With the stock market at all-time highs and interest rates zooming upwards, creating a more defensive investment portfolio with bonds may be a good idea.
The 10-year bond yield was at 0.51% in August 2020. Today, the 10-year bond yield has risen to about 5%. Therefore, investing in bonds pays more in a defensive investment portfolio. Here's a guide on how to buy Treasury bonds.
This post will review my after tax portfolio and discuss what I plan to do next. Feel free to chime in.
Defensive Investment Portfolio And Update
My investment portfolio was up 10% at one point in 2Q2015. Too bad I didn't rebalance then. Up 5.9% YTD is strong since the S&P 500 closed 2015 essentially flat. However, I didn't launch my portfolio until the end of January 2015, after the market had fallen about 3%. The timing was purposeful, but if I am to compare my performance to the S&P 500 since launch, then I'm only outperforming by 2.2%.
Select Losers
Lending Club (-25.5%): After reaching a high of $29 soon after IPO last December, Lending Club has been going straight down. The market is worried about rising competition in a nascent marketplace, as well as two large share lock-ups that just passed on June 9. The stock is not cheap at around 21X P/S and 69X forward P/E. With rising interest rates on the horizon, perhaps there is fear the lending book will slow down. That said, the stock looks compelling here.
Gold ETF (-9.2%): You would think that gold would outperform in a volatile market, but sadly gold has continued to be a dog in 2015. If Greece, Spain, and others exit the Eurozone, gold will probably rally. It's frustrating to have the right reason to own gold, but not have it perform when your reason for owning comes true.
Simon Property (-13%): REITs and other high dividend yielding stocks have taken a beating with the rise in the 10-year yield. One stock I'm eyeing is Zillow (Z), now down below when it first announced the Trulia acquisition. Yield stocks will continue to underperform in a rising rate environment as they become relatively less attractive. I still don't think interest rates will rise all that much and you are seeing strength in KB Homes +33% and Home Depot +6.1%.
Select Winners
Netflix (+48.2%): There's massive excitement about Netflix's impending launch in China. The problem is regulation and fees. Uber is spending a billion plus in China with no plans to make money any time soon. Netflix's business model of creating in house shows is working. It's just time to take some profits.
RenRen (+45.6%): I mainly bought RenRen because it transformed itself into a fintech VC. It was the easiest way for me to gain exposure. They lead the Series E $50 million round in several private companies, and have stakes in other big names like SoFi.
Yodlee (+47.8%): Is also another play on the fintech movement, as they enable companies like Empower to allow customers to securely access and link all their financial accounts so they can get a better picture of their finances for free. The fintech sector is going to be hot for the foreseeable future. Once fintech companies prove they aren't flashes in the pan by surviving for at least five years, the willingness of consumers to sign up increases due to the trust factor. Trust is so huge when it comes to one's finances. I've experienced my own uptick in readership after reaching my five year mark in 2014 as well.
Overall Portfolio Analysis
My portfolio is heavily weighted towards growth stocks that are expensive, which makes the outperformance YTD surprising given all the volatility. I think we'll be lucky to get a 10% total return for 2015, which is all the more reason why I'm kicking myself for not taking profits when the portfolio was up 10%!
My biggest portfolio changes will be to reduce winning positions with weightings over 3% (Tesla, Hawaiian Holdings, KBH, Honda Motors, and GoPro) back down to around 3%, and use ALL proceeds to increase my position in MUB, the iShares Muni Bond fund which is currently yielding ~2.7% tax free. I essentially want to create a 20% weighting in MUB in the near-term, that may go up to a 50% weighting with the hopes of achieving a 5.5% – 8% annual return on the overall portfolio.
We know the mass affluent class tend to be heavily underweight bonds based on a previous post that analyzed thousands of investment portfolios. However, with the recent bond sell-off, I'm using this opportunity to buy.
Why I'm Buying Bonds To Build A Defensive Portfolio
* Rates have moved up significantly since the bottom.
* I'm focused on MUB because my marginal federal tax rate is 33%. A ~2.7% tax free yield is therefore equivalent to a 4% gross yield vs. a 2.4% gross yield for IEF. The higher your income tax rate, the more attractive it is to hold municipal bonds, especially ones issued by your state to avoid state income tax as well.
* US bonds may rally if Greece breaks away from the EU. The probability is that Greece will work something out, and stocks in the US and in Europe will rally. But given the decline in bonds already, bonds look relatively more enticing. Note the Euro STOXX 50 index is still up 1.6% for the year.
* A recession could be on the horizon and I'd rather keep what I've gained.
Related: The Case For Bonds: Living For Free And Other Benefits
Make Money Passively In A Defensive Portfolio
I've constructed my portfolio to NOT have to constantly worry about the positions. My goal is to rebalance twice a year, and that's it. It becomes counterproductive trying to constantly trade positions in order to try and beat the stock market. You'll likely get your timing wrong, and the commissions will eat up your performance.
Make decisions based on fundamental research. Give your positions time to play out. Focus on an asset allocation that matches your risk tolerance.
In addition, focus on building passive income to pay for your lifestyle. A defensively investment portfolio with bonds is a good idea after such a massive run.
nvest In Private Growth Companies
Finally, consider diversifying into private growth companies through an open venture capital fund. Companies are staying private for longer, as a result, more gains are accruing to private company investors. Finding the next Google or Apple before going public can be a life-changing investment.
Check out the Innovation Fund, which invests in the following five sectors:
- Artificial Intelligence & Machine Learning
- Modern Data Infrastructure
- Development Operations (DevOps)
- Financial Technology (FinTech)
- Real Estate & Property Technology (PropTech)
Roughly 35% of the Innovation Fund is invested in artificial intelligence, which I'm extremely bullish about. In 20 years, I don't want my kids wondering why I didn't invest in AI or work in AI!
The investment minimum is also only $10. Most venture capital funds have a $250,000+ minimum. You can see what the Innovation Fund is holding before deciding to invest and how much. Traditional venture capital funds require capital commitment first and then hope the general partners will find great investments.
WEALTH-BUILDING RECOMMENDATION
In order to optimize your finances, you've first got to track your finances. I recommend signing up for Empower's free financial tools so you can track your net worth, analyze your investment portfolios for excessive fees, and run your financials through their amazing Retirement Planning Calculator. Those who come up with a financial plan build much greater wealth over the longer term than those who don't!
[…] there are signs that the market may soon be falling, take a more conservative approach in your investments. If you don’t have time to manage your money, then you might want to get […]
really enjoyed the article and found it to be very informative. I am thinking about investing in Silver for retirement. I found an amazing silver investor guide that was free, it gives you expert advice and it’s something I really do recommend, http://www.silverinvestorguide.com
Have you considered high yield bond funds? They have been fairly volatile lately and the funds that I hold have been down YTD several percentage points. I am often chastised for the weight of my portfolio in bond funds but it is making me a reasonable return on investment, so I don’t see where I am going wrong with it. I use USHYX (USAA high yield bond fund), DHY, and PMT. They provide a 6, 10 and 13 percent yield, respectively. To me, that return may be defensive (in that it is an investment in most sure bonds) but it is a yield that requires much less effort or monitoring. I do not fret about the price of the fund going down; in fact, I would rather it be down and make the reinvestment price a better deal.
I’ve never heard of someone “buying and early retirement home.” What does that entail? Will you be buying it with cash?
Sam, you said… “The higher your income tax rate, the more attractive it is to hold municipal bonds, especially ones issued by your state to avoid state income tax as well”.. Since you live in CA with near the highest state tax in the land, why are you putting it all in MUB instead of state issued Muni’s?.. Inquiring minds want to know.
I have CA munis as well. This is only one of several investment portfolios I have.
My mindset is the boglehead one here: I’m not trying to beat the market. I have some bonds, some stocks, in diversified ETFs, end of story. As you mentioned, people who buy constantly just get burned on the commission fee…
I rebalance only once a year, personally
I agree with your goal to not have to worry about your positions. Nice to have a portfolio that you rarely have to touch, let alone worry about. I’m sticking with 100% stocks for now, but am definitely moving more towards quality business, especially those that pay decent dividends (along with the dividend imputation tax credit we get here in Australia), rather than the poor performing, ‘undervalued’ businesses I’ve spent time looking at in the past.
I do like your rationale for buying bonds though – I’m just a little more aggressive at this stage with a small portfolio I’m trying to grow.
Cheers,
Jason
100% stocks? Is that for your entire investment portfolio? If so, sounds risky mate, especially since you were mentioning that you have been thinking of getting out of the rat race after your last job? Or has that changed?
But I guess if you have a small portfolio as you said, it’s not as big of a deal if there are losses. But eventually, you’ve got to develop a habit of creating a portfolio based on appropriate risk. Pretend the portfolio is $1 million in size. What would you do then?
Still a pretty solid gain so far this year for you. The markets haven’t been the greatest the last few weeks, hopefully they rally for the next half and we see some great gains!
Things seem pretty darn dicey now. If my portfolio is up 10%, I’m going 50/50 equities/bonds.
Thanks for the info! We are just starting down the path to financial independence and have a lot to learn. It’s refreshing to see some information on buying bonds as it seems like its on the back burner for most people. Thanks for the perspective!
-Mr. Retire by 35
No problem, but if you’re retiring by 35 then it sounds like you’ve got a quick plan to get there! How old are you now?
Sam,
What about Extended Duration Treasuries? In times of market shocks, they do better than anything else. Do you think maybe 25 percent of the bond exposure into those would make sense?
Do you have a specific ticker I can look at? After the bond sell-off, a 25% bond exposure looks just fine.
Nice job on your winners and for outperforming! I agree with MD, you have a nicely diversified portfolio there. And it does seem like an attractive time to get into more bonds. I’ll be doing some rebalancing soon and have been thinking about increasing my exposure a bit into bonds. It will certainly be interesting to see how the markets turn out between now and yearend. I don’t have a forecast of where things are headed but hopefully we will all have strong performance in our portfolios!
Total investment portfolio, I’m up around 19 percent for the year (around 15 individual + a few mutuals). I never rebalance because like you pointed out its too costly to do so. Im also in more for the long term. Fortunate to have some of this years winners. The winners I already had for a few years though before they were really considered “winners”. If I did rebalance the “winners” would be cut down sizeably but wouldn’t want to because I still do like them for various reasons.
Great return! What does the asset allocation look like?
Pretty much all stock. It’s like 75 percent domestic and 25 percent international.
Sam – I agree with your philosophy. You have a well diversified portfolio. For myself, 70 percent of my equity portfolio is comprised of 2 index funds that give me broad, global exposure for a $ weighted expense ratio of 8 basis point. Hard to beat that over time. 15% is in an active manager at 42 basis points who has a great track record and does NOT hug an index. The rest is where I try to find value. Right now, I am not finding much. I have a position in APple that I bought in 13. I had NLY, VNQ and KO but sold them late last year as valuations rose. Looking at NLY again.
As for the fixed side, I am one of those who has mostly avoided bonds. In my retirement plan, I have a healthy amount in a stable value (retirement savings trust) that is earning 2.07 percent. Unfortunately, this is only available in a qualified plan. I consider this to be bond like exposure. The rest is in 2 FDIC insured money markets earning 1 percent.
I agree that treasuries are safe at this level. I would caution you on muni’s though. Puerto Rico, Chicago and other could effect the entire GO market. If that happens I would buy. Also, the correction has quietly begun in high yield corporates. A 14 percent discount to NAV for HYT. At 22 percent, I will consider it.
Regrettably, I am not smart enough to buy firms like Netflix. I know a lot of people have made $. There is just too much Benjamin Graham/John Bogle in me, I guess. I also greatly admire John Templeton. My deep discounted, value orientation comes from him.
Thanks for a great site!
Thanks for sharing your positions MD. Can you elaborate on the Retirement Savings Trust at 2.07%?
I enjoy having 90% of my wealth in plain vanilla equity and bond index funds/ETFs. The other 10% I go out and speculate on names like Netflix, startups, etc.