An Array of Interests
I grew up in a small town in New York called Poughkeepsie where running from friend’s house to friend’s house, building forts of snow, damning streams, playing soccer, reading books, creating rubber band guns and so much more engulfed my life. From a young age, I developed a massive amount of interests across a broad spectrum of activities.
For instance, I spent my early years during the chilly September and October months down in the basement (in New York there are basements unlike Texas) where I would cut out cardboard triangles to structurally support my oversized “appliance” Halloween costume with a hot glue gun… and I directly link that experience to my enjoyment of designing and building a fence for our current house. See Halloween costume example below.
I also read about dragons as a child and picked up The Hobbit during 6th grade when the middle school offered points for every book read (so long as you passed a 10 question quiz on the book). I continue to absorb books today, and hope to write my own at some point in the future (although wishing and doing are two completely different things).
This all goes to say that my many interests could potentially create a point in time where I don’t have the time to research and pick individual stocks, choosing to focus on other endeavors.
But I will never lose interest in growing our wealth because it can support my wife and me for the rest of our lives. We strive for FI or Financial Independence. In another words, control over our choices in life. So I’ve built a back-up plan to picking individual stocks.
What I Would Do If I Didn’t Pick Individual Stocks
Step 1: I would focus on Exchange Traded Funds or ETFs.
An ETF is an investment fund with multiple holdings that is traded on a stock market exchange. The only difference between on ETF and an index/mutual fund is that an ETF can be traded throughout the day, whereas an index/mutual fund can only be bought/sold for the price identified at the end of the day. Most index/mutual funds also have a minimum amount needed before starting an investment (normally $3K or an automatic monthly payment). ETFs end up being diversified, liquid, and easy to start investing, so I tip my cap slightly to them over index/mutual funds.
Step 2: I would make sure my brokerage account (like Fidelity) allows for the purchase of partial shares.
Nothing is more frustrating that having money sit in an account because I am a few dollars short from purchasing a share of a stock. Luckily, brokerage accounts have begun to offer the purchase of partial shares. With Amazon stock over $3K for one share, it is nice having the ability to purchase a partial (or fractional) share of Amazon with $100 or $1K. One share of an ETF stock trades the same as one share of Amazon on the stock exchange, so a fractional share purchase would also work the same.
Step 3: I would purchase a split of these three (3) ETFs: VTI, VXUS, SCHD.
VTI - Vanguard US Total Stock Market Index (Expenses Ratio of 0.03%, Dividend of 1.30%) -> Top 10 Holdings include Apple, Microsoft, Amazon, Facebook, Alphabet, Tesla, JP Morgan Chase, Berkshire Hathaway, and Johnson & Johnson.
VXUS - Total International Stock Market Index (Expense Ratio of 0.08%, Dividend of 2.08%) -> Top 10 Holdings include Taiwan Semiconductor, Tencent Holdings, Alibaba Group, Samsung, Nestle, ASML Holdings, Roche Holding, Toyota Motors, Novartis, and LVMH Moet Hennessy Louis Vuitton.
Schwab US Dividend Equity (Expense Ratio of 0.06%, Dividend of 2.81%) -> Top Holdings include The Home Depot, IBM, Pfizer, PepsiCo, Texas Instruments, Cisco Systems, Coca-Cola, Amgen, Broadcom, and BlackRock.
My split of the monthly funds into each ETF would be 40%, 20%, and 40% respectively. The expense ratios are all below 0.10%, which is a very low cost for the management of the investment fund. It means that for every $10K in the account, they charge $3 for VTI, $8 for VXUS, and $6 for SCHD, which the dividends easily cover for each. With this split, I get strong growth exposure, foreign stock exposure, and a solid dividend (cash flow) accumulator.
Side Note: I like SCHD as a dividend ETF because it pairs growth with a strong dividend. Since inception in October 2011, $10K invested in SCHD with dividends reinvested would be ~$39K today, and also paying out ~$1.1K in dividends per year… resulting in a ~15% growth rate per year, even with the March 2020 pullback. SCHD is a market cap weighted fund (meaning the bigger the market cap, the bigger the position in the fund) that uses fundamental screens like cash-flow to debt ratio, return on equity, dividend yield, and dividend growth ratio to pick stocks for the portfolio. With the fundamental screens, the strong dividend, the strong growth, and the low expense ratio, it is my favorite dividend ETF.
Step 4: I would rebalance once every 5 years on a random date in the year, like my wife’s birthday, until early retirement.
Rebalancing helps make sure that one investment does not become too much of the portfolio over the others. My goal after 5 years would be to keep everything in balance with my 40%, 20%, and 40% ratio. The tricky part for me would be balancing my retirement accounts with my brokerage accounts. For example, to rebalance I might have to sell VTI and purchase more VXUS. By selling VTI in my brokerage account, I might end up with a capital gains tax. So when I rebalance, I would want to make sure that all of my selling is completed in my tax-sheltered individual retirement accounts (IRAs), so I don’t have to pay taxes on the sale.
Over time, it might become harder and harder to complete the rebalancing fully in the tax sheltered accounts, but setting aside some money to pay a capital gains tax just means that I made money for the year on passive investments. Can’t complain too much about that in the end.
Side Note: Rebalancing once every 5 years allows for the specific asset class to grow over time without selling each year, but it does create a potential large taxable event when the rebalancing occurs. On the other hand, rebalancing every year smooths out the taxable events, but ends up selling the asset class growing and could hurt future gains.
Step 5: Once in early retirement, rebalancing becomes the funds that my wife and I live off of for the year, so what was an every 5th-year event becomes an every year event.
To retire early, I have to plan to have enough in our brokerage accounts to cover us from our early retirement age to 59.5 when we can access our tax-sheltered retirement accounts. And then I need to make sure that all of our investments can then last us until we leave this earth.
A little planning can help in this regard, but in the end the goal for us is to have enough in our brokerage account to live comfortably and to only use the retirement accounts as backup.
Side Note: A Roth IRA does allow us to be able to take out the money we put in (called the principal) tax free prior to age 59.5 and after 5 years of it being in the Roth account. Although any gains/profits in the Roth will have to be left in the account until age 59.5, unless we want to pay the penalty for early withdrawal.
By investing in ETFs with dividends, I can use that cash flow first and sell less of my overall portfolio. With my current 40/20/40 split, the average current dividend would be 2.06%. The goal is to live off of 4% of the portfolio, so I would only need to sell 1.94% of the portfolio in order hit my number. I definitely anticipate my portfolio growing more than 2% per year on average.
Step 6: In actual retirement with no ability to jump back into the workforce, I would add a final ETF into the portfolio called BND.
BND - Vanguard Total Bond Market Index (Expense Ratio of 0.03%, Yield of 2.13%)
Bonds have been out of favor for a while, but they still offer less volatility with a decent yield over 2%, regardless of the pint-sized growth. The idea here is that bonds can offer that stability to tap into if the stock market is correcting/pulling back. At this point, the goal would lean toward capital preservation and not capital appreciation, especially when my wife and I hit the point in our lives where jumping back into the workforce is no longer a viable option.
In order to integrate the new ETF, I would just steadily add 3% to the BND ETF each year after rebalancing, aiming to be the following over time:
VTI - 30%
VXUS - 10%
SCHD - 30%
BND - 30%
If I tried to rebalance it completely in the first year, then I might experience a large tax bill, so I would just complete this process year over year (slowly), until the breakdown above is achieved. The portfolio would transition as follows (the numbers are percentages):
Year Zero - 40/20/40/0
Year One - 40/17/40/3
Year Two - 40/14/40/6
Year Three - 40/11/40/9
Year Four - 38/10/40/12
Year Five - 35/10/40/15
Year Six - 32/10/40/18
Year Seven - 30/10/39/21
Year Eight - 30/10/36/24
Year Nine - 30/10/33/27
Year Ten - 30/10/30/30
Even with full retirement in play, the potential to still live for another 30 years (or more) is possible, so I would still want some growth in the portfolio, along with the potentially safer bond allocation.
And finally…
Step 7: Leave everything to charity.
Over half of the 4% Rule portfolios actually ended their 30-year run with 7x or more their original portfolio size, even with the yearly selling. The safety nets we have in place should help us weather any storm, but the unexpected can occur just like this pandemic. So my wife and I will anticipate leaving everything to charity after all is said and done, if possible.
Thank You!
If you’ve made it this far, then you are an amazing human. Let me know what you think by leaving a comment. Or drop me a question. Share it with others who you think might appreciate the information. Looking forward to sending out the next issue!
**I am not a financial advisor, so please don't buy/sell anything based solely on what you read here and do your own due diligence.