Family Financial Review: Portfolio Allocation


Thursday, I shared my thoughts on the real risks I face. That’s where the action happens in my life.

Still, this is a financial review, so it’s the right time to consider asset allocation.

Having spent 30+ years locking in my Core Cost of Living, the main choice I face is how much cash/bonds/no-return assets to hold.

Here’s how I approach that topic.


There is a cost to holding cash, especially today. Zero, or negative, yield.

Cash is exposed to the “ravages of inflation” – on one side.

Cash earns nothing, while you watch bitcoin, prime real estate and other asset classes skyrocket – on the other side.

Against those costs there are benefits. The three biggest (for me) are:

  • a call option to benefit from a future crisis
  • serenity
  • cash/bonds dampen the volatility of my portfolio.

Now, here’s the questions I ask..

1/. How many “years” do I need to feel serene? This will depend on your psychological make-up, earning capacity, earnings diversity and age.

Getting my net-cashflow-burn down is the only way I’ve been able to feel serene. I just don’t have the psychological make-up to soothe myself via luxury spending, more assets or more income.

2/. How many dollars might I need to capitalize on the coming apocalypse? Being able to buy real assets in a down market will make you happy for a long, long time. I’m still happy about a couple purchases I made in 2010.

My financial assets provide me with an opportunity to get out there and live my life. Financial assets provide very little inherent satisfaction – this is a good thing as I can remain (mostly) detached in downturns.

Our actions in the real world provide satisfaction => share experiences (ideally in nature) with people you respect and love.


BTW, here’s a 2019 article I wrote about wealthy people talking about cash. Back in 2019, many wanted to be in cash. Roll forward to 2021, some of the same folks want to be out of cash! Personally, I’m about the same. I spent the intervening period paying off my mortgage and clearing my car loan.

COVID Finances

Local fires make for dramatic sunsets. This was last night at swim drop.

What strikes me most about COVID is how little we’ve been asked to do.

For those of us who avoided unemployment:

  • Stay at home
  • Wear a mask
  • Spend a lot of time with our children

I embraced all three, eventually.

Seven months in, our youngest can run her home school:

  • Print daily schedule
  • Follow links to online classes
  • Turn in her work
  • Make lunch and snacks

It’s not ideal but it’s good enough given the underlying reality.

An interesting part of the underlying reality is how well the top of tier of our society has been doing.

The noise of the election has been drowning out this story.


2 out of 3 kids returned to in-person learning on Tuesday and I hit the road for a day trip to the Collegiate Peaks. COVID has enabled me to feel grateful for things that appeared unreasonable at the start of 2020.

I made three financial decisions this year.

  • Sale & leaseback of my house (January)
  • Roll two years cash flow from bonds to equities (March 18-24)
  • Ski local, reallocate ski money into a new car (Q4)

Similar to 2009-2012, I expected to do a lot more.

However, I’ve done enough. Enough to set up the next decade and enable me to focus on what matters.

That’s a lesson.

If you’re focused on “what matters” then there’s not going to be many decisions to make. Most of your focus is going to be on the day to day (exercise, family, admin, relationships, marriage).

If, like me, you are someone who likes getting stuff completed then you’ll do well to create an outlet (other than churning your portfolio) for this aspect of your personality. Otherwise, you’re going to run up a lot of expenses, pay excessive fees/taxes and greatly increase your chance for unforced errors.

In your larger life, if you don’t give yourself something useful to do then politics, social media and petty pursuits will fill your time.

I need to watch out for these distractions => they bring out of the worst aspects of my personality.

Pay attention to who, and what, brings out your best.


The best investment I made this year was the month I spent weaning myself off social media.

It’s difficult to see the net negative return of Facebook/Instagram until you are outside of their feedback loops.

At its core, Facebook makes it easier for bullshit to reach me.

For others, Facebook makes it easy to argue.

For all of us, the algorithms reinforce confirmation bias and reduce our ability to think clearly.

The algorithms are everywhere – they live in every web interaction we have.

Instagram stimulated my desire to buy stuff and reduced my satisfaction with who I am.

Both platforms are pleasurable but what’s the source of the pleasure? The source is external validation on appearances.

Far more powerful is an internal validation for the actions I take, daily, for myself and my family.

True power is the capacity to create a feeling of goodness for the actions you take, daily, in your own life.


My biggest fan

What was your biggest problem of 1, 5 and 10 years ago?

Can you even remember?

I can.

The biggest challenge of my last decade was a little girl who doesn’t exist anymore.

She’s gone and has been replaced by someone who’s an absolute star.

The difficulties of COVID enabled her, and me, to shine.

Parents, children, teachers, students, superiors, subordinates…

What we see, as a problem, will disappear over time.

…and time is the most valuable asset in our portfolios.

Spend it wisely.

What I Talk About When I Talk About Building Wealth

SuperGirl

When people ask me about asset allocation, I guide them towards family wealth.


Over your life, you will see things blow up.

  • Jobs will be lost
  • Divorces will happen
  • Guarantees will be called
  • Companies will fail
  • Investments will go to zero

Certain habits make us more prone to blowing up:

Debt – fixed obligations can ruin you in bad times.

Lack of emotional control – this runs deeper than, say, anger management.

People who make a habit of rationalizing a lack of control in one domain (elite sport, closing a sale, acting in a client’s best interest) rarely have the capacity to control themselves across domains. If you might get caught, then you’re fragile.

Substance Abuse – it’s more than the cost of sorting yourself out – it is the lost opportunity of a life well lived and the impact on the rest of your family, especially your kids.

Spending vs Cash Flow – personal spending, burn rate and fixed costs => the more spending you have relative to cash flow, the more fragile your finances.

The above is a long way of asking, “What aspects of your life might blow up?

Which is a polite way of saying, “I’m not sure asset allocation is the most pressing issue in your life.

If you work in an ethically-challenged field, have a lot of borrowings, have a high burn rate or are surrounded by peers with issues…

…then tweaking portfolio construction is a lower priority item than immediately removing what might ruin your life.

I’ve done it. You can do it. It’s better on the other side.


How large is your current portfolio when compared to your lifetime portfolio? – AKA you might have more wealth available in your career than your portfolio.

Investing is different at 25, 40 and 55 years old.

The nature of “different” depends on your personal circumstances.

#1 => Consider your Core Capital. The single best thing I did out of college was save four years of personal living expenses, $100,000 in the mid-1990s. It sat in a bank account, while I worked my ass off at my career.

Having that money enabled me to choose better and choosing better became a habit.


Very, very, very (!) few people can be professional investors – AKA can I get rich by beating the market?

Take an honest look at the people that you know in finance. How many of them “got rich” from their own money? Remember these are the experts.

In finance, most people get rich due to the rules of their game and collecting pools of other people’s money (your money, by the way).

With your portfolio, keep it safe, simple and low-cost. A target-date fund makes a nice core holding.

Having my Core Capital enabled me to take more risks in my career path, and life experience => not with my Core Capital.


Once-in-a-lifetime opportunities happen once a decade – AKA great deals happen when credit markets are shut

Here are the assets I own and why I own them:

  1. Index funds => long-term, diversified, not linked to my home real estate market
  2. US Treasuries/Core Capital => 5 to 10 years family expenses
  3. Boulder real estate => A relative value play against California, a cost-effective way to raise a family and a fantastic outdoor life. Think very carefully before locking yourself into any location. As a young man, my lack of ties enabled me to jump at great opportunities.
  4. Cash => my early retirement was funded by three deals I did coming out of the last credit crisis. Once you have your Core Capital (say, five years living expenses) then building up a pool for “great opportunities” is a consideration.

Starting out? Read this PDF.

Be wary of home bias => you can see it in my portfolio => even more risky is having your balance sheet, retirement and job reliant on the success of your employer.


Switching Costs – AKA think carefully before you sell good assets

I have assets in my portfolio that I would not buy at today’s prices. Financial theory tells me I should sell these assets.

  • I have zero confidence in my ability to predict the future.
  • If I sell assets then I pay taxes and commissions.
  • After selling, I have to figure out where to put the capital.
  • I doubt any “new” plan will be better than my current plan, which is simple and low-cost.

Release yourself from constant optimization => good enough is good enough.

Put your efforts into being a better version of yourself.

 

Cash Holdings in Context

2019-06-09 07.03.52The Algebra of Happiness is a great read. Professor Galloway has a hit on his hands.

In the book (page 83), Professor G says “I’m 80% in cash.”

I am used to hearing about wealthy guys’ portfolio allocations, I didn’t give it much thought.

However, his statement caught my wife’s attention (Big Time) and I spent a while explaining why I’d give the Professor an “incomplete” on this short section (of an excellent book).

Here’s what I said…

Start by laying out your sources of income:

  • Social security
  • Day job
  • Consulting gigs
  • University professorships
  • Unearned portfolio income
  • Rental property income
  • Tech fund consulting
  • Royalties from bestsellers
  • Spouse’s income

The segments, and the total, are useful to review.

These are figures you should know, roughly, off the top of your head.

Now, consider the information against your core cost of living.

I guess Professor G’s core cost of living is well covered by his sources of income. I’d further guess that his balance sheet has his family’s living expenses covered for the next hundred years. He is unlikely to be hurt by any investment strategy he selects.

The spread of your income sources will show concentration and diversification. Concentration can ruin life as you know it. You are likely to have skin in this game.

Addressing concentration can save you from ruin. Tweaking asset allocation, less so.

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Next, consider the areas of your life that hold option value:

  • Youth
  • Education
  • Ownership (bi-coastal real estate, start-ups, portfolio investments)
  • Wealthy relatives
  • Carried interest in tech firm general partnerships
  • Fame
  • Bestsellers
  • The ability to spend less
  • Equity stakes people toss you for being an entertaining non-executive director
  • World-class skills in well paying, niche specialties

When successful people talk about holding a lot of cash, they rarely mention the MASSIVE option value in the rest of their lives.

+++

What is cash?

As I write this I have six weeks’ living expenses in cash.

Seems really low!

  1. What if I add my US government bond portfolio?
  2. What if I net my unearned income sources from my core cost of living?
  3. What if I take a part-time job in one of my niche specialities?
  4. What if I downsize my house by moving?

In that case, my six weeks of cash should see me through to my 75th birthday.

Incidentally, I did all of the above 2009-2012 after my professional life was crushed.

Thankfully, I had a large cash holding at the time! 😉

+++

What should you hold in cash?

When allocating capital, most people want to receive a forecast of the unknowable.

Avoid pundits, forecasters and the predictions of others. They are worse than useless.

Each time I make an important decision, I write a file note to myself. Sometimes I publish these notes! Do this for 30 years and you’ll have a written record of your strengths and blindspots.

I use my limited attention to consider the implications of being wrong.

Overweight in cash and I am right:

  • Rich already => no implication, if you’re not satisfied with what you have today then you will not be satisfied with more tomorrow
  • Rest of us => Need to decide when to invest
  • Rest of us => Need to decide what to invest

The track record of “rest of us” is clear. We do an awful job at market timing and dynamic asset allocation.

Overweight in cash and I am wrong:

  • Rich already => no implication, my unborn grandchildren inherit less unearned capital
  • Rest of us => my widowed wife runs out of money in her 80s
  • Rest of us => I become a financial burden on my adult children

Some games you don’t want to play.