2020 Q4 Financial Update Part 2: Investments Analysis, Actions, and Plans

Hi RIP readers, this is Part 2 of 2020 Q4 Update (here is Part 1).

Today I’m going to expand the “Investments – Analysis, Actions, and Plans” section left empty in my previous post. I’m going to share my beliefs, my fears, my decision making process, and will commit to some actions in order to get back into a “sane” asset allocation as soon as possible.

I’m kind of rewriting my Investor Policy Statement today.

Mind that this post is very long (9k words), and superficially edited.

It’s not just a stream of consciousness, because there’s some deep ETF research, thought process, behavioral analysis, rational decision making, and more.

I started writing this post without an outline (I never do), and without knowing what the conclusions would have been. I used this post to clarify my thoughts, and that’s what writing does for me.

I don’t write because I have something to tell, I write because I have something to learn. And as a side effect I’m sharpening my thinking skills. Writing is amazing!

Enjoy!

UPDATE: I received a lot of feedback and I decided to publish a Q&A post: Part 2-BIS, and a mail exchange with Julianek: Part 2-TER

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2020 Q4 Investment Analysis

The image above is a screenshot of the Finance Subsection of my Net Worth Sheet at the end of the year 2020. The section has a row for each tradeable asset I’ve owned in 2020. Every time I buy or sell shares of an ETF/Fund I add a comment on my spreadsheet (in the Asset/Liabilities section) with the sale date, amount, price and so on. Take a look at my Spreadsheet series for more details.

[Actually, since October 2020, I’m using Notes, not Comments on my Google Spreadsheets. I’ve solved the annoying issue of random people deleting my comments thanks to a suggestion from a reader, Mr. Brown! Comments are not dead though! You can comment on my spreadsheet if you want to ask questions or fix a bug on my formulas 🙂 ]

When I close a position (when I own no more shares of an ETF for example), I grey out the value of the asset in the Finance Subsection from the closing month on, but I keep tracking it for the current year. When a new year shows up, I delete the entries for assets I don’t hold anymore, and only monitor the prices for the securities I own.

Well, as you can see most of the Stocks/bonds/ETFs/Funds area has been greyed out. It means I sold almost all the securities during 2020.

Spoiler: that’s what the Finance Subsection looks like on January 12th, 2021:

October 2020 has not been a great month, and some of the ETFs I sold in the previous quarter fell below my sale price, lending me a hand that I should have caught. For example VT went below 79 USD/Share (the price I sold them 3 months before), and I was tempted to rejoin the stock market. But I didn’t. And now I bite my fingers.

In November I’ve sold all my VYM (US High Dividend Stocks) positions at 90.90 USD per share (116k USD proceeds, 8.7k USD “realized profits“), doubling down on my bearish attitude toward the market.

Also in November, I sold all my VBR (US Small Cap Value Stocks) shares at 127.5 USD per share (46.8k USD proceeds, 7.2k USD “realized profits“). They’re above 150 today.

Why didn’t I sell VYMI (Ex-US High Dividend Stocks)? Because it has unrealized losses, i.e. current price is below the average price I paid for the shares, and I don’t want to realize losses.

[2021 Update: I sold all my VYMI shares as well on January 6th 2021, at a small “profit” in USD…]

let me explain myself why anchoring to “Unrealized Profits & Losses” is stupid:

• If you factor in dividends/distributions (minus taxes) so far, the beak-even selling point is not at 0 unrealized P&L.
• If you factor in currency conversion rate from asset currency (USD) to my reference currency (EUR or CHF) the break-even point is hard to track.
• Sunk Cost Fallacy: how much you paid for X shouldn’t influence the decision of holding/selling X.

The right question you should ask yourself at any given point in time is “if I had all my money in cash, would I buy the number of shares I currently own of this assets?“. Of course you should factor in trade fees (and capital gain tax if your country taxes it), but given the irrelevance of fees on Interactive Brokers and the lack of capital gain tax in Switzerland the question above can be interpreted literally. And I’m implicitly answering “YES” all the time, even though if I had all my money in cash I wouldn’t buy a stock portfolio composed by only 20k of VYMI…

Holding on VYMI for a bad anchoring reason is stupid. I wouldn’t advise any person in a situation similar to mine to behave like I’m doing.

In the meantime I’ve bought more US bonds, mostly BSV (Short Term US bonds). Not because I want to hold US bonds long term, I just wanted to park some cash while I re-defined my investing strategy. BSV has a small yield (1.5%) and a predictable trajectory.

I also bought BND (Total Bond Market US), but I promised myself I won’t buy more BND. BND has better yield (2%) but it’s much more volatile. In March 2020 crash it lost 10%. It holds bonds of all kind of maturities. A minor increase in US treasury bills yield (like in early January 2021) can easily make the ETF lose a significant percentage. It lost 1% in the first 10 days of 2021. I don’t want this extra risk in my portfolio. I’m already pissed off by currency risk.

I plan to sell BND soon and at least buy BSV in the meantime. I’ve actually entered an optimistic limit sell order on January 4th, but it didn’t execute. In the two following days its price went down.

Between October and December I also sold the other minor bonds ETFs, mostly to simplify my portfolio, and purchased BSV with the proceeds:

• I sold my IEAC shares (European Corporate Bonds) at 134.9 EUR/Share (38.4k EUR proceeds, ~0 Profits but fucking 28 EUR of trade fees). Obviously they skyrocketed after I sold them…
• I sold my IEML shares (Emerging Markets Government Bonds), the “ugly duckling” of my portfolio, at 60 USD per share (24.3k USD proceeds), at a small (416 USD minus trade fees) profit.
• I sold my FLOT shares, another US bond ETF, 26.9k USD proceeds, and a 100 USD loss.

Another thing you should NOT do is to keep monitoring assets once you sold them.

All the assets I sold went up in price! I took a look at the individual stocks I played with during the pandemic: one of them is up 4x compared to my sell price… But the asset that pissed me off the most is WING, the “fallen angels corporate bonds”. It’s one of the best performing assets of 2020. It ended 2020 up by 13.6%, and compared to when I sold all my shares in May 2020 it’s up 16.8%… plus dividends.

How stupid am I??

See, the more you want to be active in the market, the more regrets, overconfidence, greed, fear, and FOMO will kill you.

Seeing kids with their pocket money all invested in Tesla and Bitcoin 10x their portfolio while I’m getting a couple of jabs every single day (bonds down a bit, USD down a bit, stocks up a lot) is consuming too much of my mental energies.

Here’s a short extract of my December Journal:

December 1st

The worst possible day. USD lost 1% vs CHF and 1.2% vs EUR. Plus BND lost 0.5%. My monthly NW Delta in EUR is negative, and it’s the first day of the month! Salary already accounted for, of course…

I feel like shit for this. I feel a lie. When in March the market was going down and everyone was losing money I felt being not alone. This time everybody is winning and I’m losing, and it hurts. I’m holding US bonds. The USD is depreciating (-10% since August), and bonds are going down, and down is going their Yield… what am I doing? How can I pretend to teach other people about personal finance when I’m so stupid? I’m performing way worse than someone who’s just keeping their money in cash, in CHF. This hurts me.

December 2nd

Another horrible day, where USD lost another 0.44% vs CHF and 0.22% vs EUR. BND went down 0.14%. It’s a shitty scenario… meanwhile, stocks go up.

December 3rd

Another shitty day for USD, we’re at -2% in 3 days… at least BND gained something today.

December 4th

A bad day for bonds and an incredible good day for stocks. It doesn’t make sense. At least USD recovered something vs EUR (not vs CHF).

December12th

The USD is declining again, this month it’s at -3% compared to both EUR and CHF… Monthly NW Delta is in the -10k range for both EUR and CHF. 2020 NW Delta is below +100k in both EUR and CHF. It’s the worst year on record for my finances since I moved to Switzerland.

It sucks…

I need to do something, this situation is not sustainable.

First, calm and relax. Take a look at this amazing Richard Coffin video if you’re feeling the same:

Second, let’s start planning in a rational way.

Where I am: I’ve sold almost all my stocks and minor bond ETFs, I’m and holding ~970k USD in currency unhedged US bonds. Waiting for something to happen.

“if I had all my money in cash, would I buy my current portfolio?”

Of course not.

What would I do instead?

How to Rejoin the Market

I would:

• Honestly reassess my risk aversion. Everything is going to be ok.
• Honestly determine the time horizon for my investments. Do I need my money now?
• Honestly assess my ability to understand the market. How sure I am that stocks are heavily overpriced? How sure I am we’re in an asset bubble? How sure I am the Efficient Market Hypothesis is not working?
• Swallow my Pride. Accept I’ve been wrong.
• Come up with an ideal asset allocation for long term portfolio, based on my risk aversion and income needs.
• Define the transition strategy. I’m not going to jump in all at once.
• Brainlessly stick with my new strategy. And not be tempted to time the market again.

Let’s do this exercise together, and please kick my ass on the comment section 🙂

Reassess my Risk Aversion

I’m scared of a strong NW decline. I think it all comes down to this. I’m addicted to seeing my net worth going up.

NW moves thanks to two forces: cashflow and market.

While I have a job, and while we save 60+% of our incomes, we still have a steady positive cashflow. The effect of a market decline could at least partially be compensated by the positive cashflow.

Once our wealth reached a certain multiplier of our yearly savings, I started feeling unsure. Savings in 2020 has been 120k CHF, while NW is in the 11-12x savings range. If we were 100% invested, a 10% market decline would zero cashflow benefits. I’d hate that.

It’s like swimming in the sea with a random current.

Your swimming skills are your savings, your cashflow, your incomes minus expenses.

The current is the performance of your investments.

When you’re “poor” there’s no current. Your ability to move in any direction depends only on your swimming skills. If you save, you build wealth. If you don’t, you stay poor.

While your wealth grows, the strength of the current increases.

The impact of your swimming effort decreases with the raising current. At one point you’re at the mercy of the random current. Your swimming skills help, of course, but where you’ll be tomorrow depends almost entirely on the strength and the direction of the current.

If your expenses grow your savings shrink, your swimming skills drop, and the impact of the current grows. Expenses are like extra burden you carry with you while swimming. If you drop your burden you can swim faster.

If your income shrinks your savings shrink, your swimming skills drop and blah blah blah. Your income is your physical strength. If you stop working out, your swimming skills degrade. While Michael Phelps can fight open ocean currents, I’m probably unable to fight lake currents.

Our wealth has reached a point where currents are strong. I’ve experienced a couple of market corrections and the flash Covid market crash, and holy shit how uncomfortable it has all been!

At the same time I see that our expenses are going up, and will continue to do so at least until BabyRIP leaves child care. 2021 will be a way worse year with regards to expenses.

Plus, since my 2019 burnout I’m perceiving my career very close to the end. Every month I think this is the last month I have a salary. I don’t see myself as someone with a good salary, but as someone who won a lottery. My nice salary history belongs to the past. Yes, I’m still cashing a good 200k salary, but it won’t last. I don’t want it to last. 2020 has been my last year of good earnings.

In the “swimming with a random current” example I was experiencing a strong current, a weakened body, and a 10kg block of concrete that I have to carry with me. I’m scared.

I’m scared even though I know the current is not supposed to be random. Historically it has showed a bias toward your desired direction. Apparently, at one point even if you constantly swim in the wrong direction (say… when the wealth reaches 25x your expenses 🙂 ) you’re expected to move in the right direction in the long term.

The current is our friend, we’re in a river, not in the open sea!

Even though I’m aware of that, I seem to only care about short term results now.

The current has been very strong in the right direction for too long, and I fear a reversion to the mean – even though nobody knows where the mean is.

Meanwhile, everybody seems so enthusiast of the strength of the current, and I’ve always been “fearful when others are greedy“.

In conclusion: my risk aversion comes from short-termism, lack of self confidence in my present and future ability to earn an income, and expenses that are objectively too high. And probably from a genetic, cultural, environmental lack of familiarity with managing a 7 digits wealth.

But maybe I shouldn’t beat myself up too much, it’s understandable to feel this way. Please, listen to this amazing Rational Reminder Podcast episode with William Bernstein (author of The Four Pillars of Investing). There’s nothing wrong with being more protective with your wealth once you’re “old”, or at your career sunset.

I will fight a bit, and push myself out of my comfort zone. Actually, I don’t know what my comfort zone is now. There’s no way not to play the investing game once you reach 7 figures. You can’t keep all your money under the mattress or in a checking account with negative interest rate.

I’ve not much to lose anyway.

Determine the Time Horizon for my Investments

This is connected with the previous step. The longer I perceive my money could stay on the market, the more I’d be ok with taking more risk, buying into a bubble, thinking long term, being Bob. The current can do crazy things in the short term, but over a longer period of time you’re gonna flow to the river delta!

As I said many times, our expenses keep growing and our incomes are going to disappear in a few months for sure. We might be exposed to a 100k CHF/Year negative cashflow for a while. I know, this is unrealistic and extremely pessimistic.

But it’s what my brain wants to account for. Let’s have a chat with him…

A -100k/year cashflow would require zero income and expenses growing by 22% compared to 2020. Ok, this is unrealistic on both sides. Well, not sure on the expense side, but in case of prolonged zero earnings I’m pretty sure we’d cut some expense, or even move back to Italy at one point. I don’t plan to completely stop earning money, and I will never accept such a negative cashflow for more than 1 or 2 years.

But even if we’d burn thru our cash for 10 years at a crazy rate of 50k per year, I can safely say that out of 1.387M CHF (our Net Worth in CHF on December 31st 2020), 887k CHF won’t be touched for the next 10 years. Ok, we might decide to buy a house (I don’t think in Switzerland though), but then the burn rate would decelerate. Say 800k can be thought as long term investments.

Some of my money are locked in Tax Deferred Accounts, like Pension Pillar 2 & 3, and that should be taken into account since I can’t withdraw them. Should I add them to my 500k “cushion + short term” amount?

Luckily no. My Pillar 3 is fully invested in tax efficient way, costing me less than the money invested in my taxable account. Pillar 2 is currently not invested, but I can consider it as part of the 500k “cushion + short term” investment at the moment. When I won’t have a job anymore I can move the money into a Vested Benefits Account, invest all of it, and moving some money from my taxable account into “cushion + short term”.

Given that I have ~300k CHF (growing monthly while I have a job) in my Pillar 2 I can keep extra 200k in cash / short term investment, and invest all the rest in a long term portfolio, with a time horizon of 10+ years.

Awesome!

Assess my Ability to Understand the Market

Wait, is 10 years “long term” enough?

Is 10 years enough to claim with absolute certainty that the market will be up?

According to the US Large Cap Stock Market (S&P500) it seems very likely.

But we’re not Americans, our “market” is the World Market (possibly ACWI, i.e. All Country World, i.e. developed plus emerging countries) and we mostly care about returns in our close currencies: EUR and CHF.

This is the best data source I’ve found on 1-5-10-15-20 years annualized returns of the world market, by Investment Moats, a nice Singaporean blog:

Also take a look at this graphs from Allocate Wisely:

Again all graphs show nominal total returns in USD.

It seems 10 years is a long enough time horizon, even though recent total nominal returns are closer to 5% than to historical average of 10%. And if we take into account current high valuations I’d bet the future will be less rosy than the past.

And it also seems that the USDCHF direction is not exactly helping:

“Yeah, but this is just 2020, let’s look at the historical data!”

Sure:

“Oh, come on… you’re still cherrypicking! Look, since late 2010 the USD is up, I’m bullish! Show me more data!”

You’re welcome:

“Oh… crap! 😐 ”

It seems like I’m arguing against the foundations of this entire “passive investing” thing, and to some degree I am. I also wrote a post about how little confident I am that the 4% Rule will work in the future.

I still think long term – very very long term – mankind will could grow indefinitely, and the exponential nature of growth makes today “high” joining price irrelevant. But I’m talking about 50 years in the future. I think we’re already priced 20 years from now. Reversion to the mean could last a generation, we could enter a global Nikkei index phase:

We live in a hyperinflated scenario where every asset is expensive, and risk-free rate is zero. Everything that can generate a recurring revenue stream is getting a crazy price tag. That’s also why the house market is booming again everywhere.

Still, stock prices go up, vertical. This is happening at the expense of future returns, just inflating “multiples” like P/E Ratio.

I’m not sure we can extrapolate too much from the past this time.

And I’m almost 44 years old, In a generation I’ll be gone.

In the long run we are all dead

– John Maynard Keynes

Ok, let’s take a deep breath.

All I’ve written so far in this paragraph is what my guts are telling me. Not just my guts, also my biases and my limited understanding of the complex phenomenon behind supply and demand.

I’m aware of it. I think market valuations are irrational, but I know that I’m the one who’s probably acting irrationally. And I know the worst thing to do right now is to act emotionally.

The rational investor in me who tries to keeps emotions at bay, trust the EMH, and believes in the human potential to unlimitedly improve society is telling me to stop and ask myself few more questions:

1) Can I predict when the market is going to drop? NO.

2) Is it guaranteed that when/if it drops I’ll have a chance to buy stocks at a cheaper price I see today? NO. Maybe these are the last days in human history where VT is priced below 100.

3) Will I buy stocks in the mid of a freefall, as soon as the index will hit 0.01$ below today price? NO. I would probably want to wait at least another 10% decline… else, why not buying stocks today instead of waiting to be offered today price in the future?

Am I just betting that tomorrow I’ll have a 1+% discount?

Well, in that case I’m betting on the green area below:

If tomorrow will be a day outside the green area (which happens 85-90% of the trading days) when am I supposed to get back in?

And if it’s inside that area, and tomorrow market drops by 3%… will I buy or wait for a larger crash?

I sold all my VT shares at ~79 USD/Share in July. VT price went up and down, offering me the option to rejoin the game at a similar price two times. I missed them.

A couple of weeks ago Michael Batnick wrote a post about why you shouldn’t wait for the stock market to crash, and it’s a very good one.

I’m convinced.

Even though it feels discomforting, I need to get back in.

Swallow my Pride

It’s hard to admit that in the last 6 months I underperformed the dead investor by a lot.

It’s hard to admit that I would have been way better off just asking a portfolio manager to handle my money, and paying them even a 5% fee!

It’s hard to admit that I would have been way better off giving my money to a Roboadvisor even though I know I wouldn’t need to pay a 1% fee to buy the same basket of ETFs.

The behavioral aspects of investing are the hardest to get. There’s no way to learn them 100% on paper, you must feel the pain. You can’t play poker with a paper account, it’s not poker.

So… I’ve been wrong for now.

“WRONG! Oh, sorry, I didn’t introduce myself: I’m RIP’s rational half“.

Now what? Should I buy VT at 94 95? I could buy 18% 20% less of shares with the same amount of money. I sold a used car and I’m buying it back at a 18% 20% higher price…

“WRONG way of thinking! We already discussed that. It’s a Sunk Cost”

Yeah but… all at once? I don’t feel like it. If I buy stocks and the market drops 20% the day after I’d feel really bad 🙁 And it’s not like the other consideration about high expenses and a dead-end career would disappear… they’re real.

“Ok, that’s a fair point. You can do Dollar Cost Average, Value Average or any other capital deployment strategy. But I’m glad to see that we moved to the next step!”

But I really, REALLY hate to accept I’ve been wrong!

“Would you feel better if you had never sold, and kept investing in stocks during the last 6 months?”

Yeah, of course!

“And if you still owned your VT, VYM, and EIMI shares, would you sell them today?”

I don’t think so!

“Are you the same person who wrote few paragraphs above the following quote?”

The right question you should ask yourself at any given point in time is “if I had all my money in cash, would I buy the number of shares I currently own of this assets?“

Well… yeah…

“Your honor, I have nothing more to add 🙂 ”

I see… well, maybe I would have sold. I started biting my fingers when VT reached 70, maybe at 85 or 90 I would have sold anyway. I don’t know.

“No no no shut up! We already covered it. Annie Duke, which is a black belt on this kind of games, said it perfectly at 5:23 of her latest James Altucher Podcast appearance: ‘you should be treating every second you held a stock as a new buy order‘. History doesn’t matter, your investment decisions should depend on strategies/formulas that don’t have ‘what happened in the past’ among their variables”

But I’m investing in the first place because ‘what happened in the past’, i.e. stocks returned 10% on average, the market always went up…

“Well, ok, that’s the only piece of information you should take from the past”

So… that can’t be questioned? I must believe that it will continue to be true? Even though Earning Yields (1/CAPE) is below 3%? And what about the future of USD?

“Ahem… I need to go”

And I should drop a lot of money into high volatility, low expected future returns, overpriced assets just because “There Is no Alternative“?

Wait, don’t leave me alone!

I’m not ready yet 🙁

“That’s a matter of risk tolerance, and we’ve already been there. I understand that you don’t feel comfortable investing even your long term money 100% in stocks, and that’s fine. Find an asset allocation that makes sense for you (I bet your 100% US currency unhedged Bonds is not your ideal long term asset allocation), one that you would accept investing into if you had all your money in cash today”

Ok, it makes sense now.

Ideal Asset Allocation for my Long Term Portfolio

All the rambling above has been going on in my head during the last 3-4 months.

I am at this stage now. I’ve accepted I’ve been wrong, and I need to find a good asset allocation that achieves several goals:

• Peace of Mind but some Yield.
• Has room for some small bets.
• It’s more aggressive when “valuations are low” and more conservative when they’re high.

Peace of mind (with some yield) is achieved by investing less than 100% in stocks (but also more than 30-40%), and by picking lower volatility stocks. I’m still in love with Value stocks, which are underperforming growth stocks for a couple of decades, but that might be more solid in case of a “traditional” market crash. I might want to play with the Five Factor Portfolio, that the guys at PWL Capital (Ben Felix above all) explained in this amazing Rational Reminder Podcast episode, and that’s based on Eugene Fama and Kenneth French research:

Here the link to the detailed PDF by Ben Felix, and here a list of few exemplificative portfolios that implement the strategy, tilted toward Canadian Investors.

Room for small bets means keeping a fraction of my portfolio “active”, say 5%, as a “relief mechanism” to give myself the illusion of control under the agreement that the remaining 95% of my portfolio will follow strict rules. Rules that can’t be changed by emotions, but only by sitting down and thinking, analyzing data, taking rational decisions.

Aggressivity based on valuations means the percentage of stocks should be function of one or more measures of relative stock misprice. I know this is probably suboptimal, but it allows me to be more invested when a crash has happened and less invested in situations like today, which helps keeping fear at bay. That’s a necessary compromise to keep my sanity.

A good candidate for a measure of valuations is Shiller P/E Ratio, also known as CAPE. Or the more recent ECY, also from Robert Shiller. The problem with CAPE is that it’s an absolute measure but we have no idea what’s the “right” value. The problem with ECY is that it’s a relative measure but it doesn’t tell us when everything is nonsense (put all your money into Tesla, it’s much cheaper than Bitcoin!).

I prefer to use CAPE, rebalance quarterly, and eventually re-evaluate the formula yearly.

I’m thinking about a stock percentage between 50% and 100% based on current CAPE value of MSCI ACWI:

• 50% if CAPE > CAPE_MAX
• 100% if CAPE < CAPE_MIN
• linear interpolation between CAPE_MIN and CAPE_MAX

I’m thinking about MIN = 10 and MAX = 30. MAX and MIN to be reviewed once per year, but shouldn’t move too much.

Basing one’s confidence on a singe market metric (that one is free to re-calibrate over time) looks good to me. Basing one’s optimism on CAPE is also what Big ERN found more likely to work during the withdrawal phase, given that the 4% Rule is Dead.

There are also many resources on CAPE-based asset allocation on bogleheads forum, though the general sentiment is that they’re suboptimal. I’m ok with that.

While S&P500 or Total US market CAPE is available everywhere, current MSCI ACWI CAPE is hard to find. The best proxy I’ve found is on StarCapital website, but it’s lagging few months:

And I don’t understand why the value they’ve calculated for CAPE are greater than respective P/E ratios. If earnings are growing over time, CAPE values should be greater than P/E Ratios, right? Am I missing something obvious? I don’t want to use a data source if I don’t fully understand it.

And btw, lagging more than 2 months might mean a lot: US CAPE is claimed to be 29.8, but it’s close to 35 today (January 7th 2021):

At the current (two month ago) World CAPE value of 22.3, according to my function, I should invest 69.25% of my long term portfolio in stocks. LGTM!

First Draft of a Sane Strategy

What do we have so far?

• 500k CHF liquid, or invested for the “short term”.
• 5% of the reminder (45k CHF, which is 5% of ~900k CHF) for “small bets” and fun money.
• What’s left should be the long term portfolio, ~850k CHF.
  • 70% of the long term portfolio (600k CHF, which is 70% of 850k CHF) in stocks, according to an asset allocation strategy TBD, inspired by factor investing and my desire to perceive an income from dividends. Even though dividends are tax inefficient in Switzerland, and irrelevant in general, high dividend yields are usually correlated with value factor.
  • 30% of the long term portfolio (250k CHF, which is 30% of 850k CHF) in bonds (which one, TBD).

On a monthly basis:

• Reinvest dividends. Use them to rebalance. Don’t sell assets to rebalance on a monthly basis, unless there has been a major gain/loss (10% movement or more in the market).
• If it’s a positive cash flow month (thanks to salaries and/or other profits), invest more money into IB or into tax deferred accounts like the Pillar 3A (if it makes sense, and if I haven’t already dropped the full jackpot yet).
• Have fun with the fun money. Do not rebalance if I lose money. Do not rebalance even if my bets are winning, until the relative weight doubles (10% of the long term portfolio).

On a quarterly basis:

• Put more money into the long term portfolio if the short term one is bigger than 500k. Do nothing if the short term portfolio goes below 500k. The initial “500k short term portfolio” is not target amount to be maintained over time, but a buffer that should last at least 10 years even if we have negative cash flow.
• Find the new stock/bond split in the long term portfolio based on the new CAPE.
• Rebalance among asset classes and within each asset class, taking into account tax efficiency in various asset locations (Pension Pillars, Brokerage accounts and so on).

On a yearly basis:

• Re-evaluate the 500k CHF size of the short term portfolio. It should not grow above that number, but it can shrink if my confidence increases, or if my endeavors generate some money, or if our expenses shrink.
• Re-evaluate MIN_CAPE and MAX_CAPE, and min and max stock percentage.
• Consider extra fun investment money if the year went particularly well: according to the strategy described so far, I’m never adding extra fun money. If our NW grows, the relative size of fun money can unfairly shrink. Anyway, I need to keep an eye on this. Having fun money to play active investing might consume a lot of mental energy and foster greed & fear, and other behavioral problems.

In a few (2-3) years:

• Re-evaluate the whole strategy, consider alternative assets, consider real estates (primary residence or rental properties), and so on.

First Considerations and some Preliminary Tuning

I kind of like the overall picture, but I’d like to make some considerations and tune some parameters.

Final Definitions: our Net Worth is made of short term money, long term fund, and fun money. When/if real estates or other illiquid asset classes join the party I’ll review the overall framework.

I like to call the long term “fund” because that’s my real “pension fund”, something you don’t want to touch a lot. The others are just “money”, to be used or played with.

Given that my strategy for the long term fund is already conservative enough, either I enlarge its initial size (shrink initial 500k short term money), or I play more aggressively with it.

I like to keep the dependency on CAPE, and not be fully invested in stocks at the mercy of high market valuations even in the long term fund, so I’d rather shrink the short term money down to 300k CHF, which means 4-6 years at least of living expenses (assuming pessimistic but not crazily pessimistic negative cash flow).

I’m also lowering the initial fun money down to 3% of the remainder. I want to invest the money guilt-free, better to keep the amount very limited.

Given that our NW on January 1st 2021 is 1387k CHF (yes, while we live in Switzerland I will use CHF as reference currency for investments), initial fun money is 33k CHF (3% of 1087). Ok, let’s round it up to 35k 🙂

The remining 1052k CHF constitutes the long term fund. The long term fund can only receive more money and can’t be withdrawn from unless other conditions apply.

In particular:

• If at any quarterly (or monthly) check the short term money is above 300k CHF (this Short Term Cap can change at yearly review time), the difference will be put into the long term fund, and maybe a small amount into the fun money. This is usually the case when we have a positive cashflow (salaries), and the shot term money is already capped.
• Dividends distributed by assets in the long term fund must stay in the long term fund, even though it’s cash, and in my Net Worth all cash sources are summed up. It will be an accounting hell, but I don’t want my long/short term strategy to change based on distributing vs accumulating ETFs. From now on, cash on brokerage account is not “cash” but part of the long term fund. Well, my short term money will also contain assets on IB that might distribute dividends… I’ll explore setting up multiple virtual accounts on IB.

The asset class allocation among stocks and bonds (more on “why bonds, in 2021?” below) will follow the CAPE based formula, with Stocks percentage decreasing linearly from 100% to 50% when World CAPE is between 10 and 30:

Which means today our long term fund should be invested ~730k CHF in stocks, and ~325k CHF in bonds.

The short term money should be held in cash, short term bonds, and other low risk assets.

Any liability should be covered by the short term money. It means if expected tax liabilities are ~10k, this amount is algebraically added to the rest of the short term money assets.

The short term money assets can overlap with the long term fund. I can hold the same product (probably bonds) in both portfolios.

Monitoring and Alarm Signals

If the short term money drops below 100k, then “somebody should do something“.

It probably means our cash flow is strongly negative, or it has been negative for quite some time. We still have 1-2 years of runway money, but it’s better to start looking into a plan B.

The condition can be met in very different scenarios like:

• In 20 years from now, and by then our long term fund has 10 Millions, which means it’s not a problem at all, and we should enjoy a FatFIRE (not early anymore) retirement.
• In 4-5 years from now, while the long term fund grew a bit and it’s now at 1.5M, which means we’re doing ok, and we might just want to refill the short term money.
• In 2 years from now, while the market crashed and the long term fund value is 500k, which means we’re screwed and it’s already too late.

As you see, the condition “short term money < 100k” is not the only one that needs to be monitored.

The Ravenna Threat is also still up and running:

Mapping between current holdings and the three funds model

The elephant in the room, of course, is my Pillar 2 while I still have a job. It’s not stocks, it’s not bonds, it’s not cash… what is it?

Well, I can keep modeling it as bonds. Very good bonds, actually. 1% guaranteed return in CHF, with a 3% effective returns in last 2 years (but I missed at least 9 months of good returns in 2020 because I moved the money out of Hooli Pillar 2 in October 2020). So I consider my Pillar 2 as bonds.

Given its size (close to 300k, growing by 2k CHF per month while I have a job) it must belong to the long term fund. Which means if the bond portions of the long term fund should drop below the size of my Pillar 2 I have accounting problems. as I said above, the long term fund should be invested 325k CHF in bonds… it’s borderline!

Let’s say the market crashes tomorrow, and I need to rebalance via selling bonds, and buy even more stocks because CAPE decreased… how would I do that?

If it happens while I still have a job and a Pillar 2, I’ll live with that. I’ll temporary “move” some of the Pillar 2 amount virtually into the short term money, and some of the cash / short term bonds into the long term fund and rebalance. Yes, it’s a cheat, but while I work (and while I have a positive cash flow) I can handle a “loan” from the short term money to the long term fund.

When I’ll quit, my Pillar 2 will be moved into one or two Vested Benefits Accounts, probably VIAC and/or Valuepension. The money in the VBAs will be highly invested in stocks, which means I will sell some of the stocks in my brokerage account and I will get back full control of my short term money.

I guess the rest is easy to attribute:

• Cash (excluding IB cash positions), taxes, and others will be “short term money”.
• Pillar 3A, VBAs, and most of my Interactive Brokers investments will be the “long term fund”.
• Some of the short term money will also be in Interactive Brokers, probably invested in short term bonds (like BSV, but not only).
• My Fun Money will probably be in IB (individual stocks? options?) as well, but may also be I’ll explore other alternative assets “just for fun”.

Few words on Bonds

“Hey RIP, I don’t know if you noticed but it’s 2021! Are you really investing in bonds?”

Yeah, I still think bonds can play a role. Lending money and cashing an interest is still a valid business model. Sadly, central banks are screwing us up, but I consider bonds to be “something”, while other unproductive-but-hyped assets like Gold and Cryptos to be “nothing” in terms of investment. Good for speculation, yes, but not for investing.

This is not a good time for bonds, but sooner or later rates will rise – they have to. If central banks won’t succeed in killing the free market, a time for bonds will come back.

Sooner or later I’ll write my post series on bonds, promised.

I want to keep investing in bonds, mostly as a place where to park cash for a small but positive return (in the short term money), and maybe play with more aggressive bonds in my long term fund.

If low yield, minus bond ETFs TERs, and eventually currency hedging costs will make the game not worth playing, I’d hold cash instead. Eventually split in many banks to stay below the negative interest rate threshold.

Yes, cash is trash, but I don’t buy the T.I.N.A. argument either: there’s always an alternative, we’re just not looking for it hard enough.

Few words on Alternative Assets

Gold? No.

Crypto? Nope!

P2P Lending? Nein!

Private Equities? Non!

Real Estate? Nunca Mas!

I’m excluding alternative assets from my long and short term strategies for now.

Of course I feel free to experiment even all of the above with my fun money 🙂

Few words on Real Estates

The low yield environment, and the T.I.N.A. ghost might suggest a house purchase.

Given my employment instability, location uncertainty, and the high prices of Real Estates literally everywhere, it doesn’t make sense to consider a primary residence purchase at the moment.

While I don’t exclude a drastic switch to a “rental properties strategy” for yield in the future, this is not something we’re considering in the first iteration of this strategy, a 2-3 years horizon.

Not today.

Few words on Currency Hedging

I intend to write a full post about this topic sooner or later.

I want to keep playing the stock game unhedged: a globally diversified portfolio of stocks is the best hedge against a single currency.

About the bond game, I’m currently feeling the pain of a strong dependency upon the USD vs CHF fluctuations. But currency hedging doesn’t come for free, and bonds yield is pretty low these days. I’m considering manually diversifying among bond markets and skip currency hedging.

I haven’t made my mind yet.

Few words on my Age

The CAPE based “stock percentage” formula above doesn’t take into account my age, i.e. the “real” time horizon of my investments. Target retirement funds in US are funds that automatically reduce stocks allocation with age, to reduce volatility at the expense of expected returns.

I don’t do that in my formula, but I explicitly plan to review the formula after 2-3 years.

Instead of adding extra age-related complexity in the formula, I’d rather re-assess my risk aversion, time horizon, and the other parameters in a couple of years, when we might have a less foggy picture of our future.

Few words on Money-based Life Decisions

As I mentioned above, the StupidiFI plan (Ravenna Threat) is still up and running.

We are not trying to design a full “withdrawal strategy”, or “life plan” today.

We are observing, monitoring, ready to take actions based on our desires first, and our financial conditions second.

If I’d stop producing an income and our Net Worth drops below a threshold, I will consider going back to work.

If living in Switzerland becomes financially unsustainable, and getting (and keeping) a new job happens to be hard and/or painful, we’d move back to Italy before we lose FI status there.

I perceive less freedom than our Net Worth suggests, that’s how I’m wired, but I think we’ve room for relax. We’re not fully FI, our desired lifestyle is not 100% financially covered, but we’re comfortably sitting somewhere in the middle of the FIRE Spectrum.

Long Term Fund

The long term fund takes possession of:

• My entire Pillar 2
• All our Pillar 3As with Finpension
• Mrs. RIP Vested Benefits Account with VIAC
• BND and VYMI positions (oops, they’re gone!) in Interactive Brokers
• Cash positions in Interactive Brokers
• Cash Deposit for the flat (let’s consider it Swiss bonds that yield 0%)
• Old Italian Bonds (yielding 6%, I won’t touch them until maturity date)

It’s currently invested:

• ~10% “World ACWI” stocks, a bit tilted toward Switzerland (VIAC + Finpension)
• ~30% in “Untouchable” bond-like funds (Pillar 2, Cash Deposit, Italian Bonds)
• ~60% in US total bond market (BND)

Very bad.

The Ideal Asset Allocation should be:

• F(CAPE): stocks
• 1-F(CAPE): bonds

With strategies TBD within both bonds and stocks.

At current World CAPE 22.3 (source), stocks should be 69%, and bonds 31%.

The long term fund should start with ~1.050M CHF (730k Stocks, 320k bonds).

Bonds

The bond strategy should be half “global bond market, all countries and all maturities” (like Vanguard BNDW) and half more “local”, or at least “less American”.

Since BNDW is composed by 46% BND (total bonds US) and 54% BNDX (total bonds ex-US), I might just buy the two underlying ETFs in different proportions.

If I can get an overweighed EUR and CHF exposure, I’m ok with non currency hedged bond ETFs. BNDX is composed of 60% European bonds. I might get a mix of 20% BND and 80% BNDX for a ~50% exposure to Europe bonds, 20% on US bonds, and 30% on everything else.

It means I can keep part of my BND shares (20% of 320k = 64k CHF).

It doesn’t matter that the traded currency of the ETFs is USD, what matters is the currency exposure of the underlying products, which will be “a lot of currencies, but at least 50% EUR+CHF”.

… but we have a problem: my Pillar 2.

While I have a job and a Pillar 2, I must consider it part of the bond component of the long term fund. Given its size (minus expected lump sum taxes) of 280k CHF, there’s not much room for other bonds at the moment.

It’s ok, I’ll live with that while I have a job.

Stocks

730k CHF should be allocated in stocks. Currently, only 93k (Pillar 3As and VBA, minus expected lump sum taxes) is invested in stocks.

My ideal asset allocation within stocks should:

• Be as passive as possible.
• Have exposure to Total World (ACWI) stocks, like Vanguard VT (and Pillar 3As and VBAs), say 50%.
• Extra exposure to Emerging Markets, like VWO or EIMI, say an extra 10%.
• Exposure to small cap value stocks (world), like VSS + VBR and  10%.
• Extra exposure to value/dividends stocks (world), like IWVL, or [VTV/VYM]+VYMI, 30%.

As I said I got inspired by PWL Capital Five Factors Portfolios, illustrated by Ben Felix in a recent Rational Reminder podcast episode.

Here’s their 100% stocks portfolio:

As we can see the Red components reconstruct a “World ACWI” index, a bit tilted toward Canadian stocks (US + Canada + EAFE + EM), while the Green components track Small Cap Value Stocks, (US + Ex-US). Small Cap Value stocks add up to 16% of this portfolio.

My portfolio is a bit different, with lower exposure to Small Cap Stocks, but higher exposure to Value Stocks.

The ETFs I indicated are not final yet.

Few words on Small Cap Value

There are many Small Cap Value ETFs for the US Market by Vanguard (VTWV, VIOV, VBR), by SPDR (SLYV), by BlackRock/iShares (IWN, IJS).

I picked VBR because it’s the largest in terms of AUM, but the others are just as good. The difference among funds from the same provider is usually just the actual index being tracked in the US Indexes jungle:

Sadly, there isn’t a good enough “World”, or “Ex-US” small cap value ETF.

There are indexes, like the MSCI ACWI SMID Cap Growth Index (there also a Developed World – non ACWI – version), but I couldn’t find any ETF tracking the index that meets some basic criteria like a reasonable TER, and large AUM.

The one proposed by PWL Capital (Avantis AVDV) is a bit small (400 M$), too young (2020), and it has a large TER (0.36%).

I’d rather take VSS for the Small Cap ACWI Ex-US. Large (7 B$), old (2009), and cheap (0.11% TER).

It’s tracking small cap stocks, not small cap value stocks, but I’m already getting 30% extra exposure to Value Factor elsewhere in my asset allocation.

Few words on Value/Dividend Stocks

Like for small cap stocks, tracking the Value factor outside US is neither easy nor cheap.

iShares IWVL tracks MSCI World (Developed) Value, it’s a 4 B$ fund, launched in 2014, Ireland Domiciled (UCITS compliant, available from European brokers, but also more expensive to trade, higher TER, high bid-ask spread, subject to stamp duties…), mentioned on JustETF.

Good, but not excellent.

Also from iShares, EFV tracks EAFE Value, which is Developed World excluding Us and Canada. 20 Developed nations instead of 22. It’s an old (2005), large (7.5 B$) US domiciled fund, with a surprisingly high TER (0.39%).

Again, good but not awesome.

I might decide to stick to VYMI for the World (ACWI) Ex-US Value, even though it’s not exactly “value” but “High Dividend Yield”, which is correlated but not the same.

“But you just sold VYMI, RIP!”

Ehm… yeah… but…

“It was the “coward RIP” who did that. If you didn’t notice we’re taking this thing over 😉 ”

Exactly, thank you my dear left brain!

Anyway, for the US part of Value Stocks the default solution should be VTV: US large cap value stocks.

But I don’t like this asymmetry. VYMI demands VYM in my portfolio. I might buy a piece of both.

I might invest 15% in US (5% VYM, 10% VTV), and 15% in Ex-US (15% VYMI) for a relative 50-50 split among US and Ex-US.

Not final yet.

Few words on Emerging Markets

This is my personal bet. It’s been my bet also during corona crash, and it played our pretty well.

I doubled down with EIMI on March 16th and 18th 2020 (21 USD per share), but of course I sold all my shares few months later at prices between 27 and 30 (for a 30-45% gain).

It’s now sitting at 37.70… almost up 90% from March 2020, and more than 30% above my sell price… it hurts a lot!

Maybe it’s too late for this bet 🙁

“Trick: don’t buy the same ETF but buy VWO 😉 ”

Yeah, you’re a genius! Wait, is this a rational thing to do?

“Ahem… I need to leave, bye bye!”

Few words on Vanguard Life Strategy funds

“RIP, why the hell are you complicating your life so much? Just buy one of the new Vanguard Life Strategy funds and you’re done! Ireland Domiciled, 0.25% TER, a percentage of bonds of your choice… what else do you want?”

I wanted to write a post about the new Vanguard Life Strategy funds, which I think are cool and should be more than enough for most of you.

But I want to fine tune both my bond percentage, based on CAPE, and my stock allocation based on Factor Investing (and some personal bias).

Pass.

Short Term Money

The short term money must be quickly available, preferably held in cash or other short term tools, like short maturity bonds.

I want the net “cash at hand” (actual “cash” + “taxes” + “others” in my spreadsheet) to be around 100k CHF. More than a year of expenses.

The reminder should be invested in short term bonds – if I can get a positive expected yield in my reference currencies (EUR/CHF). Else just hold extra cash, assuming I don’t incur in negative interest rates.

Currency Hedging, high TER, and low (when not negative) interest rates – especially for short term bonds – reduce the odds of finding a positive return in the bond world.

At the moment my BSV plus cash positions exceed the 300k short term money allocation by ~75k CHF.

I will keep ~100k invested in BSV, and another 100k in some EUR short term bond or EUR cash.

I know it’s a waste of resources, but it’s my short term fund. I can sleep better at night with it.

Maybe I’ll keep more BSV, up to the whole 200k, if I can’t find any EUR alternative. But I don’t want to experience another year of such a strong dependency upon USD currency fluctuations for my bonds.

Fun Money

The fun money portfolio will start with 35k CHF.

I don’t know yet what to do with it, but it will be fun 🙂

“RIP, it’s less than 1 BTC…”

Yeah, it doesn’t seem much… but I’m definitely not buying 1 BTC with my fun money 🙂

Of course investing my Fun Money is lower priority than putting back on track my long and short term funds, which means I have no idea at the moment what I’ll do with it!

Come back later 😉

Accounting

I’ve been talking about long, short, fun portfolios, but where are they? Am I going to open more brokerage accounts?

No, I won’t open any new account for now, unless required by some of the Fun Money activities (Angel Investing? Crypto? P2P lending?).

Long, short, and fun portfolios represent the strategical, virtual split of our net worth.

Bank accounts, tax deferred accounts (Pillar 2, Pillar 3As, Vested benefits accounts), brokerage accounts represent the physical split of our net worth.

I’ve implemented a WIP sheet in my spreadsheet called “Long Short and Fun“, that is going to deprecate the investing sheet.

I’m at 9k words for this post, I’m not going to explain the spreadsheet in detail today, but let’s say that when each entry in the last column is close to Zero my strategy has been fully implemented 🙂

Final 2021 Investor Policy Statement

Everything I’ve written above should be summarized in a new version of my Investor Policy Statement.

I will update my IPS doc asap.

I think having your strategy written down and yourself committed to it is a strong motivator.

The IPS should list “the why, the how, and the what” of your financial life. Go write your own!

Transition Strategy

I’ve more or less defined the “target” Asset Allocation for my portfolios. Yes, some small details are still undefined, but there are already a lot of “action items” that need to be done.

“RIP, where are your SELL and BUY order?”

Not so fast… I don’t feel comfortable in applying the strategy all at once.

“I thought we had an agreement, RIP…”

Yes, yes, I’m committing to reach ideal AA before the end of 2021.

I will move at lest 50k each month in the right direction.

I’ll give precedence to the assets that “don’t hurt”.

“What does that mean?”

It means that:

• Buying VSS shares without having ever held them doesn’t hurt.
• Buying VYMI shares at 64 USD after having sold them at 63 USD hurts a little.
• Buying VT shares at 96 USD after having sold them at 79 hurts a lot.

I’m only human, after all 🙁

Stick with the Strategy

“So, how long before you change your strategy again?”

I’m committing to review my strategy in 2-3 years, which is also a reasonable time horizon for my current personal crisis.

In 2-3 years I’m either still a Software Engineer, or a full time Creator / Blogger, or something else.

In 2-3 years either we decided to stay in Switzerland forever, or we packed our shit and moved back to Italy.

In 2-3 years either we had another child, or our family is not going to grow anymore.

In 2-3 years either my predictions about the market being a giant bubble have turned out to be true, or I won’t make predictions anymore.

This “half-assing everything” period should be over, and I won’t be revolutionizing the strategy anyway. Maybe some minor adjustments, maybe the impact of some bets reduced, I don’t know. But no more revolutions.

Meanwhile, I will brainlessly stick with my new strategy. No chickening out allowed!

So what?

It’s been a long long post, and if you’re still reading here I can’t thank you enough for your time 🙂

I hope you got value out of my long and investment specific post.

Please leave me a feedback, kick my ass, tell me I’m wrong…

[UPDATE: I received a lot of feedback and I decided to publish a Q&A post: Part 2-BIS, and a mail exchange with Julianek: Part 2-TER]

I’ve been exploring and building my strategy “live”, while writing the post. I’m not sure I’m going to edit it much, since I like its unstructured structure.

“But it’s boring, unnecessary long, repetitive… please, cut something out!”

Maybe it’s worth remembering that I’m mostly writing for myself. I’m thinking in public, and committing to publish my thoughts mostly for accountability and feedback.

Being useful, informative, and entertaining is a nice byproduct, but not the main goal of my writing 🙂

Having said that, I hope you had fun and learned something today!

Have a nice day!