Portfolio Review: IPS course-correction for small/value tilt

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daave
Posts: 189
Joined: Thu Nov 07, 2013 7:28 pm

Portfolio Review: IPS course-correction for small/value tilt

Post by daave » Thu Jun 14, 2018 11:49 pm

Hi Bogleheads,

Thank you in advance for your thoughtful input.

Cash / Emergency Funds: A little over $200k, much of this earmarked for a house down payment in the very short term, sitting at Ally Bank.
Debt: $8k in student debt at 1.8%, no other debt.
Tax filing status: Married filing jointly
Tax rate: 24% federal, no state income tax (will likely scrape into 32% bracket next year)
State of residence: WA
Ages: 30/33

Up to this point, I've been invested in a fairly typical indexed portfolio, with a minor small-value tilt, and with the only unusual thing being a 10% (shall we say "play money"?) allocation to individual real estate loans through PeerStreet. Although the PeerStreet notes have been performing reaosnably well (7% IRR), and I do believe they are adding some diversificaiton (no individual loan is for more than $1000, and this asset class is imperfectly correlated with equities and bonds) - overall I find the level of micromanagement required and the cognitive overhead to not be worth it any more, so I'm planning on exiting this position as my notes mature.

I've also been doing more reading and research, and am increasingly convinced by the crowd that advocate tilting towards small and value in the hopes of improving long-term risk-adjusted return. As a result I'm planning to change my asset allocation.

Additionally, my 401(k) plan has recently made a USD-hedged international bond index fund available, which I would like to use to diversify interest rate risk.

Current target asset allocation

Code: Select all

75% stocks
	40% US Total Market (30% of total)
	20% US Small-Cap Value (15% of total)
	40% All-World Ex-US (30% of total)
10% real-estate
	100% PeerStreet first lien notes with maximum LTV ratio of 80% (10% of total)
15% bonds
	100% US Total Bond Market (15% of total)
Desired asset allocation

Code: Select all

80% stocks
	25% US Large Blend (20% of total)
	25% US Small-Cap Value (20% of total)
	25% Internaltional Value (20% of total)
	25% International Small (20% of total)
20% bonds
	50% US Total Bond Market (10% of total)
	50% Ex-US Bond Market, USD Hedged (10% of total)
Current retirement assets
Retirement portfolio size approx $300k.

His 401(k) at Vanguard (65.41%)
19.39% Vanguard Institutional 500 Index Trust (0.012%)
8.50% Vanguard Institutional Extended Market Index Trust (0.031%)
25.12% Vanguard Institutional Total International Stock Market Index Trust (0.058%)
12.40% Vanguard Institutional Total Bond Market Index Trust (0.025%)

His Roth IRA at Vanguard (12.28%)
12.28% Vanguard S&P Small-Cap 600 Value ETF (VIOV) (0.20%)

His Roth IRA at PeerStreet (9.89%)
9.89% A few dozen individual real estate notes.

Her Traditional IRA at Vanguard (12.01%)
12.01% Vanguard Target Retirement 2040 (VFORX) (0.15%)

Her Roth IRA at Vanguard (0.41%)
00.41% Vanguard Target Retirement 2040 (VFORX) (0.15%)

Weighted average expense ratio (excluding PeerStreet): 0.072%

Contributions
Pre-tax 401(k): $27750 (including $9250 employer match)
Mega back-door Roth via After-Tax 401(k): Paused for the last couple of years whilst saving for the house down-payment, but plan to resume at $25250 next year.
His back-door Roth: Paused as-above, but will resume at $5500 next year.
Her back-door Roth: Because of the funds in her Traditional IRA and the pro-rata rule, we've been hesitant to use this option. Trying to decide when/whether to convert the ~$35k in her TIRA to Roth to "open" the back door.
Taxable: None at the moment (all going into the savings account), but once we buy the house, we should be able to start contributing at least $40k/year to a taxable account earmarked for retirement. Unless we do something stupid like buy a boat.
We're also contributing the maximum to an HSA, but are not counting it as part of the retirement portfolio.

Funds Available in his 401(k)
In addition to what's listed here, there are a few dozen target date funds and several active fund options I'm not bothering to mention.

Vanguard Institutional 500 Index Trust (0.012%)
Vanguard Institutional Extended Market Index Trust (0.031%)
Vanguard Institutional Total International Stock Market Index Trust (0.058%)
Vanguard Institutional Total Bond Market Index Trust (0.025%)
Vanguard Total International Bond Index Institutional Shares (VTIFX) (0.07%)
Vanguard Real Estate Index Fund Institutional Shares (VGSNX) (0.10%)
Vanguard Wellesley Income Fund Admiral Shares (VWIAX) (0.15%)
CRM Small Cap Value Fund (CRISX) (0.92%)

The plan also has a brokerage window option, which allows me to purchase Vanguard ETFs commission-free, and any other ETFs at a $2 commission per trade.

Questions

1. Does my proposed new asset allocation seem like a good way to capture the small and value risk premia? This allocation was inspired by TrevH's famous thread. Alternatively, is there a good option bogleheads recommend for internaltional small-value? In which case I could use that for the last slice, and use the very low cost Total International in my 401(k) in place of International Value.
2. How would you recommend implementing this desired allocation given the accounts and funds available? Here's one approach that comes to mind, after the PeerStreet notes are rolled into my Roth IRA at Vanguard:

His 401(k) at Vanguard (65.41%)
10% Vanguard Institutional Total Bond Market Index Trust (0.025%)
10% Vanguard Total International Bond Index Institutional Shares (VTIFX) (0.07%)
20% Vanguard Institutional 500 Index Trust (0.012%)
20% iShares MSCI EAFE Value ETF (EFV) (0.39%) | via brokerage option
5.41% Vanguard FTSE All-World ex-US Small-Cap ETF (VSS) (0.13%) | via brokerage option

His Roth IRA at Vanguard (22.17%)
20.00% Vanguard S&P Small-Cap 600 Value ETF (VIOV) (0.20%)
02.17% Vanguard FTSE All-World ex-US Small-Cap ETF (VSS) (0.13%)

Her Traditional IRA at Vanguard (12.01%)
12.01% Vanguard FTSE All-World ex-US Small-Cap ETF (VSS) (0.13%)

Her Roth IRA at Vanguard (0.41%)
0.41% Vanguard FTSE All-World ex-US Small-Cap ETF (VSS) (0.13%)

Weighted average expense ratio: 0.156% (0.084% more expensive than the current portfolio)

I think the approach above works nicely, since we are only actively making contributions to the 401(k) and my Roth, I can maintain balance with contributions just in those accounts, and unless it drastically outperforms, we won't have to do any rebalancing in my wife's accounts.

3. Is there a better optional for international value? An ER of 0.39% feels "steep" given all the other funds we're talking about, and in the context of total internatoinal being available for 0.058%.

4. Any feedback on my overall situation/strategy? My goal is to be financially independent with mortgage paid off by age 50, being able to draw $70k/year (in today's dollars) from the portfolio at that time if needed. I'm in the tech industry and I see a lot of folks finding themselves less competitive in the job marketplace once they pass mid-40s. Do you think I'm on track for this goal? Anything you'd be doing differently (aside from rehashing the "to tilt on not to tilt" debate.. I can find plenty of that in the archives)?

Thanks again :)
Last edited by daave on Sat Jun 16, 2018 11:24 am, edited 2 times in total.

Chip
Posts: 2130
Joined: Wed Feb 21, 2007 4:57 am

Re: Portfolio Review: IPS course-correction for small/value tilt

Post by Chip » Fri Jun 15, 2018 5:36 am

First, WOW do you ever have a good 401k.

I think the approach seems pretty darn good, though I would suggest a couple of minor tweaks.

Using the SP500 fund in your 401k makes sense because of the low expense ratio, but it's a tilt towards large. So either compensate by adding the extended market fund (1:4 ratio) or make that entire position VTI (the ETF for Vgd Total Mkt Index).

I like your plan of splitting only one of the positions amongst the IRAs. For ease of maintenance it helps if the single ETF that is spread across multiple accounts is easy to trade from a spread & volume standpoint. I think VSS is better than VIOV in this regard, but neither is nearly as good as something like VTI. So, should you choose to use VTI instead of the SP500 fund, I'd be tempted to put it into the IRAs instead of VSS. Again, this is a minor tweak.

IVLU (ER=.30%) has been recommended here for international large/mid value. Volume is very low. I own FNDF (ER=.25%) but it's one of those Schwab fundamental indexes that you should research thoroughly to see if it fits your needs.

I'm not crazy about international bonds, especially dollar-hedged funds. And especially with the low allocation overall to bonds that you have. Have you read any of the discussions here about them?

All in all it looks really good to me. The market will decide whether you hit that goal of retiring at 50. :beer

I would not convert your wife's tIRA at this time due to your high tax rate. Since you're planning early retirement there will be plenty of time to convert it then at a lower tax cost.

JohnDindex
Posts: 53
Joined: Wed Feb 07, 2018 10:59 am

Re: Portfolio Review: IPS course-correction for small/value tilt

Post by JohnDindex » Fri Jun 15, 2018 6:33 am

I think this is a reasonable approach, if you can stay the course is really the most important aspect.

I would consider a couple of things:

1.) Do you need to tilt your portfolio away from the market to achieve your goals? It could help, or hurt, but it will certainly be different in some regard.

2.) It is not a bad idea to manage the total PORTFOLIO as one, but based on the back of the envelope math you have enough money in all of the accounts to hold more than one asset. I think limiting an account to VSS only or VSS and VIOV is not very wise.

3.) You appear to be saving 90K per year ( or planning to shortly) with 300k already saved. You should easily have FIRE at 50 with very modest market returns. I would use target date funds/life strategy and just not deal with all of this.

4.) Lastly, Vanguard recommends 40% international, Fidelity recommends 30%. I personally do 33% because I like the idea of having twice as much at home than abroad. 50% is good in the sense that you are always half right, but in the past it has added more volatility than has been rewarded.

livesoft
Posts: 61944
Joined: Thu Mar 01, 2007 8:00 pm

Re: Portfolio Review: IPS course-correction for small/value tilt

Post by livesoft » Fri Jun 15, 2018 7:18 am

It looks like you don't need any help at all from the peanut gallery.

I like that the smaller accounts are single funds and the 401(k) is used for all rebalancing with almost a fund from each asset class. Of course, one can do double trades (exchange in Roth, then exchange in 401(k)) to do any kind of rebalancing that one wants to as well.

I will toss this out: Your play money of 10% ... how about using it to explore momentum? I have chosen to work with MTUM for a while.
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daave
Posts: 189
Joined: Thu Nov 07, 2013 7:28 pm

Re: Portfolio Review: IPS course-correction for small/value tilt

Post by daave » Fri Jun 15, 2018 10:22 am

Chip wrote:
Fri Jun 15, 2018 5:36 am
First, WOW do you ever have a good 401k.
Yeah, I'm really lucky in that regard. It's one of the FAANG tech megacorps.. I suppose the large employee base with a very high 401(k) participation rate makes it possible for them to get a great deal with Vanguard.
Using the SP500 fund in your 401k makes sense because of the low expense ratio, but it's a tilt towards large. So either compensate by adding the extended market fund (1:4 ratio) or make that entire position VTI (the ETF for Vgd Total Mkt Index).
If I add extended market to approximate total market, then that component would overlap with the SCV in my roth, whilst including small-growth, which would be worse for my value factor loads, right?
IVLU (ER=.30%) has been recommended here for international large/mid value. Volume is very low. I own FNDF (ER=.25%) but it's one of those Schwab fundamental indexes that you should research thoroughly to see if it fits your needs.
Thanks for the suggestions, I'll research these funds.
I'm not crazy about international bonds, especially dollar-hedged funds. And especially with the low allocation overall to bonds that you have. Have you read any of the discussions here about them?
I've read Larry Swedroe's book 'The Only Guide to a Winning Bond Strategy You'll Ever Need', and a few forum threads.
I'm trying to balance what sounds good in theory with what's easy to implement.
In particular, I'm convinced by his argument that currency-hedged international bonds continue to fulfill the role of reducing portfolio volatility (in the investor's local currency), but with added diversification of credit risk and interest rate risk compared with a US-only bond portfolio.
That said, going 50/50 on us/int'l bonds may be overdoing it. I'll consider doing 15% US 5% Int'l bonds rather than 10%/10%.

Thanks for your thoughts chip!
Last edited by daave on Sat Jun 16, 2018 1:07 pm, edited 1 time in total.

daave
Posts: 189
Joined: Thu Nov 07, 2013 7:28 pm

Re: Portfolio Review: IPS course-correction for small/value tilt

Post by daave » Fri Jun 15, 2018 10:28 am

JohnDindex wrote:
Fri Jun 15, 2018 6:33 am
I think this is a reasonable approach, if you can stay the course is really the most important aspect.

I would consider a couple of things:

1.) Do you need to tilt your portfolio away from the market to achieve your goals? It could help, or hurt, but it will certainly be different in some regard.
Agreed that staying the course will be the big challenge, especially if there is significant tracking error (in the negative direction) compared with the "default" option of a Vanguard Target Date fund with 20% bonds.
So far I've been very cautious in making portfolio changes, this is only the second time I'm making an AA change (the first was when I first introduced SCV), and each time I've waited a year after doing the research and feeling like I want to make the change before actually moving towards implementation.. so I think I have the ability to be patient and not rapidly pull out of a position if it's under-performing... but that said I stated investing shortly after the '08 crisis, so I haven't yet experienced a true crash or bear market.

As for whether I need to tilt to meet my goals.. the answer is "probably not". If the monte-carlo simulators are to be believed, my chances of hitting "my number" by age 50 jump from ~90% to ~94% if I tilt. I know there's a risk that the factor tilt could result in extended lower performance, but the same could be said of anyone choosing to invest in equities over some other "neutral" position... hard to say.
2.) It is not a bad idea to manage the total PORTFOLIO as one, but based on the back of the envelope math you have enough money in all of the accounts to hold more than one asset. I think limiting an account to VSS only or VSS and VIOV is not very wise.

Could you elaborate on this? Why is it not wise, especially as we are considering all the retirement accounts to together as a single portfolio?
4.) Lastly, Vanguard recommends 40% international, Fidelity recommends 30%. I personally do 33% because I like the idea of having twice as much at home than abroad. 50% is good in the sense that you are always half right, but in the past it has added more volatility than has been rewarded.
Vanguard Total World Stock Index is presently 53% US, 47% rest of the world... so I consider this market-cap weight to be the default "starting position". Up to now I've been 60/40, and this new allocation moves to 50/50.. mostly to make the numbers nice and round, partly because valuations would imply international has higher expected returns, and partly to come closer to global market-cap.
I'm not sure how much weight to give to past performance, even over the very long term.. but then again past performance is what makes us believe stocks will outperform bonds...

I should also add, that though I'm a US Permanent Resident, I'm not a citizen and have been here less than a decade (though my wife was born here).. so I don't have quite as much home-country bias towards the US as the typical boglehead. Long term I think it's likely that we'll stay in the US and I'll become a citizen, but there's some chance we'll end up going back to my home country (Australia) depending on family health and things like that. All of this to say that I seem to have a bit of "international bias", and I don't have a very systematic way of choosing a desired international allocation.

Thanks for your reply John!
Last edited by daave on Sat Jun 16, 2018 1:08 pm, edited 1 time in total.

daave
Posts: 189
Joined: Thu Nov 07, 2013 7:28 pm

Re: Portfolio Review: IPS course-correction for small/value tilt

Post by daave » Fri Jun 15, 2018 10:29 am

livesoft wrote:
Fri Jun 15, 2018 7:18 am
It looks like you don't need any help at all from the peanut gallery.
I've read a lot of your posts livesoft and always appreciate you sharing your thoughts here. The lack of criticism in your reply increases my confidence level significantly! 8-)
I will toss this out: Your play money of 10% ... how about using it to explore momentum? I have chosen to work with MTUM for a while.
I'll read more about it for sure.
Small and Value are compelling to me because there's both a risk story and a behavioral story to explain the higher expected return, Momentum seems to be entirely a behavioral story, which I worry could be more fickle. That said, I don't know that much about it and will read some more.

Thanks!

livesoft
Posts: 61944
Joined: Thu Mar 01, 2007 8:00 pm

Re: Portfolio Review: IPS course-correction for small/value tilt

Post by livesoft » Fri Jun 15, 2018 10:31 am

Yeah, I'm really luck in that regard. It's one of the FAANG tech megacorps.
If you work for one, then maybe MTUM is not for you.
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Chip
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Re: Portfolio Review: IPS course-correction for small/value tilt

Post by Chip » Fri Jun 15, 2018 11:13 am

daave wrote:
Fri Jun 15, 2018 10:22 am
If I add extended market to approximate total market, then that component would overlap with the SCV in my roth, whilst including small-growth, which would be worse for my value factor loads, right?
I was approaching this from the "usual" way of thinking about tilted portfolios: start with a TSM fund then add SCV, etc. So I was trying to get that slice to approximate TSM, which in your case would be roughly 16% SP500 and 4% Extended Market. But I now see that's not the way Trev H set up his portfolio. Plus there's really not that much difference between SP500 and TSM. So, NEVER MIND. :)
I've read Larry Swedroe's book 'The Only Guide to a Winning Bond Strategy You'll Ever Need', and a few forum threads.
I'm trying to balance what sounds good in theory with what's easy to implement.
In particular, I'm convinced by his argument that currency-hedged international bonds continue to fulfill the role of reducing portfolio volatility (in the investor's local currency), but with added diversification of credit risk and interest rate risk compared with a US-only bond portfolio.
That said, going 50/50 on us/int'l bonds may be overdoing it. I'll consider doing 15% US 5% Int'l bonds rather than 10%/10%.
It sounds like you've researched this thoroughly. I would say that if you're convinced, go with your original plan. Lowering the int'l allocation to 5% does nothing to simplify your portfolio but halves any benefit you might receive.

As livesoft said, you don't seem to need any help from us. Good work!

JohnDindex
Posts: 53
Joined: Wed Feb 07, 2018 10:59 am

Re: Portfolio Review: IPS course-correction for small/value tilt

Post by JohnDindex » Fri Jun 15, 2018 12:01 pm

IMO the ROTH is a valuable piece of the portfolio. I would be more comfortable having a more broad equity position there versus only international small, and or US small value. At least 50/50 broad market and small. If you believe that the higher "expected" return from small and or value is a real thing, then you may do far better than what I am saying. I cannot predict the future, so I personally have broader equity exposure in my Roth.

Having all of your fixed income in your TIRA or 401k I think makes a lot of sense, I just don't see why you couldn't have the same equity exposure in all of your accounts. It would require more re-balancing, which takes a few minutes once per year. I don't tilt to small or value, but highly enjoy reading about the constant debate here on the subject.

On international allocation, you are correct that past performance means little. I think it is preference and 50/50 is pretty logical, probably what I should be doing given how much better the valuations are EX-US at the moment. I just wanted to point out the studies they had done, they may be right, or wrong. It may be that 30% versus 50% makes little difference as has been the case in the past.

Good Luck.

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