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How I manage our retirement portfolio

A friend of mine (Hi Matt!) made the awful mistake of asking how I manage our retirement portfolio. I decided to put together a relatively quick (and hence incomplete) explanation. It comes down to a total of five investment types so it's not too bad.

1 Disclaimer

I am not a financial adviser. I am not a tax expert. In fact I'm a bear of very little brain. Below I explain what we want to do and give a little insight into why. There are no warranties, promises or anything else on this article. Heck, I might have just made it all up. So read at your own risk.

2 Cash

First I calculate how much cash we need. This covers everything from an emergency fund to saving for new cars to college savings, etc. See here for where the emergency fund cash goes. But the short version is “credit unions”.

3 Stock/Bond Split

The remaining taxable cash and all tax exempt cash (e.g. IRAs, 401(K)s, etc.) goes into our retirement portfolio. I split our portfolio between stocks and bonds. No real estate, gold, etc. When we own a house I don't count it as part of our retirement portfolio, although I do hope to have a paid off house by the time we retire because of the income stability it brings. I currently split our stock/bond money 70/30. I can't justify this split. It's just what I use. Every attempt I've seen to justify a split turns out to be crystal ball gazing with some hocus pocus thrown in. So I decided to stop pretending I know what split to use and just pick one.

4 Stocks

I want to invest in exactly two stocks, Vanguard Total Stock Market and Vanguard Total International Stock. The first represents the U.S. market and the second represents the rest of the world. I balance the two based on their current global weights. For why I picked these two stocks and how I balance them please look here. I have no illusions that I can beat the stock market so I just buy the whole market (e.g. across the planet) and call it a day.

5 Bonds

I buy three types of bonds, short term Treasuries, short term corporates and long dated (30 year) TIPS (yes, actual bonds). I don't trust corporations with long dated bonds because they have too many incentives to cheat so I only buy short term corporate bonds. I buy short term Treasuries under the dubious argument that historically the premium for going long term hasn't been much so the risk wasn't worth it. I buy actual TIPS bonds because that part of my portfolio is for inflation protection so the longer the bond the longer I have protection. I must admit I haven't been buying TIPS recently because the interest rates are insanely low (I usually like to see 2%) but I suspect I'll crack soon and start buying again.
I split bond money into 1/3s across the three types of bonds. I can't justify this. It's just what I do. Note that all of this is more or less stolen from Bernstein. I use the following bond funds:
  • Vanguard Short Term Corporate
  • Vanguard Short Term Government Bond or Vanguard Limited-Term Tax-Exempt Mutual Fund (for when I have to put bond money in a taxable account)
  • Actual long dated (30 year) TIPS bonds

6 Portfolio Allocation

I only buy TIPS bonds with tax exempt money (e.g. 401(k)s, IRAs, etc.) because the tax implications of TIPS bonds in particular (today's phrase is 'phantom interest') are pretty awful. In fact, in general, all my bond buying goes into my tax exempt accounts since taxes are a terrible thing to do to a bond. When I have spill over (e.g. I need to buy more bonds than I have tax exempt money for) then I'll use the Vanguard Limited-Term Tax-Exempt Mutual Fund I mentioned above. Note that I live in Washington State which doesn't (currently) have income tax. If I came from a high tax state (I'm looking at you CA) then I'd have to pick a short term muni fund that would protect me from state taxes as well.
When I need to spend tax exempt money on stocks (due to balancing issues) I tend to spend on the Total International Stock fund before the Total Stock Market fund. I do have reasons for this but there are really good counter arguments for why this is a bad idea (e.g. the Total International Stock fund gets me the foreign tax credit, a juicy benefit). But, whatever, flip a coin.

7 Roth vs Traditional IRA/401(k)

I use a Roth 401(k) mostly because I believe that tax rates are likely to go higher in the future (or the revolution will come sooner in which case my retirement portfolio will be the least of my worries). Note that I haven't rolled over our traditional IRA accounts to Roth IRA accounts. I officially claim this is because I want to hedge my bets in case I'm wrong about future tax rates. But the reality is that I'm lazy and I find all this financial stuff stressful.

8 Re-balancing

I target rebalancing once or twice a year depending on cash flows. If I get a bonus or grants from work then usually I'll do a rebalancing to absorb any new money targeted for retirement.
Note that I don't sell assets in taxable accounts for rebalancing purpose. I will sometimes sell assets to buy other assets in tax exempt accounts since the fees are typically low or zero and there are no tax considerations.

9 How much to save?

Based on some extremely dubious historical accounting I usually tend to think that my wife and I can safely withdraw around 4% of our retirement portfolio's initial net worth when we retire in real terms (e.g. adjusted for inflation) every year 'forever'. So in theory, in order to retire, our portfolio needs to be worth (yearly living expenses while retired including taxes)/0.04. I use a program called ESPlanner to help me calculate how much our living expenses will be during retirement. But right now our portfolio is no where near where it needs to be to let us retire at the quality of life we have now so I'm not worried about having too big of a retirement portfolio.
Still, this begs the question - how much money do we need to save each year to hit our goal? Given that I'm putting our retirement money into gambling (a.k.a. stocks) I can't really say. But our general goal is to save 30% of our gross income for non-immediate needs. This includes the cash categories given above as well as retirement savings. The 30% number is my wife and I's answer to the 'hit by a truck' problem. If we were hit by a truck tomorrow and dying we wouldn't want our last thought to be “Damn, saved too much for retirement, didn't get to enjoy life!” In talking it over 30% of gross (e.g. before taxes) was about where we felt like we weren't choking off our current life for the future while also saving a reasonable amount of money.
Will 30% give us enough to retire at the quality of life we want? I neither know nor care. At some point enough is enough. We'll save 30% and live with the consequences.

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