Why I Am Cool With My Terrible Portfolio Performance in 2015

I’ve taken a real beating in the stock market this year. My performance has been worse than a 50/50 blend of US and International index funds. My personal year to date return is somewhere in the neighborhood of -10%. As I write this, the broad US stock market returned close to 0% year to date and the broad International stock market returned about -6% over the same period. Am I a fraud? Should you completely ignore all my financial musings due to my under performance? The good news is that I have a very specific rationale for investing the way that I do. It helps me stomach my terrible portfolio performance in 2015. Understanding why I have a 100% stock allocation and why I’m not selling anything in response to the market downturn will help you the first time you see a 5 figure loss staring back at you on your account statement.

Why Did I Underperform the Indexes?

The short explanation is my asset allocation. I have about 65% of my portfolio in international stocks. Of that 65% not invested in the US, about 40% is invested in emerging markets. Within my US stocks, I have a large overweight to small companies trading at low valuations relative to their earnings. In particular, I tried to catch a falling knife as oil plummeted down to $50 a barrel, only to watch it fall even further down to $35. When it was at $40 a barrel, I bought more oil stocks, and even those positions have losses.

Looking at a broad oil stock fund like VDE, the Vanguard Energy ETF, the energy sector is down about 22% on the year. If I look at VWO, the Vanguard Emerging Markets ETF, it’s down about 17%. If I combined the broad International and US stock funds in the same 65%/35% split that I have in my portfolio, I’d be down about -4%. If you layer on the big overweight to Emerging Markets and oil, it easily explains why I’m down about 10% overall.

 Why Do I Have a 100% Stock Allocation as an Early Retiree?

The worst thing that can happen to your portfolio after retirement is for it to fall precipitously. Why then would I hold such an aggressive 100% stock allocation? It flies in the face of all conventional financial wisdom. Some might say I deserved the 10% loss or had it coming. I was more aggressively invested than the “your age in bonds” rule of thumb, which would suggest I need at least 25% in bonds.

That advice is cookie cutter and not one size fit all. It totally depends on your situation how much bonds you should have. I would rather risk needing to come up with income from side jobs than invest too much in bonds, an asset class that I think will return a horrifically low rate for the coming 30 years.

For anyone thinking about buying a bunch of gold for their portfolio, consider the fact that $1 invested in the US stock market returned 35,000 times as much as $1 invested in the shiny yellow metal over this 200 year period. Obviously no one lives 200 years, but even over one individual lifespan, stocks beat bonds by a long shot. Stocks utterly destroy the return from gold, savings accounts, high fee annuities, and can’t miss investment opportunities from your in-laws. You end up much wealthier long term if you are heavily invested in public stock markets. The big caveat is you cannot need to sell your stocks in the event of a massive collapse like the Great Depression. If your expenses require you to liquidate your holdings at the worst possible time, you will never become wealthy because your stocks will never get the opportunity to recover. If the Great Depression happened again, I suppose I would go hike the Appalachian Trail. I’ve heard it’s hard to spend money there. Then I don’t need to sell my stocks.

What most people leave out of the conversation is that all stocks are not created equally. Large utility stocks with predictable earnings and strong balance sheets have much lower ups and downs than a small oil drilling company.  Walmart should have less volatility than Facebook. In other words, you can put it all in an index fund or you can invest even more aggressively than that in expectation of higher return long term. Just as stocks lose out big to bonds sometimes, a portfolio of aggressive stocks will lose out big to a portfolio of larger conservative stocks sometimes. As long as I do not need to sell, I can hold onto my aggressive strategy. If I had a $0 cash position when I retired from my job, I would have been in big trouble. Truth be told, I was very lucky I had more cash on hand than I thought I would need when I retired in June of 2015. If I had not had that level of liquid assets, maybe I would have had to sell some of my holdings.

Why I Think I Will Be Right in the Long Run

Here’s why I’m comfortable with my admittedly bizarre portfolio that has underperformed and flies in the face of conventional wisdom. The South African rand today is about 15:1 for every US dollar. The Mexican peso is about 17:1. When I visited these two countries several years back, the ratio was 7:1 and 10:1. In other words, emerging market countries have seen their currency values plunge by 50% or more in some cases. If you look at Europe, the euro has fallen about 30% over the course of the past couple years.

It has been a terrible time to be invested overseas, but not because the earnings of these international companies hasn’t been real. The bad performance is primarily because the dollar has been on a rampage. With all the turmoil abroad, the US dollar has been a bedrock of stability thanks to the strength of the US economy and international preference for US dollar denominated assets. If you were a wealthy Russian the past few years, how could you have protected your wealth in terms of global purchasing power? The ruble fell over 65% as sanctions and recession destroyed your economy. One solution was to convert all of your rubles into dollars.

The federal reserve is getting ready to raise interest rates for the first time in almost a decade. Meanwhile, the rest of the world is still trying to figure out ways to keep their economies propped up on stimulus. All of this background noise has kept the US dollar at unprecedented highs while world currencies have been obliterated.

So what would you do in my position? The rest of the world looks ridiculously cheap in terms of dollar purchasing power. Any increase in the value of global currencies would bump up the cost for my year of traveling the world. Not wanting this historic currency advantage I held to go to waste, I quit my job, partly so I could take advantage of the fantastic exchange rates. I’m actually not kidding; the pivotal moment for me was probably around the end of 2014 when the dollar and euro were almost at 1:1. My second step was to buy international stocks and take my percentage from 50% up to 65% of my total holdings. I figured if I was wrong, I could enjoy higher purchasing power with my US dollar cash reserves. If I was right, I would get a great return out of my stock portfolio and could use some of my profits to pay my higher bills for travel. I tilted my portfolio to international stocks partly because I thought they were cheap, and also because I wanted to hedge my expenses for the year.

My heavy investment in oil is a similar story. My biggest single expenditure this year is going to be plane tickets. Now that oil futures contracts are starting to roll off for airlines, you are slowly seeing great deals return to the market for air travel. My flight to Paris in April will be about $300. My flight from Paris to Beijing should be about $200. The thing that could end these fantastic deals? A steep increase in oil. I hedge this risk by having a large overweight to energy stocks.

I believe if I’m able to hold onto this portfolio, I will experience higher returns than investing in large US stocks. Because I invested in this alternative portfolio when international and oil stocks were “cheap,” I think this hope for a higher return is a rational expectation. The problem with cheap stocks is that they can always get cheaper. As long as you are able to hold onto the ups and downs, it could still prove to be a good investment.

Lessons For Your Portfolio and How I Would Manage Other People’s Money Despite Terrible Portfolio Performance in 2015

The big takeaway for you should be when an investment falls in value, you generally should not panic and sell everything. If I sold my holdings this year I would lock in my 10% loss without hope for better returns in the future. As I wrote this article today, the global stock market went up almost 3%. If I had sold after a rough Monday this week, I would not have participated in Tuesday’s gains.

If you buy stocks, I can tell you one thing about your portfolio that I’m absolutely certain of. I guarantee you will lose money. Sometimes, you will lose A LOT of money. A mentor once told me, “never put any money into the stock market that you can’t afford to lose.” That has been some of the best advice I’ve ever received. It has given me emotional permission to be wrong, make mistakes, and also not sell at rock bottom prices. If you have trouble with the risk of an all stock portfolio, add bonds until the possible loss doesn’t scare you anymore. In general, you could expect to lose about 50% with 100% stocks at times. With 50% stocks, you might lose about 25% in an environment like 2008. With 100% bonds, you can still lose money, but probably not more than 10% to 15% because all the broad bond indexes have medium to short average maturities with lower interest rate risk than long term bonds.

If you are investing for a lifetime with a fraction of what you think your final net worth will be, then why not invest aggressively? Perhaps you should not be as aggressive as I am in the stock market, but even Ivy League professors are saying young investors are way too conservative in investing. These same professors suggest borrowing money to hold stock positions greater than 100% of your portfolio. That strategy is very, very risky. You could lose more than the amount you have invested. However, it is not a bad idea in theory for someone with a small portfolio and decades to recoup losses. Rather than invest with borrowed money, I think it’s easier practically to just hold more stocks and fewer bonds. So ask yourself if you should not be more aggressive with your portfolio.

To handle the times when you will lose lots of money on paper (it’s never a real loss until you sell), just save more. A lot of financial advisors suggest tilting a portfolio really conservatively once you have achieved your goal because the need to take risk is not there anymore so why take it? I suppose this line of reasoning might become more appealing as I get older and appreciate the importance of feeling like you have a secure college fund for your kids, health care expense account, etc. However, why not just be a little more disciplined with your personal finances and increase your savings rate? If you get unlucky in the stock market you will still be able to live your life because you oversaved. If you get lucky in the stock market, you will be a multimillionaire with the ability to impact a lot of lives for the better, whether through providing for your family or donating significant amounts to charity.

If I was managing a stranger’s portfolio, I would invest mostly in generic broad based index funds than what my portfolio looks like. My approach of buying lots of different stocks and overweighting sectors and regions of the world is complicated. To be frank, it might not work too. I would still want to have more money invested in value and international stocks than the average portfolio, but one of my biggest lessons from the past few years is the value of simplicity. You will go mad trying to find the perfect plan. Best pick a really incredible one and invest in index funds directly through Vanguard. If you need advice or want someone else to manage it, Betterment or Wealthfront are great options as well. Here’s to a more profitable 2016, and for higher oil prices so my oil stocks go back up!

What do you think about my portfolio? Do my overweights in Emerging Markets and Energy look foolish or do you agree that we could see a big rebound? Are you overweight in certain sectors and if so why? Comment below!