell anything, especially under duress. This allows compounding returns a chance to grow the value of the investments.
As an aside, dividends should also be considered a small part of this firewall. Currently our dividends collected are modest and quarterly. They are reinvested (although we have a dividend day celebration every quarter), but could potentially be utilised for emergencies if absolutely needed.
Level 5 – Credit, extra work, downsizing
Our lives would have taken a seriously surprising turn if this firewall is reached. Credit is not a great strategy for getting yourself out of a financial emergency lest it become the emergency itself. However, if all else has failed, we have the option as long as we still have an income.
Additionally, there is a big market across Asia for tutors so picking up extra work would be a possibility. Failing that, it’s time to sell some posessions. Frankly this would actually make our lives easier as the next step is having to leave Asia and hightail it back to the motherland for Level 6 anyway…
Level 6 – Parents and support network, Benefits in the UK, Skills
The final backstop before homelessness, rack and ruin. We are fortunate that we could stay with Shortbread’s parents if we suddenly had to leave Asia. For all its faults, the U.K still offers some benefits (or welfare to North Americans) to help people in need, plus healthcare is free. If headlines are to be believed, there is a growing teacher shortage too so getting some work is likely.
We’ve been building these firewalls for a decade, so it’s hard to imagine what events could transpire to bring us to Level 6. This would really be a starting over from nothing. Obviously never say never, but it’s a priviledge to be in a position where this has become unlikely.
Other firewalls
Our firewalls will change as we continue our journey, and they certainly will when we move from the accumulation to the withdrawal phase. There are other firewalls we could look towards; rental income is a popular source for many FIRE devotees. We could potentially diversify away from our stock portfolio in the future to add this. Additionally, expats should be more than comfortable with geographic arbitrage. Some people choose to start businesses – it’s not something we’re particularly interested in, but successful enterprises can act as a firewall too.
Writing up our firewall defences makes us a feel a bit more secure. In some ways it can act as a plan against the unexpected difficulties life can throw up. It’s something we’re likely to come back to in the future.
What are your firewalls of financial defence?
Summer break
Obviously one of the upsides of being a teacher is summer break. The site needed to be upgraded via a migration, so hopefully all that has now been ironed out and set for a few more years! Having the time to migrate your website is nice (even if the actual migration was a bit irritating). We’re mainly trying to escape the heat by going swimming and booking the local badminton court. Neither of us had ever really played badminton before, but we’ve found we quite enjoy it. It’s super cheap too!
The markets have been rising the last week or so – could this be the beginning of the climb back to new highs? Perhaps. It’s interesting keeping an eye on the financial news sites – Marketwatch is a great example. The headlines are so clearly geared to generate emotional responses. Having a week of bearish doom and gloom followed by lead stories that say the absolute opposite show just how important it is to not be distracted and stay the course. All the froth about inflation in the U.S.A. has been interesting to watch in the news (along with the U.K. with regards to energy bills), but we have been quite fortunate to not really be so affected where we are in Asia.
We’ve been pretty hardcore settled on utilising stocks to fund our FIRE ambitions, but we recently considered how we might diversify into housing in a few years time. Running a few numbers and considering leverage as a way of generating returns was interesting. It’s not something we are going to rush into any time soon. I’m sure I’ll write a post about it at some point in the future.
I hope everyone is staying cool and enjoying the summer!
So How Do You Actually Do This Investing Thing? Part II – Asset allocation
It was written a while ago, but Part I of our “So how do you actually do this investing thing?” series can be found here.
Now we have a brokerage, understand that we are buying ETFs and have considered taxes, now is time to think about what we are investing in.
Asset Allocation is the term for what you invest in and how it is allocated within your portfolio. Some people get so caught up in asset allocation trying to put together the most efficient portfolio possible. I understand why people are driven to try and get the best returns, but I think it’s best when starting out to keep things simple. To be honest, I think it’s probably best to keep things simple all the time! Remember, the more you play around, the more you are likely to fall into the various biases which can affect you. You are also likely to end up racking up more fees than you need to.
Stocks vs Bonds?
This is the first decision you must make. Stocks (or equities) are the heavy lifters in a portfolio. These are the bad boys you want to grow and make you money from your money. Bonds are for defence when things get rough. The Bogleheads have a few ideas on different portfolios – I love the idea of a lazy portfolio! There are many ideas about the percentage of your portfolio you should keep in stocks. This is all about personal tolerance to volatility. Personally, I recommend a 70/30 equity to bond split as a minimum. 80/20 is where we started, and we’ve moved to 90/10.
Some would consider this quite aggressive, but I feel that the main risk you are battling here is volatility. This isn’t a financial risk, it’s emotional, in that the market is not going to plummet to zero and wipe you out! If you understand that the market rises over time, a higher balance of equities is only risky in the emotional sense. As long as you can stay the course when your portfolio takes a battering (and it will from time to time!), an aggressive allocation is ok. This is where personal finance becomes personal – you must decide what will help you sleep at night!
Equities
You also need to decide which indices you will use to guide your portfolio. Some of my friends and colleagues just choose a global ETF. This is a pretty amazing proposition really – with a single ETF you can invest in thousands of global companies. This is probably about as diversified as you are going to get! However, some may want to bias their portfolio towards a particular region or country. The most obvious nation is the U.S.A. – still the dominant financial nation in the world. Our portfolio is biased towards the U.S.A (bring on the McDonald’s, Coca-Cola, and freedom).
You can do this in two ways – either a total US market ETF or the “classic” S&P500. The latter seems to have given such similar returns to the former that I’m not sure it makes a great deal of difference. The total market is (as the name suggests) all publicly traded companies in the U.S.A., whereas the S&P500 is it’s 500 largest companies.
There is an argument to suggest that the largest American companies are fundamentally international anyway – think Apple, Microsoft, Tesla etc. Thus, holding both a US-centric fund alongside an international fund gives too much overlap. In any case, it largely depends on how much bias you want – most All-World international ETFs are cap-based anyway, meaning that the larger the company, the larger the holding in the fund.
Our portfolio uses an S&P500 ETF as it’s “backbone” and an All-World international stock to supplement it. We also have Asia-Pacific and Developing Markets ETFs, although we regret buying these and have reduced their allocation over time. We value simplicity!
Bonds
Bonds are the defensive portion of a portfolio. Generally, they have an inverse relationship with equities, although this hasn’t been the case this year as inflation kicks the crap out of global economies. Bonds are like you giving out a loan – this can be to a government (or multiple governments), a corporation or other entities. Loaning to governments is generally the safest form of investment you can make. The US government is unlikely to default on its bond repayments as this would be very, very bad (as in, it probably indicates the US economy has collapsed). Corporate bonds can be potentially more lucrative than government bonds, but we can’t help but feel that the added risk (even if it’s low) defeats the purpose of bonds as a defensive element of a portfolio. Look to equities to do the money making when the economy is smoking!
Just like with equities, Bonds are available as indexed funds. Just selecting a US-centric bond is probably simple enough for most people, although international bonds are available too. Personally, we think the U.S.A. is a pretty safe bet for bonds so we just went with that.
REITs & other asset classes
- REITs are a method of investing in property without having to buy and manage property. Most funds have a mix of commercial and residential property holdings. Dividend income is supposedly very lucrative from these funds. We’re interested in putting some money into REITs at some point, although the number available to expats is a bit limited. Additionally, the performance of those we’ve looked at seem quite tied to the stock market. Dividend yields have been comparable to our S&P500 fund, so we haven’t taken the plunge yet as there seems to be a lot of overlap.
- Commodities – Might be a good idea. However, other FIRE bloggers seem to ignore them, and we’re not interested in them. Not recommended.
- Crypto/NFTs – just no. We’ve written about this previously. The fact is the value of cryptocurrencies can fall to zero. For us, this is not a risk worth taking on. If you see Cryptocurrency etc., as being more than just speculation, have at it (but we don’t agree with you).
Biases
You can be biased towards or against a region (like your home country) and this can cloud your judgement. We were initially biased towards Asia-Pacific and Developing Markets and away from the U.K. and Europe. This was, in part, due to things like Brexit. We figured that the Asia-Pacific region would be the place to be investing. Then Covid hit and made us realise we were just trying to predict the market and investing with a certain amount of emotion. Our holdings in our Asia-Pacific and Emerging Markets funds have been down for a quite a while now. We are going to hold on to them and sell them when (hopefully) they rise in value. We won’t replace them with anything – simplicity is the goal!
There is also an argument against market cap weighted asset allocations- small cap funds (e.g., funds consisting of smaller companies) often outperforms large cap. While there is some precedent for this, you have to decide the level of complexity you want in your portfolio. JL Collins says simplicity is best…and he’s probably right! Having lots of different funds provides greater temptation to play with allocations. This is a fast track to giving in to recent performance bias. If you are balancing as you are buying, there will be a temptation to pile more into the best performing assets. Simplicity removes some of this temptation.
2/3/4/5 fund portfolios
So, we have a choice of how complex our portfolio is going to become. The Bogleheads have written amazing documentation on everything financial so it’s worth reading. There are some great portfolio suggestions. I think the Bogleheads are a bit conservative sometimes; Jack Bogle himself suggested having your age in bonds, which is going to make FIRE increasingly difficult if you’re starting in your mid-thirties to forties and beyond! If you have less time to grow your portfolio, an aggressive asset allocation probably makes more sense (as long as you accept that volatility is normal).
Simplest
- All-World International equity fund
- All-World Bond Fund
The simplest stock & bond portfolio. You only need to decide what allocation you want (as previously mentioned, we recommend an 80/20 equities to bonds allocation.) This will probably be fine.
Simple
- S&P500 equity fund
- All-World International (excluding the USA if possible) fund
- All-World Bond Fund / US Treasury Bond fund
A simple three fund portfolio. You can decide how biased towards the U.S.A. you want to be by swapping out the S&P500 equity fund or the US Treasury bond fund. Bear in mind that the U.S.A. is still the economic powerhouse of the global economy, like it or not.
You could turn this into a 4-fund portfolio is you decided to go with both bond funds too. This is what we are moving our portfolio towards.
Some complexity
- S&P500 equity fund
- All-World International (excluding the USA if possible) fund
- All-World Bond Fund / US Treasury Bond fund
- REIT
This is similar to the simple portfolio, but with a REIT. This should probably be no more than about 10% of the portfolio, but it might provide some extra diversification.
Next up…criteria for selecting ETFs. We shall get to that later.
The Bigger The Risk, The Bigger The Reward
Given the cryptocurrency & NFT implosions over the past few months (including various exchanges going bust and locking out customers from their accounts, values crashing, scams etc), I’ve read and heard people using the phrase “the bigger the risk, the bigger the reward” more than usual. I think it’s worth examining it a little as I think it’s used to justify decisions and behaviour that don’t seem grounded in proper financial consideration. Both “the risk” and “the reward” need to be considered as I’m not sure either are accurate ways of looking at the decisions this phrase justifies.
The Risk
Risk is an interesting word in English as it’s not particularly specific. What constitutes a risk is hugely subjective. In finance there are two forms of investment risk – volatility and complete loss. These are two completely different things and represent the differences between sound investments and speculation.
Volatility is largely an emotional risk – it’s very much the personal in personal finance. How calm have you been checking your investment balances this year? Or in 2008? Or in 2001? If you were (or are) invested into broad based index funds, hopefully you were super calm! This is because the day to day of the market is just noise for you. It’s largely meaningless. Volatility is nothing to get excited or worried about; it’s to be expected. You work on the (historically supported) assumption that the markets you have invested in will rise over time. There are many theories as to why this is, but ultimately the risk posed by volatility is not financial, it’s emotional. As long as you can stay the course, risk is largely down to whether you can stomach a spiky graph.
On the other hand, complete loss is a totally different form of risk. It’s not something you need to be concerned about when investing in index funds as a complete loss means that a market economy has ceased to exist – in which case you have far bigger problems to contend with! Complete loss is the form of risk associated with an asset that can lose all its value – individual stocks, cryptocurrency, NFTs, beanie babies etc. This is a huge financial risk when compared with emotionally enduring volatility, to the extent that a prudent investor must recognise the gulf between the two. Accepting the risk of complete loss doesn’t make you a particularly savvy investor, it makes you a speculator.
Volatility is a risk that can be lived with if you have basic financial literacy. Complete loss is not a risk that should be tolerated, particularly if you are as personally interested in the “RE” of “FIRE.” The phrase surely reflects embracing the speculative latter rather than the risk of volatility.
The Reward
Considering your own biases is important in understanding the implicit rewards in “the bigger the risk, the bigger the reward.”
The phrasing plays to your confirmation bias by disproportionately representing the upside of a risk. If we are considering the risk of complete loss, (certainly the bigger risk when compared to the risk of enduring volatility) then the statement should be rephrased as “the bigger the risk, the higher the probability your supposed asset will lose you money.” Doesn’t sound so upbeat now does it? The original phrasing is like a mental shortcut, bypassing the inconvenient truth that the risk of being wiped out is more likely than the reward. This is what an investor wants to avoid, not embrace! It justifies poor financial behaviour by cherry-picking probabilities.
Let’s, for a second, consider a situation where taking a big risk has seemingly paid off. In this case, the risk actually expands beyond loss – If you do go “to the moon” with an asset, but keep these as paper gains, you haven’t been rewarded. You’ve simply expanded your risk. Now you have confirmation bias playing an even larger part in decision making to increase the risk even further. The longer you hold this risky asset, the greater the probability of a market downswing taking you back to the same place you started. You have to combat your own bias – you were not a genius investor, you were a lucky speculator. You need look no further than the recently chastened crypto crowd to see the power of this bias. Unfortunately the risk did not turn to reward.
“But what if you sold the asset at the top of the market!” the speculators counter with. The thing is, the vast majority didn’t sell their cryptocurrency and NFTs several months ago. You can’t time the market! That pesky bias where you wanted to believe that the risk had paid off also feeds your sense that it was your actions, rather than luck, that caused it. Various news outlets have reported that the crypto market’s value has decreased by two thirds. Did everyone sell at the right time? Nope. Many are still holding, convinced that they’re buying a dip. Again, no rewards to be found.
If you bought cryptocurrency prior to a few months ago and felt like a genius based on your paper gains, you have probably now realised that rewards should be based in money, not ego. If your speculative asset went big, but you held on as it nosedived as fast as it grew you haven’t received a reward.
Some people have made money from all of this. They were lucky. Most have lost an awful lot and continue to do so. The idea of big risks giving big rewards so often rests on a fallacious consideration of the particular risk, combined with the bias of fixating on potential rewards despite the probabilities. It’s lying to yourself.
Q2 update – The market is kicking our arses!
We celebrate every quarter by taking a morning to have some brunch and discuss our wins and goals. We figured that sharing our numbers might be motivational if anyone actually stumbles across our blog (the analytics suggest this is not happening…ho hum).
Back in Q1
Net worth: $788,721 / Portfolio: $235,824
What a quarter it has been! We contributed $10,525 to our portfolio, although this is going to go up significantly as a result of Shortbread getting a bonus at work. This will technically still be Q2, but after our Dividend Day celebrations so we’ll just include it in our Q3 update.
That said, we’ve had quite a slide backwards. Our flat has dipped in value and the markets have tanked. We’re not too worried though, this is the long game!
The numbers now look like this:
- Net worth: $719,501 (-$69,220)
- House: $454,700 (-$43,300)
- Retirement Accounts: $37,298 (-$3,599)
- Portfolio: $213,504 (-$22,320)
- Cash: $14,000
Wins this quarter:
Another largest dividend for the quarter – $1,229.75! That’s nearly $2k for the year, which is more than we got throughout 2021 combined and we’re only two quarters done. Obviously all this just gets reinvested at the moment, but it’s a nice mental boost when things are a bit tough. I know some in the FIRE community would scoff at any level of emotional reaction to markets and proclaim dividends as a forced sell-off. However, we live in a jurisdiction where there is no taxation on capital gains or dividends, so the downside is the (very low) fee we pay for reinvesting. We’ll appreciate that dividend income when we move from the accumulation phase.
As a result of tracking our spending for the last year (we use a tool called Firefly III) we have set ourselves a fairly aggressive budget. We live in one of the most expensive cities in the world, but we have found it doesn’t have to be as expensive as we first considered. We have become a lot more conscious of our spending, as well as living somewhere that reflects what we really value (namely cooking and eating great food!). We have had a couple of expenses we didn’t expect, but we still came in under budget.
Goals going forward:
• Increase our cash allocation.
Shortbread is pregnant! This has come at a great time as her bonus will cover private pre- and post-natal healthcare. This is going to cost a lot of money, but we have decided this is something we will value. We have heard that the public system here is fantastic, but somewhat brisk. We are going to pay to avoid it because we can, and we value what going private offers. We have held a relatively small amount of cash over the past few years, largely because of access to a lot of credit and the liquidity of ETFs as investments. We think it might be a good idea to have a bit more cash on hand now though – it’s our first child and we have only a rough idea of what things cost at the moment! 6 months living expenses seems a good idea to aim for.
• Save for a new iPhone
In years gone past we have rarely ever saved for something – we just bought what we wanted and moved a little less money into savings that month. This was never a huge problem as we never really spent much anyway! My iPhone is 5 years old now and the battery is struggling to make it through a day. I used to have a nice little side business fixing iPhones, but the newer models are less friendly to that if I want to keep using features like touch id. I figure I’d just set up a piggy bank in Firefly and put the recommended amount of money in each month until October when the new models come out. Look at this intentionality!
• Summer holiday
Is it the best part of being a teacher? It’s definitely not the worst part.
Here’s to Q3.