My Personal Portfolio: 2021

Every once in awhile – I won’t say once a year because that would be more frequent than is true – I like to think about my asset allocation. This is different than thinking about making more or spending less. This is about how I split the money I have across different asset classes. I’ll first share how I thought about this decision and then the resultant allocation. I share my thinking for two reasons. On the one hand, others may find it helpful. On the other, others may be able to point out where I’m making a mistake and help me.

Considerations

Here are some of the factors I considered when I was thinking this through:

Target Outcome

I like using the word ‘outcome’ instead of ‘goal’ or ‘objective’, as I think it forces me to be more concrete. When I use the word ‘outcome’, I’m really asking “what does the (relevant part of the) world look like if I’ve done this well?” In this case, the target outcome is that I can sleep at night knowing that my finances have appropriately balanced risk and return while providing me sufficient optionality for the future. More concretely, this implies a few subprinciples with the following order of priority:

1. Don’t do anything too stupid to mess up the future.
2. Ensure a comfortable retirement.
3. Provide exposure to events that could materially increase wealth.

Optionality

In my view, optionality is provided by cash and highly stable, liquid assets. Public market securities (i.e. stocks and bonds) are fairly liquid. Therefore, these assets ought to get a bit more weight than they might have otherwise. Whereas investing in illiquid assets is a difficult-to-reverse decision, liquid assets allow me to quickly correct myself if I realize I’ve made a mistake or the situation (personal or the macro-environment) changes.

Avoiding the Worst Case Scenario

To help plan, I wanted to define the worse case scenario and then, as a first priority, make sure that the chance of the worse case was near zero.

I first defined the ‘worst case scenario’ as comprising either of two outcomes:

1. A significant loss of capital such that I wouldn’t be able to go at least 2 years without working with no loss in lifestyle and without dipping into retirement savings.
   
2. A material change to my retirement outlook (which I predefine as starting at age 65), such that my public securities portfolio alone (which has significant historical returns data) wouldn’t be able to support my “minimum acceptable” retirement income with at least 95% probability.

#1 implied that I wanted to maintain a fairly large position in cash (or other conservative assets). #2 implied, for at least a portion of my public securities positions, a combination of high diversification and a clear and explicit tail hedge. While these two things were likely to damp returns, they provided downside protection.

Allocations

Reserve Account

One of the first things financial advisors always recommend is having a ‘rainy day’ fund: cash enough to maintain your standard of living for at least six months. I took that view and modified it in several ways.

First, because of the relative rarity of the roles I’m likely to accept, I adjust the six months to twelve. Further, because one of my most likely routes is to start another company (which not only takes time without income, but also initial business expenses), I wanted to plan for a two year timeframe.

Now two years worth of cash for me is quite a bit of cash to be sitting on. Having that much sitting in a bank account (at near 0% yields at the time I’m writing this) didn’t seem to make a lot of sense. Money markets weren’t much better. CDs were an option but the yields there weren’t that good either and had penalties for early withdrawal. What I really wanted was a place where I could park my money that was liquid, could earn a reasonable return, and would be relatively safe.

Now I’m fairly risk-seeking by nature so what seems ‘relatively safe’ to me may seem risky to others. That said, I ended up deciding to assign 80% of the value of my ‘reserve account’ to an allocation close to Ray Dalio’s All-Weather portfolio. This has averaged about 8% returns but more importantly has shown relatively minimized drawdowns across economic cycles. Even during the Great Depression (when the S&P 500 lost almost 65% of its value), back-tested All-Weather was shown to have lost just over 20%. Is 20% meaningful? Absolutely. Is it a risk I’m comfortable with? Yes, particularly because I still hold 20% of my reserve in cash and have a tail hedge position (more on that below).

Public Equities

Next in my allocation is public equities. Here I’ve divided my allocation into three strategies.

First is my allocation to net-nets. If you’ve never heard of them, they are basically deep value stocks where the total value of the company (as implied by the stock price times the number of outstanding shares) is less than an estimate of how much an investor could get if they bought the whole company and liquidated its assets. In essence, buying dollars for pennies. Now the availability of attractive net-nets varies so my allocation to this strategy will vary with time, but 10% represents my target position.

Next is my allocation to a concentrated buy-and-hold portfolio. This follows Warren Buffett’s adage that “it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”. One of the main reasons for this is tax-advantages: if you can let a company’s stock price compound for many years without selling, you avoid the loss incurred by having to pay taxes when you sell. (Of course, there are many other reasons as well.) Here my target is a 10% allocation to no more than 7 companies that I expect to hold for 10 years or longer. The high bar is intentional, as it forces me to focus and think through what I’m doing. Of course I may hold for less than 10 if circumstances (or my views) materially change.

Finally is an allocation to a widely diversified portfolio of both US and international stocks. This is primarily a nod to the fact that I don’t know what I don’t know. Here, my focus in on simply buying broadly diversified exposure through low- or no-fee ETFs.

Tail Hedge

My current allocation includes a 3% position in TAIL, a means of providing a tail hedge on my portfolio. My view on this is that it allows me to be more aggressively invested most of the time, since when a big downturn happens (such as in March due to COVID), my tail position will offset it. Moreover, during these big drops after the hedge spikes, I can sell off a portion of it and use it to purchase stocks a bargain prices when appropriate. I consider my 3% position a bit larger than what I’d probably do normally, but I am also generally concerned about valuations broadly in the market and believe the combination of historically unprecedented support from the Fed and likely further shifts in both monetary and fiscal policy create higher-than-usual concerns from me about a rapid, negative shock.

Real Estate

I’m a big fan of residential real estate: as businesses go, it’s relatively simple to understand and operate; it’s fairly localized; residential in particular is relatively recession proof (people still need somewhere to live); there are significant tax advantages; and appropriate leverage is easy to come by. Most importantly, however, my wife and her family are very handy: she has assembled her team – agents, brokers, bankers, accountants, and repair folks – that de-risk our investments substantially. For those willing to do the work, owning real estate can be an attractive investment; even for those that aren’t, consider REITs or a private real estate platform like Roofstock or Fundrise (disclosure: I am both a fund and equity investor in Fundrise).

Angel Investments

As an entrepreneur, I feel fairly comfortable making early-stage startup investments. I approach this asset class with a few things in mind. First, due to the power-law nature of returns in startups, I focus on building a large portfolio of bets: 100-125 at any given time (consider AngelList funds for broad diversification). Second, I try to minimize the amount of capital gains tax I need to pay via Qualified Small Business Stock or through investing via my Roth Solo 401k.

New Business Ideas

Beyond traditional angel investments (which are passive), I also am always continuing to think of new business ideas that I may want to start myself or in conjunction with others. Doing so often takes some amount of money, so I have an allocation to this pool as well. I do this to provide myself with some boundaries and make sure I don’t just spend all my money on my own ideas that I fall in love with. While investments in this bucket obviously take the most time, they also provide the most upside potential.

Cryptocurrency

Finally, there’s cryptocurrency. I know very little about cryptocurrency. That said, some investors I respect are quite bullish on crypto and I do see the incredible potential it (along with blockchain) has; a few years back Fred Wilson at USV recommended the ‘average investor’ have a 3% allocation to crypto; as I tend not to invest in things I don’t feel I understand, I further reduced my allocation to 2%.

Summary Table

Given all that, here’s where I end up:

There are a few things to comment on here:

Allocation to Equities

First, when you include the equity position within the All-Weather part of the portfolio, 42% of this portfolio is made up of public equities. While less than the 60% in a typical 60/40 portfolio, public equities still make up a sizable portion of the portfolio. (Bonds, in contrast, make up a much smaller part. Part of this is that I’m attempting to acheive diversificationt through other asset classes. The other part is that I don’t feel I know as much about bonds, and I try to invest in things I feel I understand.)

Second, though there are still sizable allocations to illiquid investments like non-REIT real estate and angel investments, over 60% of this portfolio is still liquid.

Third, a comment on the public equities positions. In reality, these allocations are a bit more fluid. While I intend to keep the diversified holdings invested at all times, the net nets positions depend on the availability of such deals. These tend to get more rare in hot markets (like we’re in as I write this), so deals are not always to be found. The same holds true for the concentrated positions: since here I’m looking for “great companies at a fair price”, sometimes those can be more difficult to find. In those cases where I’m ‘building up’ reserves to allocate to those other areas, I plan to split that reserve 50/50 between cash and the all weather portfolio.

Finally, Insurance

Something I didn’t talk a lot about here but should be part of every investor’s “portfolio” (and is part of mine) is insurance. As you can tell from the above I’m a big believer in managing downside (and tail) risk, and that’s exactly how I view insurance. Beyond health insurance, I have term life insurance sufficient that, if I die and the proceeds are invested in an all-weather portfolio, the income generated from that would be sufficient to take care of my family. In a few more years, I expect that my net worth will be such that we can self-insure and let the insurance expire.

Conclusion

So that’s how my assets are allocated, along with the reasoning that got me there. It lets me sleep at night, allows me to focus where I feel most comfortable, balances risk and return, and feels appropriately diversified. I’m sure it’s far from perfect but it works for me.