I’ve been giving a lot of thought as to where I want our long-term portfolio allocation to be. There are a few changes that we need to make to get there.
It’s really hard to visualize what a good long-term portfolio would be. And when I say long time I mean something that would make sense when I’m 60 years old and well and truly in retirement mode. If you asked me the broad buckets that I think would make sense I would say definitely equities, real estate and a small holding of bonds and cash. As I think about how to weight these elements it would probably be something like 50% equities 30% real estate and 20% bonds and cash.
As far as equities exposure, I’d like to see 75% of the equity exposure come from developed economies (including the US) and 25% from emerging markets. I’d also like to see 50% of our equities exposure come from direct investments with the remaining 50% coming from exposure to index funds
Where are we right now ?
At the moment our asset allocation is extremely equity centric. While we are at our target weight in times of real estate exposure, our equity holdings probably make up 70% of our net worth with minimal exposure to bonds and cash.
I’m okay with this waiting as it stands right now. Cash has been a poor source of returns given the low interest-rate environment for much of the last decade. Bonds also haven’t been terribly exciting in terms of returns, however I think that’s going to progressively change over time with the normalization of interest-rates.
I also think that it will become more important to have a greater source of lower risk cash and bonds on hand as we move out of an asset accumulation phase and into drawing down assets. Building up sources of cash and selectively moving into bonds is something that I’ve got targeted as a goal to accomplish slowly and steadily over the next decade,
As far as the real estate exposure is concerned, we have direct real estate exposure to a specific rental property in the US. I’m thinking that a far wiser approach would be to invest in a global property fund that provides exposure to both commercial and residential property rather than taking asset specific risk on a specific rental unit in a specific market.
We do like a rental though it provides a nice rental yield for our purchase price however I think a more reasonable strategy would be to have a more diversified exposure to the asset class.
Finally I think there’s a lot more work to be done as far as our equity exposure goes. At this point in time we still carry too much exposure to Australian specific equities and not nearly enough exposure to emerging markets. I’d also say that almost 70% of our equity exposure is directly held stock, versus index fund based. The index fund portion of our holding will progressively increase over time with additional investment into the S&P 500 via a 401(k)’s. I’m at a bit of a loss as to what to do with my Australian investments though.
My plan is to just keep them as they are for the most part, perhaps selectively trim a few non-core positions. I expect that the Australian portion of my portfolio gets progressively shrunk over time as a portion of our total assets given that I’m not actively adding to that part of our portfolio anymore. I really do like the nice healthy dividends that Australian companies tend to pay year after year. They’ve been responsible for the dividend wealth that we enjoy today.
The emerging markets exposure is a big piece of the puzzle that we currently haven’t really developed a plan around. I’ve identified a Vanguard emerging markets ETF that I’m keen to slowly and steadily build up quarter after quarter, year after year to achieve our target emerging markets exposure.
What’s the rationale?
So why change something that’s not broken?. Well as I think ahead to a time when I won’t be actively working, I think I’ll just generally need to have more cash from a security perspective if nothing else. While the dividends would provide a regular source of cash flow I just would like to have a bigger stash for emergency purposes. You don’t know necessarily what your health will be like and what contingencies you may have to meet in the absence of having a regular job. So some increased cash holdings are probably necessary and prudent at that point in time
As far as moving from individual stocks to a greater index fund allocation, I realize that there could easily be a situation where you just get to wedded to your individual stocks and you become blindsided to changes and disruption that could be occurring in the markets that your companies are operating in.
As I get older and older I’m not sure if I’ll necessarily have the willingness and the ability and the interest to spend hours researching stocks and staying abreast of the changes that are impacting them in the markets that they operate.
While index funds certainly have disadvantages, the advantages are that they provide low-cost expenses and that they are market weighted. What this means is that the index fund responds to negative changes that affect a given company by simply weighting it lower, or even replacing it entirely from the index. That removes the risk of a Kinder Morgan or a Kodak or an Enron blowing up your portfolio returns.
And why emerging markets? Well anyone who’s been following the emerging markets space for a while would know that it’s been a bloodbath in terms of returns the stocks. These stocks are volatile and they haven’t had great returns for investors up until this point.
But it’s partly the fact that returns have been so poor that is almost reason enough to start building up an emerging markets portfolio. If one looks at macro trends in the global economy, there is an increasing share of GDP output that is going to come from those economies.
I also expect that in emerging market currencies to appreciate against the US dollar given greater share of GDP output from those countries as well. Longer-term, what should result are stronger returns on a US dollar adjusted basis from emerging markets.
I want to position myself with the ability to benefit from that growth through regular investments in a low-cost emerging markets Index which will give me exposure to the larger, more stable emerging-market names companies like China Mobile or TenCent for example, which are real businesses making real money.
I’m not as interested in getting diversified international exposure to my portfolio outside of emerging markets. There a couple of reasons for this.
The first of these reasons is that if one looks at the top names in the S&P 500, most of these names such as Google, Apple, Coca-Cola Procter & Gamble and Pepsi have the majority of their revenues actually coming from international markets today. In particular, that exposure is often heavily weighted to developed emerging market economies such as Europe and Japan.
I’ve got little interest in doubling down my exposures to Europe or Japan given Europe has a variety of labor force reform issues that need to be resolved before sustained growth will occur, while Japan seems to have been in a state of economic stagnation for the better part of two decades. I’m content with my indirect exposure to those two regions to my S&P 500 investment.