Objective and Independent review of my asset allocation

[DalioGold10]

Dear all,

I am in my early 30's. Started to invest in late 2017 (after I had fully paid my mortgage debt), however being from an Eastern European country my options in terms of brokers are limited, hence I chose Interactive Brokers (via Lynx Brokers - an introductiory broker).

Nevethtless, my plan is to build a decent size portfolio by age 45 (very doable in my case), allowing me to cover basic expenses (e.g. utilities, food, fun etc.) for one person, i.e. sort of achieve Barista FIRE. And once achived, no new contributions will be made to the portfolio until age 50-55 as I plan to step back from my carried (which is very stressfull) and only do jobs that allow me to cover current living expenses.

I need some objective and independent review of my assets allocation/portfolio:
Asset classes (100%): Equity- 40%; REITs- 10%; Government Bonds- 35%; Gold -15%.
Equity split between S&P 500- 20%; 10% Developed Europe (UK included); 10% Emerging markets;
REITs- Global Developed markets REITs from ishares;
Goverment bonds- 15% US treasury+20 years; 20% Emerging market government bonds.

I have read a lot of investing literature and opinions and I am well aware of bogleheads philoshopy, but in the same time I fully agree with Ray Dalio's investing phylosophy. More or less, I thinks, this is reflected by my AA.

Thank you all for your review of this.
Much appreciated.

[TheHardenedInvestor]

Not really sure what you’re looking for here. It sounds like this is what you want to do. If you are comfortable with your AA who is anyone else to tell you to change it? With that being said, why 15% in gold? Sure, because of Ray’s eternal doom strategy. But 5% max in gold. My preferred allocation in gold is 0%, but again, it’s your AA.

[Andy R]

Can you not put it all on one line. It is like writing all the rest of your info as a single long paragraph with no new lines.

Equity 40%
20% S&P 500
10% Developed Europe (UK included)
10% EM

REITs 10%
10% Developed markets REITs

Bonds 35%
15% US govt
20% EM bonds  (assume home country?)

Other 15%
15% Gold


1. I assume your EM bonds are in your country and currency of residence? Having bonds in an emerging market is a tough one. I'm curious what others think of this. I have not seen much discussion on the topic.

2. The purpose of gold is essentially for Armageddon, so I assume you have your gold in physical storage and not in ETFs since if Armageddon happens an ETF may not be particularly helpful, also even then 15% is a huge amount. 5% or maybe 7.5% max.

3. Don't even get me started on the Anthony Robbins bastardisation of the Ray Dalio investing philosophy.

4. At first I thought barista FI sounded cool, but when I realised that an extra 2 years of work would equate to another 10 years of part time low paid work, it no longer made any sense to me.

[bacchi]

That's way too many EM bonds.

The correlation (or lack of) to the S&P is good but it changes drastically during world panics.* That is, just when you need bonds to smooth the ride, they've become more correlated with the sinking S&P.

That many EM bonds is great for building up the stash but it's too volatile for withdrawing.


* See conclusion, https://www.imf.org/external/pubs/ft/wp/2010/wp1006.pdf

[Laserjet3051]

Interesting. The risks I may face could well be different than those you face in the country you live in, which I dont know. This is a factor in setting AA.

Your gold allocation seems a bit high but that may be tied to the risks you perceive, that I don't.

Why would you invest over 40% of your bond allocation in long term US treasuries? It doesnt appear that the interest rate risk is being properly rewarded (return).

Personally, I dont invest in international (non US) bonds. What is your rationale for weighting them so heavily in your bond allocation?

[DalioGold10]

Can you not put it all on one line. It is like writing all the rest of your info as a single long paragraph with no new lines.

Equity 40%
20% S&P 500
10% Developed Europe (UK included)
10% EM

REITs 10%
10% Developed markets REITs

Bonds 35%
15% US govt
20% EM bonds  (assume home country?)

Other 15%
15% Gold


1. I assume your EM bonds are in your country and currency of residence? Having bonds in an emerging market is a tough one. I'm curious what others think of this. I have not seen much discussion on the topic.

4. At first I thought barista FI sounded cool, but when I realised that an extra 2 years of work would equate to another 10 years of part time low paid work, it no longer made any sense to me.

Thanks Andi R for arranging the AA :)

EM bonds is actually J.P. Morgan EMBI Global Core Index (USD) , so hard currency global EM bonds. I read a Vanguard paper on EM on how they improve return, whilst Sharpe ratio is maintained.

You are right on the 2 extra years. It may be my case as well.

Thank you for your input.

[DalioGold10]

That's way too many EM bonds.

The correlation (or lack of) to the S&P is good but it changes drastically during world panics.* That is, just when you need bonds to smooth the ride, they've become more correlated with the sinking S&P.

That many EM bonds is great for building up the stash but it's too volatile for withdrawing.


* See conclusion, https://www.imf.org/external/pubs/ft/wp/2010/wp1006.pdf

Thanks bacchi,

I am aware of EM bonds behavior of equity-bond mix and they get quite correlated to equity markets in periods of distress. However, they are less volatile than stocks. As a hedge, I keep my gold  and US +20 years treasuries allocations to hedge in periods of high distress.

In terms of withdrawing, I opted for the distributed version of the index, hence I get my 5% yield (monthly distributions). I know is not very tax efficient, however, at a tax rate of 10%, I still get my 4.5% after tax (above the SWR of 4%).

[DalioGold10]

Interesting. The risks I may face could well be different than those you face in the country you live in, which I dont know. This is a factor in setting AA.

Your gold allocation seems a bit high but that may be tied to the risks you perceive, that I don't.

Why would you invest over 40% of your bond allocation in long term US treasuries? It doesnt appear that the interest rate risk is being properly rewarded (return).

Personally, I dont invest in international (non US) bonds. What is your rationale for weighting them so heavily in your bond allocation?

Good observation there :) . All my assets allocation within the portfolio avoided my country (Romania)/region as these are already factored in the other pension funds I am contributiong to. So, I tried to get exposure to factors outside my current close environment, i.e US/Developed Europe/EM (China, India, Brazil etc)/ US bonds and EM bonds(Romania holds only 1.6% weight in this index).

Gold is definately too high as a weight in my AA compared to others, but there are several assumptions/factors behind this:
1. I like gold and its volatility & uncorrelation to other assets classes. I expect to take my return from rebalancing.
2. I am a fan of the permanent portfolio (20% gold allocation). By backtesting my AA, I am quite comfortable with the weight of gold as it reduces the overall volatility and I see it as a good hedge for the downside risk.

So, I have only 15% in US +20 years treasury bonds. I am aware that the interest rate risk is high, however this allocation is purely a hedge next to gold. Moreover, I do not foresee rates going up, actually my expectations is to live in a very low interest rate environment for decades. Hence the 3% return is fair.

Regarding the international bonds, I avoided Europe & Japan (where the returns are very low) but opted for the Emerging market bonds index due to high yield offerd (over 5%). If low rates is the new norm for decades, then I expect more upside with this allocation.

[BicycleB]

All my assets allocation within the portfolio avoided my country (Romania)/region as these are already factored in the other pension funds I am contributiong to. So, I tried to get exposure to factors outside my current close environment, i.e US/Developed Europe/EM (China, India, Brazil etc)/ US bonds and EM bonds(Romania holds only 1.6% weight in this index).

Gold is definately too high as a weight in my AA compared to others, but there are several assumptions/factors behind this:
1. I like gold and its volatility & uncorrelation to other assets classes. I expect to take my return from rebalancing.
2. I am a fan of the permanent portfolio (20% gold allocation). By backtesting my AA, I am quite comfortable with the weight of gold as it reduces the overall volatility and I see it as a good hedge for the downside risk.

So, I have only 15% in US +20 years treasury bonds. I am aware that the interest rate risk is high, however this allocation is purely a hedge next to gold. Moreover, I do not foresee rates going up, actually my expectations is to live in a very low interest rate environment for decades. Hence the 3% return is fair.

Regarding the international bonds, I avoided Europe & Japan (where the returns are very low) but opted for the Emerging market bonds index due to high yield offerd (over 5%). If low rates is the new norm for decades, then I expect more upside with this allocation.

Based on the first paragraph quoted, your allocation doesn't sound crazy to me. I'm not an international expert, though!

Please be aware that there is some dispute about whether the backtesting for gold has predictive value. To the extent that gold's track record includes the shift from the gold standard to fiat currency, it contains an anomaly that may not ever be repeated.

From what I've read, the costs and logistics of holding gold present risks that other asset categories don't always have. If you're willing to accept these, I suspect you're right in guessing that gold is uncorrelated and would give a layer of security that other assets wouldn't. Whether it's enough to produce 4.5% after fees and risks are accurately calculated, I don't know.

The real test of this portfolio is whether you can maintain it through multiple business cycles. In other words, like anything it will fail if you back out of it at the wrong moment. So I say, stick with it for a couple of decades and good luck to you. Keep us updated!

[Andy R]

If the EM bonds are not from your home country, then I think 20% is way too much. They are more volatile than US bonds and I would consider them as part of the equities portion.
Also when you add on EM stock, you have an enormous amount in the highly volatile EM market.

[DalioGold10]

Not really sure what you’re looking for here. It sounds like this is what you want to do. If you are comfortable with your AA who is anyone else to tell you to change it? With that being said, why 15% in gold? Sure, because of Ray’s eternal doom strategy. But 5% max in gold. My preferred allocation in gold is 0%, but again, it’s your AA.

Thanks TheHardenedInvestor,
I may have a bias towards gold :)). Nevertheless, I highlighted some of my reasons for holding gold foregoing.

[DalioGold10]

If the EM bonds are not from your home country, then I think 20% is way too much. They are more volatile than US bonds and I would consider them as part of the equities portion.
Also when you add on EM stock, you have an enormous amount in the highly volatile EM market.

Not from my country ? Why ? If they were from my country then I would label it as a home country bias :)

I do not see US bonds returns (government/treasuries) lifting above 3-3.5% bechmark for the next decades, hence maybe is one of other biases I am exposed to :) There is a lot of downside in holding US treasuries as opoosed to EM bonds.

[Andy R]

If the EM bonds are not from your home country, then I think 20% is way too much. They are more volatile than US bonds and I would consider them as part of the equities portion.
Also when you add on EM stock, you have an enormous amount in the highly volatile EM market.

Not from my country ? Why ? If they were from my country then I would label it as a home country bias :)

I do not see US bonds returns (government/treasuries) lifting above 3-3.5% bechmark for the next decades, hence maybe is one of other biases I am exposed to :) There is a low of downside in holding US treasuries as opoosed to EM bonds.

It's not as simple as that.

If an country A has inflation of 4% and bonds offering 5% and country B has inflation of 2% and bonds offering 3%, is there really an advantage in the bonds of country A? What you gain in nominal interest, you lose with inflation and potentially more. It is not a free lunch.

Of course, maybe the currency in country A does not lose ground at the relative rate compared to the currency of country B and then yes you are ahead, but by the same token, if the currency in country A loses ground faster than country B then you are behind. But this is separate to the nominal return of bonds and you are essentially gambling on exchange rates at that point.

--

The reason I mentioned if it was from your country, is that your purchasing power is partly tied to the currency you will spend down in, so there may well be a valid reason to bias bonds in your own currency.

The idea is that you don't really want a situation where your external currency bonds purchasing power tank while my home currency purchasing power is thriving.

It would not be a good situation to invest in a currencies that go down or stagnate while local currency goes up.

On the other hand, if local tanks and you tank with it, you are all in the same boat.
Very different from everything in local country being in the same boat while you are drowning.

Again though - I am not sure how this applies to emerging markets.

[DalioGold10]

If the EM bonds are not from your home country, then I think 20% is way too much. They are more volatile than US bonds and I would consider them as part of the equities portion.
Also when you add on EM stock, you have an enormous amount in the highly volatile EM market.

Not from my country ? Why ? If they were from my country then I would label it as a home country bias :)

I do not see US bonds returns (government/treasuries) lifting above 3-3.5% bechmark for the next decades, hence maybe is one of other biases I am exposed to :) There is a low of downside in holding US treasuries as opoosed to EM bonds.

It's not as simple as that.

If an country A has inflation of 4% and bonds offering 5% and country B has inflation of 2% and bonds offering 3%, is there really an advantage in the bonds of country A? What you gain in nominal interest, you lose with inflation and potentially more. It is not a free lunch.

Of course, maybe the currency in country A does not lose ground at the relative rate compared to the currency of country B and then yes you are ahead, but by the same token, if the currency in country A loses ground faster than country B then you are behind. But this is separate to the nominal return of bonds and you are essentially gambling on exchange rates at that point.

--

The reason I mentioned if it was from your country, is that your purchasing power is partly tied to the currency you will spend down in, so there may well be a valid reason to bias bonds in your own currency.

The idea is that you don't really want a situation where your external currency bonds purchasing power tank while my home currency purchasing power is thriving.

It would not be a good situation to invest in a currencies that go down or stagnate while local currency goes up.

On the other hand, if local tanks and you tank with it, you are all in the same boat.
Very different from everything in local country being in the same boat while you are drowning.

Again though - I am not sure how this applies to emerging markets.

Fully agree with the theory you laid out above.

Over the long term I expect the country with high inflation to have its currency depreciating, i.e. the interest rate parity theory. However, due to intervention of central banks over medium term the theory does not hold. Over the long term it holds.
For example, Romania's currency took a 2% hit this year due to the political context (trigger event), however this depreciation was overdue as the exchange rate was artificially kept by the central bank (Romania's inflation rate has been 3.2% for the past 18 months).

My EM bonds exposure is to EM USD (hard currency) govermental bonds (5% yield), hence I am having exposure to the countries specific risks and not so much to local inflation. As I see it, USD treasury bonds vs EM treasury bonds (USD currency) - the risk premium of 2-3% on the EM bonds (USD) is the country risk premium (i.e. default risk playing the biggest part).

Honestly, given the high debt levels of US I expect more risk within US bonds markets and lower expected returns for US treasury bonds. Ultimately, high debt burden will restrict FED to raise rates further.
With respect to EM, the story is different (i.e. corruption, political risks, nationalism etc.), however the debt to GDP is around 60% as opposed to above 100% levels in developed economies.
The above makes me to hold a high allocation to gold and tilt my AA from US treasuries to EM.

[Andy R]

I am guessing that the reason the US has much higher debt then emerging countries is because they are much more stable and much less likely to default, therefore there is more willing to be lent to them.
Ah yes you mentioned that - a risk premium for higher chance of default.

It seems you know more than me and are in a better decision to make the call.
What matters is that you understand all the factors and are making an informed decision.
If you would like other points of view, I would also post this over on the boglheads forum.

[DalioGold10]

I am guessing that the reason the US has much higher debt then emerging countries is because they are much more stable and much less likely to default, therefore there is more willing to be lent to them.
Ah yes you mentioned that - a risk premium for higher chance of default.

It seems you know more than me and are in a better decision to make the call.
What matters is that you understand all the factors and are making an informed decision.
If you would like other points of view, I would also post this over on the boglheads forum.

Thanks Andy for suggestion.

Regarding the debt levels and dafault risk, for me personally, debt levels in excess of 100% GDP is unhealthy for the economy over the long term. There is little room for maneuver and likely high chances of very low economic growth. But, this is just my subjective opinion.

I am betting on emerging markets (equity -10% and bonds -20%) as I see a lot of room for real economic growth there. I would have increased my  share of EM equity, however due to corruption and low regulation my risk tolerance cannot bear a higher allocation :)

[TheHardenedInvestor]

Thanks TheHardenedInvestor,
I may have a bias towards gold :)). Nevertheless, I highlighted some of my reasons for holding gold foregoing.

Sure. So did you make any changes to your AA after reading anyone’s comments from this thread?

[DalioGold10]

Thanks TheHardenedInvestor,
I may have a bias towards gold :)). Nevertheless, I highlighted some of my reasons for holding gold foregoing.

Sure. So did you make any changes to your AA after reading anyone’s comments from this thread?

Of course :)

Reduced my gold allocation to only 7.5%.
Increased my S&P 500 allocation by another 5%.
Increased US +20 yrs treasuries by 2.5%.

[TheHardenedInvestor]

Thanks TheHardenedInvestor,
I may have a bias towards gold :)). Nevertheless, I highlighted some of my reasons for holding gold foregoing.

Sure. So did you make any changes to your AA after reading anyone’s comments from this thread?

Of course :)

Reduced my gold allocation to only 7.5%.
Increased my S&P 500 allocation by another 5%.
Increased US +20 yrs treasuries by 2.5%.

Fair enough!

[DalioGold10]

https://personal.vanguard.com/pdf/ISGEMB.pdf

I attach the link to Vanguard study on EM bonds :)

[MustacheAndaHalf]

The biggest flaw I see is using a retirement portfolio when you should be accumulating.  If you're far from retirement, then you might want 90% stocks.  But even if you plan to retire in 2030, you'd want a lower bond allocation.  Here's the allocation used by both Vanguard Target Retirement 2030 and Schwab Target 2030:
70% stocks
30% bonds
https://investor.vanguard.com/mutual-funds/profile/portfolio/vthrx
http://portfolios.morningstar.com/fund/summary?t=SWDRX

So I'd suggest 70% stocks if you plan to begin withdrawing money in 2030, and a higher allocation if you plan to let those assets grow until a later retirement date.  When you hit a correction, your portfolio isn't supposed to have lower volatility - it's supposed to take a massive drop... and then you make contributions which greatly improve things.  Your protection against crashes is your income, your salary.

Same goes with gold.  If you want a permanent portfolio, you don't need it before retirement.  Any correction is an opportunity to buy more shares.  You can ease into your gold allocation as you need it - as you approach retirement.

You can also look at Vanguard Total World to see that U.S. equities are roughly 55% of the world (by market cap), so a 50/50 split between U.S. and international is actually quite reasonable for a foreign investor.  If you can get a "total U.S. stock market" fund or ETF, even better (VTI, SCHB, ITOT are examples that trade on exchanges, that you might be able to purchase through Interactive Brokers).

[DalioGold10]

The biggest flaw I see is using a retirement portfolio when you should be accumulating.  If you're far from retirement, then you might want 90% stocks.  But even if you plan to retire in 2030, you'd want a lower bond allocation.  Here's the allocation used by both Vanguard Target Retirement 2030 and Schwab Target 2030:
70% stocks
30% bonds
https://investor.vanguard.com/mutual-funds/profile/portfolio/vthrx
http://portfolios.morningstar.com/fund/summary?t=SWDRX

So I'd suggest 70% stocks if you plan to begin withdrawing money in 2030, and a higher allocation if you plan to let those assets grow until a later retirement date.  When you hit a correction, your portfolio isn't supposed to have lower volatility - it's supposed to take a massive drop... and then you make contributions which greatly improve things.  Your protection against crashes is your income, your salary.

Same goes with gold.  If you want a permanent portfolio, you don't need it before retirement.  Any correction is an opportunity to buy more shares.  You can ease into your gold allocation as you need it - as you approach retirement.

You can also look at Vanguard Total World to see that U.S. equities are roughly 55% of the world (by market cap), so a 50/50 split between U.S. and international is actually quite reasonable for a foreign investor.  If you can get a "total U.S. stock market" fund or ETF, even better (VTI, SCHB, ITOT are examples that trade on exchanges, that you might be able to purchase through Interactive Brokers).

Thanks MustacheAndaHalf,
Really appreciate your view/input on this.

You are right on the growth/accumulation phase - but my current 37.5% allocation to bonds + 7.5% gold = total of 45% weight reflects my low-medium risk tolerance.
Moreover, job stability is an issue, i.e. in times of distress things may go south and I may end up either with a much lower salary or even jobless (this is another fear I am facing) so I cannot make new contributions to the portfolio and hence miss buying opportunities when market crashes.

So, by assimilating the 20% allocation on EM bonds to equities-like assets, actually my AA embeds 75% risky assets (i.e. 25% S&P, 500, 10% Developed Europe & UK, 10% Emerging markets equities, 10% REITs, 20% EM bonds). The remaining 25% (17.5 % US treasuries +7.5% gold) is my hedge.

As an European we cannot purchase US based index funds but need to go with UCITS versions (Irelnad based funds). Nevertheless, there is a Vanguard total stock market index available which I can buy, however, I prefer to stay away from Japan/other Pacific countries. Additionally, I expect US weight in global indexes to drop in the following years due to emerging China. My AA on equities does not include Japan and includes a higher weight on China - 5% (compared with global index weights)- part of my current bets.

I admit my portfolio construction has lots of biases or "bets against current market weights" (look at China weight, avoidance of Japan), low US bonds weight, gold weight, overweight of REITs, but all is in light of recent global trends and reflect my judgement.

Really appreciate your input and I hope you are not offended by my arguments to deter/debate your advice :)