Psssst… yes, it’s a 5k words article as usual, but SPOILER ALERT halfway thru the article there’s a section with best ETF selection by Mr RIP!
Hi RIP friends,
As announced in my last quarterly update I’m spending some time to review our life and financial plans on several levels.
It will not be a quick process: this is a major revision and not some incremental improvements.
It’s like launching “RIP Financial Strategy 2.0“, something worth an announcement and a step by step public review!
I hope you can get some inspiration, benefit from it, and (finally and most importantly) give me some feedback 🙂
Anyway, the RIP 2.0 is not over yet. I’ve just scrubbed the surface and only grabbed the low hanging fruits as I’m going to describe here with, as usual, a lot of details.
Why a major review?
It’s been almost 2.5 years since I started investing for FI and more than a year since I drafted my incomplete initial plan under the form of an Investor Policy Statement, as suggested by PhysicianOnFire.
It’s been incredibly helpful to me: it helped me defining a strategy, sticking with it, avoid following trends and trying to be smarter than the dead investor. I recommend you to write an IPS before start investing.
But as time passed I acquired more knowledge, priorities changed and goals are changing too. It’s healthy to review your overall strategy every 2-5 years or after any major event, and make it match your new goals, needs and changes in life in general.
I’ve been accumulating ideas, notes, feedback for a while, thanks to the FIRE bloggers community and also thanks to you my readers. It’s time to put them at work and let the revolution begin!
What do I mean by a “revolution”?
Let’s start introducing the Hierarchy of Financial Abstractions (copyleft by Mr.RIP 🙂 ), i.e. the abstraction layers of my financial review, sorted from philosophical to pragmatical:
1) Life Goals
The big questions!
Like: “what’s my goal in life?“, “where do I see myself in 5 years“, “what am I passionate about?“, “where do I want to live and how?“. These questions may not seem related to money but of course they are!
Want a better question? “what would I do if money weren’t an issue?”
Those are hard questions that take some time and require introspection. For most people these questions will be unanswered until deathbed time, where regrets happen. I like to spend a lot of time asking myself deep questions and getting to know myself more. I’m with uncle Socrates:
The unexamined life is not worth living.
Anyway, I’m not alone anymore in my decisions. And answers to the above questions change over time. When the dust of this vibrant period of my life settles I’ll demand family meetings to draft plans for the “second chapter” of our lives 🙂
2) FIRE Plans
To address, answer and act on the
mid life crisis fundamental questions above one has to fix the “how will I bring some food on our table and a roof on our heads?” question too, i.e. you need a financial strategy.
It could be “find a job you love that pays the bills and work there till you die”, or it could be “save some money to get another degree” or “move to a different country” and so on… Or combinations of “so on”s.
In my case, eventually reaching Financial Independence and being able to Retire Early is the goal.
Ok, it’s not the actual goal. We all know that Early Retirement is not a goal itself, but something that enables you to devote more time and energy to self actualization (hi Maslow!).
So even if the “Life Goals” step is WIP, I know by heart that I feel so much more fulfilled if I can follow my passions and I don’t have to sit on a desk each and every day.
Which means it is ok to see FIRE as an intermediate step toward Life Goals.
I need to focus on the details of my FIRE plan, like: “how much will I need per month/year?“, “which strategy? Entrepreneurship? Real Estate? Stocks? All of the above?“, “which SWR (if stocks)?“, “regular FIRE or leanFIRE? fatFIRE? baristaFIRE?“, “regular ER or semi retirement, intermittent retirement (sabbaticals), permanently working part time, seasonal working, whatnot?“, “where are we in the mobility spectrum? Retiring in a permanent location, planing to move every few years, traveling forever?“, “owning or renting?“, “children? How many? How much financial support are we providing tot them? Until what age? Planning to leave a fat inheritance after our death or… who cares?”
Those are very important questions! They will impact lower levels: if you plan to buy an expensive house in 5 years you probably don’t want to invest in high volatility assets.
According to your FIRE plans you need to act on several verticals of your life. Those who impact your finances are Earning, Saving and Investing (the so called ESI scale).
Note that the IPS covers mostly the Investing aspects of the ESI scale. In mine you’ll find few lines regarding desired earnings, savings and saving rate but not much more. Below the FIRE plan layer, and sibling to the IPS layer, there should be other layered structures on Saving (spending, frugality, budgeting) and Earning (skills building, career growth, side hustling).
Here we will only focus on Investing.
The IPS describes the overall dynamic wealth management and growth strategy. You may decide to split your future timeline in an accumulation phase and a withdraw phase, or maybe add a coasting phase at the beginning of your ER (like Joe @ retireby40 is doing), or maybe you want a Yield Shield for the first 5 years of ER (like Wanderer @ millennial-revolutions is doing).
I said dynamic since your IPS may contain some conditional statements (I like to call them life algorithms) like: “if NW < 20Expenses I’ll go back to work” or “if market returns are negative we can cut our expenses by 20%” or “if NW > 50Expenses we will invest in riskier assets or donate money to charity or fund a Ping Pong school for Pastafarians or whatnot“.
IPS should also mention withdraw strategy, safety margins, and, of course, your detailed asset allocation and how you plan to change it over time.
The IPS makes sense even if you’re not investing in stocks/bonds at all, i.e. if you’re following another path to FI.
It actually makes sense even if you’re not aiming to FIRE: you should always know what you are investing for, as much as you need to know what you are investing in.
4) Asset Allocation
Coarse grained asset allocation usually ends up into the IPS, but can be thought out independently.
Your goals and your plans will impact your AA but to some extent that’s probably a nice point of decoupling. It’s so nicely equidistant from both ends of the hierarchy that enables random locker room chats and after-three-beers rants without having to share values or life goals or your actual finances.
It’s the abstraction layer (along with components allocation) for which I get more questions from friends who know I’m into investments.
By coarse grained I mean “how much in cash? how much in gold(lithium)? how much in bonds? how much in stocks? real estates? what else?“, or “do you bind your A.A. to your age? to current market situation? to inflation rate? to interest rate? to your country? to your geographic area (EU/US/Pacific…)”
5) Costs vs Efforts (and control) investment spectrum
How do you implement your investing strategy? How much effort are you willing to put into it? Here the spectrum ranges from full control, low cost and high effort to minimal control, minimal effort, high costs. Sorted from full control to no control:
- Trade individual assets like individual stocks, bonds, precious metals. Good luck with diversification and with handling thousands of securities.
- Trade geo, capitalizations and sector specific index funds like ETFs like US Tech high dividends, Europe small cap Energy, Emerging Market consumer goods, Chinese High Yield corporate energy bonds, Finnish furniture large cap and so on.
- Trade geo and capitalization specific ETFs, like US large cap, Euro mid cap, US small cap and so on
- Trade geo specific ETFs like Pacific, US, Euro, Emerging…
- Trade home & away ETFs, like total domestic market and total foreign market. Common in US where domestic and foreign are almost the same size. Doesn’t make sense if you’re from Andorra though 😀
- Trade world ETFs. One ETF to rule them all.
- Use Roboadvisors. I don’t want to make decisions. Mr Robot, please, invest for me.
- Invest in Managed Funds. Give your money to suited up banksters for an amazing 2% yearly fee and sub sub sub optimal performances!
You’re not bound to stay only on a single layer here, I own assets at almost any layers above, including managed funds (just for Pillar 3A), but I suggest you to pick one layer as a base where to invest the majority of your net worth.
As a passive but awake and aware investor I strongly discourage to pick the two extremes 🙂
6) component allocations
This is fine grained AA.
You decided you want to invest 60% in “stocks” and you’re ok with the relatively low effort “geo specific ETFs” strategy. Now, which percentage do you want to invest in US? Europe? Pacific? Emerging Markets?
Same for other asset categories (bonds, precious metals, cryptocurrencies, real estate markets and so on).
7) security choice
Given you want to invest 10% of your net worth in Large Cap US stocks, which is the fund that better works for you? Which is the index you want to track? Is S&P500 ok? Do you want a distributed or accumulating ETF? How to compare two ETFs that track the same index?
This is mostly a manual and objective task than doesn’t leave much room to opinions, but still some.
I mean if the quality difference of two funds is high enough you can easily tell which one is shitty, but if they’re close it’s a matter of personal taste and not always an apple to apple comparison – and in the end it doesn’t matter much.
For example you might trust more an ETF with higher TER than another one that also has bigger market capitalization or more tax efficient distributions of profits. You may want to avoid US domiciled funds for estate tax risks even though they’re more tax efficient (and you get back the 15% US dividend withholding tax). Or maybe you already own shares of a slightly inefficient fund but switching to a better fund costs trade fees which don’t justify the move.
I’ve written a long post on how to pick an ETF given an index you want to track, go read it!
8) trading details & broker choice
Given a specific ETF, in which stock exchange you want to trade it? In which currency?
Yeah, minor details.
How am I going to take decisions on this hierarchy?
It seems the normal approach would be to go top-down: from existential questions all the way down to small details.
That paralyzed me for a while: asking myself deep questions in this time of continuous personal change scares me and my instinctive reaction is to procrastinate and wait until the dust settles.
By continuous changes I mean facing some sort of mid life existential crisis, switching from dating to married and soon becoming a father, watching my body going thru physical changes and experiencing passions and interests solidification, drifting away from what’s considered normal.
These changes could be summarized in a general lack of confidence in future ability to perform at the same level. 10 years ago I could have starved for a week if necessary. I could have worked on a job I didn’t like more than 10 hours each day, if necessary. I was strong and resilient. Now I’m scared of becoming irrelevant and being obsoleted away. Having enough money in the bank alleviates the problem and it actually gives me some sort of excitement and makes me not care about young and smart guys obsoleting me away on fields I care lesser every day.
If I were living paycheck to paycheck I’d be scared to death, I don’t know how normal people who don’t save enough and who work on easily automatable jobs can live with this giant Damocles Sword hanging over their heads!
Anyway, since the philosophical stuff is pretty messed up these days, I decided to start bottom-up and top-down in parallel, meeting my Life Goals somewhere halfway.
In this “RIP revolution chapter 1” I’ll describe changes and decisions up to the Asset Allocation layer.
The lower levels
I like Interactive Brokers and I don’t plan to switch to another broker, but I’m considering broker diversification to reduce risks and maximize coverage in case of a broker failure.
The question I’m trying to answer is: “I have more than 500k USD invested in IB (500k is the SIPC limit coverage, and yes IB-UK accounts are covered by SIPC), do I feel comfortable having all my eggs in one basket?”
Probably IB is “too big to fail”. It’s a solid company as old as I am (founded in 1977) with investors assets locked away from company capital. The risk of losing my assets is comparable to the risk of losing my money in a checking account with a big bank.
Anyway, it’s worth considering at one point opening a second account with Swissquote or Degiro or whatever else. Yes, these are the problems associated with having money 🙂
So far, my decision is to stick with an IB-only portfolio and reconsider it when my total assets invested with them will reach 750k (nice arbitrary value, I didn’t even specify the currency!) or if IB S&P rating would decrease from current BBB+
On the stock exchange side, I’ll let IB do the smart thing among stock exchanges that trade the ETFs I want in the currency I want.
Example: assuming I want to stick with CSSPX (my current ETF tracking S&P500), then I need to pick a ticker among the following:
The ticker selection doesn’t change the overall performance of the fund, it’s just just a way to decide on which stock exchange and in which currency I want to trade the ETF.
I usually care about the currency and don’t care about the exchange. Maybe one day I should, since trade fees change according to stock exchange.
My guidelines here are:
- avoid too many forex trades, for efficiency reasons.
- avoid having other currencies in my portfolio than the magic three (EUR, USD and CHF), for simplicity reasons.
This micro decisions are not interesting to you dear passive investor friends, so let’s not waste your time here. Btw, in the example above I’d pick the USD ticker traded in London Stock Exchange (CSPX.LN), but usually let IB be “smart”.
That’s where a lot of effort has been done so far in my RIP Revolution chapter 1!
Luckily, I’ve not been alone in this.
The Italian Hooli Investment Club (IHIC for friends, which is composed by myself and 2 colleagues and dear friends of mine), after roughly a week of its members spare time, has put together an amazing “best ETFs” spreadsheet that I’m going to share with you here, enjoy!
We’ve put in the spreadsheet our favorite ETFs and colored them by asset type and geographic market. We collected ETFs that we owned and those who we heard of from friends, other colleagues and broader Hooli financial groups. I guess we can claim that this is a collection of the best ETFs available in Switzerland (maybe Europe?). Most of them are domiciled in Europe (mainly Luxembourg and Ireland), some of them in US.
What’s in the ETF list sheet?
- Asset type: stocks, bonds, real estate, precious metals and so on.
- TICKER symbol (one of those associated to the fund ISIN), ISIN, fund domicile.
- Profits (or virtual profits for Swiss taxes for Accumulating ETFs, more info in my ETF 101 post) in last 3 years as reported on ictax for tax purpose. N/A means the fund was not on ictax for year X, which is usually bad, while a question mark means that past year (2017) profits are not in ictax yet. Essentially, between 2 accumulating funds it’s preferable the one with lower profits (it means less taxes) while between 2 distributing it’s preferable the one with higher profits. To compare an accumulating vs a distributing you would need to do a discounted cash flow analysis or trust your gut feelings 🙂
- Geographic area and actual tracked index.
- Total Expense Ratio, a.k.a. TER. The lower, the better.
- Fund capitalization. The higher, the better. The capitalization is in “millions” (of EUR/CHF/USD).
- Use of Profits, i.e. Accumulating or Distributing.
- Who issued (and manages) the fund. Vanguard, iShares, UBS and so on.
Note that we didn’t collect funds performances data. We assume that 2 ETFs tracking the same index should have similar performances before TER (tracking errors are kind of random).
So, here you have 3-4 or more ETFs for each index we care about.
Feel free to use our analysis and build on top of it 🙂
Personal conclusion from this analysis can be found on the second sheet of the spreadsheet, along with the tentative asset allocation.
Here’s a screenshot:
Here you can see our AAs, mine and those of my 2 friends who I’ll call “Friend A” and “Friend B”.
I’ll get back on the AA later. Let’s focus on security choice, i.e. which ETF to pick given an index.
Bonds – Low risk
Swiss pension Pillars 2&3 and Italian CDs. Low risk, low rewards. I can’t control much here.
Bonds – High Yield Corporate
Friend A did some investigation and suggested few ETFs.
I like the WING one, more exposed to EU than US.
Bonds – Emerging Market Governments
Same here, I let my friends do the research and prepared myself to jump on the bandwagon.
My pick here is IEML: slightly lower TER and bigger size.
I like REIT. I like real estate investing without having properties. I still have a property, but once it’s gone I may invest more in REIT. It’s a good Yield Shield for the first years of early retirement, where sequence of returns risk can screw your plans.
Anyway, the funds we found are so different from each other that may be worth differentiating among them. Since I’m not going to invest much here, I decided to just pick one. I may change this decision in the near future, once I sold my apartment.
My preference is for IPRP thanks to good returns and nice size. Friend A goes with CBHOUS and friend B with REET which is probably the best, but I’m trying to avoid investing in US domiciled funds.
Stocks – US Large Cap
The first elephant in the room!
One of the big question marks in our meeting was: “US domiciled funds or not?“. After running my numbers I decided that it’s not worth for me to do the switch, i.e. sell all the CSSPX and buy the popular ETFs IVV (iShares) or VOO (Vanguard). So I stay with CSSPX, which is also issued by iShares btw.
If I were starting today from scratch and ok with investing in US domiciled funds I’d surely pick VOO.
Stocks – US Small Cap
The Small Cap US funds analyzed are mostly similar. Excluding the US domiciled one, the two by iShares are both IE domiciled: CSUSS and IDP6. Differences are in the index tracked (MSCI USA Small cap vs S&P Small-Cap 600) and profits distribution, but small caps are usually growing companies and not dividend companies.
I didn’t investigate much, but given that I already own CSUSS I prefer to stick with it.
Stocks – US Tech (NASDAQ)
I used to have a tech ETFs (XKLS, not listed here) but I sold all my shares in September 2017. I don’t like to mix too much in the Costs-Effort spectrum and I also don’t want to double down on tech, given that I work for a tech company.
My friends both own Nasdaq ETFs, preferred is QQQ (US domiciled).
Stocks – Europe Large Cap
The other elephant in the room.
Two years and half ago I did my research and ended up investing in SC0C. I’ve done a new round of research in April 2018 and I can see SC0C is definitely not a top class ETF.
Shame on me for having been such a bad model!
Anyway, I decided to switch to MEUD even though justETF says “This fund does only have marketing distribution rights for Germany, Norway, Sweden, Austria, Finland, Denmark, Luxembourg, Italy, United Kingdom, France, Spain, Netherlands“, implying “not Switzerland” I guess.
But rule number one of the investment club is “if it’s on ICTAX, you can invest in it“, and it is.
In EU Large Cap there’s been no agreement between the three of us: friend A picked EMEUAS and friend B picked VEUR. Friend B is a Vanguard addicted 🙂
Stocks – Europe Small Cap
Shame on me again!
I thought STOXX600 index held 200 Large, 200 Mid and 200 Small cap in equal weight, but that’s actually the STOXX600 Equal Weight index! So the actual weight of small cap in the index is not 33% but an insignificant 0.44% (according to this thread on bogleheads forum).
That means so far I’ve not been investing in Small Cap EU at all.
Given their recent and historical performances, shame on me again!
To fix this I had two alternatives: investing in a STOXX600 Equal Weight fund, covering EU Large and Small cap with a single fund, or invest separately in Large cap and Small cap funds.
I decided for the latter.
The small cap ETF I chose is CSEMUS, which is the same one chosen by my friends.
Stocks – Switzerland
Investing in domestic market is a form of home bias that makes sense.
Switzerland is not a huge home market though. Also, it’s not growing much. Anyway, 3 out of the top 5 stocks in the STOXX600 index today are Swiss (Nestlè, Roche, Novartis), totaling 6% of the fund capitalization.
I don’t invest in any Swiss specific fund (excluding the PostFinance Pension75 Pillar 3A fund).
Friend A agrees with me while friend B invests in CHSPY, by iShares.
Stocks – Asia/Pacific (no Japan)
My pick in Pacific (excluding Japan) is CSPXJ. Nice fund size, low TER. The only problem is high taxation, but still manageable.
Both friends A and B go with UIQI, they’re obsessed by taxes.
Stocks – Japan
We used to differentiate between Pacific and Japan since our first analysis back in early 2016.
So I and friend A invest in “Pacific excluding Japan”, while friend B invests also in Japan.
There are still amazing large cap Japanese companies like Toyota, Honda, Mitsubishi and Sony. Well, if we exclude Sony (that’s still on top of its game) the others are kind of dinosaurs compared to where the world is heading.
Anyway, given a 30 years long recession maybe the Japan CAPE is very very low… let’s take a look… holy sheeeet that’s ridiculous! It’s 28.30 today and has always been above 20, with peaks above 100!!
Stay away from Japan!!
Wait, RIP, are you trying to be smart??
Yes, I know, this contradicts some of my principles. The fact that Japan has problems is already reflected in stock prices.
Anyway, I’m living with my contradictions and will come up with a resolution. We humans are complex creatures, contradictions awareness is a very good start in self understanding 🙂
Friend B, Vanguard addicted who invests in Japan, picks VJPN.
Stocks – Emerging Markets
Again, shame on me. I was investing in an inferior ETF (CBMEM).
I switch to EIMI. Lower taxes, better replication, bigger fund size and same TER.
Stocks – High Dividend Yield Stocks
I know, I’m messing up with the cost-effort scale and mixing layers. But again, I’m aware of my contradictions.
I’m experimenting with Yield Shield, and Dividend stocks are one of the shield key components.
It’s not very efficient in Switzerland (profit is taxed while growth is not) and the fund I pick is not US domiciled so I also lose US withhold tax. It seems stupid from any point of view, I know.
My fund is VHYD, at least I’m with Vanguard 🙂
These are my picks (and my friends’). My picks follow a somehow consistent strategy of avoiding US domiciled funds to stay away from US Estate Tax at the small cost of leaving some fraction of my dividends on the table.
Apparently, since everybody who owns a financial blog seems to need some kind of bullsheet disclaimer here is mine: I’m not a professional financial advisor bla bla bla so do not sue me if you do stupid things bla bla bla use your brain, double check whatever is told to you and go fund yourself if things go south.
Ok, cool, let’s move on 🙂
- 25% Large US
- 10% Small US
- 25% Large EU
- 10% Small EU
- 5% Pacific (no Japan)
- 5% Emerging Markets
- 20% World High Dividend Yield
Symmetry between EU and US, significant exposure to small caps (historically higher returns and higher volatility), significant exposure to dividend stocks (historically lower but steady returns, with some cash flow), maybe too small exposure to Emerging Markets and Pacific and “gg Japan, thanks for the robots and the animes!”
- 90% Low Risks (Pillar 2, Pillar 3A saving accounts, government CDs)
- 10% Global High yield corporate
- 10% Emerging Markets Governments
I’m not much into bond yet. Just read few introductory resources on high Yield bonds (1, 2, 3, 4) and decided to give it a shot. That’s not happening soon since my bonds coarse grained allocation is more than covered by the low risks, which are locked (Swiss Pensions).
That’s still messed up a little bit.
I would like to stabilize myself in the “geo and capitalization specific ETFs” of the cost-effort spectrum, but I own assets at other abstraction levels, like world funds, geo specific and maybe in future some individual assets.
I perceive that with time I’m moving toward “lower costs, higher effort”, which is somewhat dangerous and not at peace with the “simple path to wealth”.
I attribute this trend to my growing curiosity for finances, my desire to optimize and some dangerous not-so-hidden desire to “be smart”.
Asset (type) Allocation
Stocks vs Bonds vs Real Estates vs Gold vs Cash vs what else? Cryptos? Art pieces?
It’s ok to change your AA over time. Apparently there’s also a correlation between net worth and asset allocation.
Here’s an amazing graph from visualcapitalist.com
My final-for-now Asset Allocation is:
- 65% Stocks
- 30% Bonds
- 5% REIT
It’s the right exposure to stocks according to my risk aversion and loss aversion.
65%, 30% and 5% of what? of your Net Worth?
The 100% pie to allocate is not my full Net Worth, but what’s left after I remove:
- Cash cushion (emergency fund) of 30k. Decreased from previous value of 50k. The cash cushion is the sum of all cash accounts and the “other” category of my net worth like liabilities, and “real” credits.
- “Virtual” credits. Take a look at latest financial update for more details.
- My flat in Milan.
Why I don’t consider my flat an investment? Well, it definitely isn’t. It messes up with my asset types percentages. I would like to invest 5% of my NW in Real Estate or REIT, but since my house is worth 9-10% of my NW I can’t rebalance and other assets would be underrepresented. When (if?) I’ll sell it, I invest the proceeds according to my AA strategy.
I face the same problem with other locked assets like Pension Funds, but I don’t want to cut them off my AA or everything would be messed up or I would have to artificially adapt bond allocations. When I’ll get my Pillar 2&3 back (leaving Switzerland) I will likely redo a major financial review at AA level.
The plan is already effective! I’ve executed it on April 19th 2018 🙂
Sold all my SC0C and CBMEM shares and bought MEUD, CSEMUS, EIMI and IPRP.
There’s no place for bonds minorities (WING and IEML) since low risks bonds are over-represented and locked.
Fun fact: since my investing tab has all values in CHF, when I bought MEUD I confused the 125k allocated to EU Large Cap as EUR instead CHF. But 125k EUR is ~150k CHF, so I bough more than planned (25k CHF more) and now EU Large Cap is over-represented in my portfolio. Shame on me!
I didn’t want to sell right after having bought (that could also be considered an active trader action, with bad tax implications), so now I need to wait for a ~150k CHF NW growth before EU Large stocks will be back in their allocated percentage.
Last but not least, I traded ~500k CHF worth of funds for a total trade fee paid or ~190 CHF (<0.04%).
It’s not cheap to trade large quantities, especially on European stock exchanges (another point for US domiciled funds…) But thanks to my broker, Interactive Brokers, these fees are acceptably small.
Nest steps are straightforward: cover the upper part of my financial revolution: Life Goals, FIRE Plans and IPS.
I’m investigating Safe Withdrawal Rates spectrum (candidate for next post), exploring actual FI Metrics in Switzerland and in Italy, exploring alternative FI path (semi, lean, barista…), also exploring sabbatical and/or a job and/or career change.
Stay tuned 🙂