My 1st Investment Portfolio

This post is a back to basics posts to help new investors get started with their 1st investment portfolio.  After setting up a budget, understanding the orders of operations for where to invest next, and deciding to tackle this yourself, it’s time to actually start investing. This is the step where most people get overwhelmed by the choices and sometimes retreat back to a financial advisor.  The goal today is to discuss some strategies to set up your 1st investment portfolio.

What’s An Asset Allocation?

Two of the fundamental concepts of modern portfolio theory is diversification and risk tolerance.  One is like the horsepower of an engine (risk) and the other is the seat belt or airbags (diversification) to help buffer the impact when you hit the gas too hard or a deer decides to jump in front of your car on the way to financial independence.  There are plenty of math equations and graphs we could use to talk about the efficient frontier or risk ratio of the investment but for our discussion,  horsepower and airbags will do just fine.

Now blending these two concepts together can be challenging because of the sheer number of options out there from stocks to bonds or ETFs to REITS.  I am a believer in the KISS (keep it simple stupid) thought process early on in your investing journey.  The more complex you make it the higher likelihood there is to stumble and give up.  The risk and diversification profile of a portfolio is decided by the asset allocation of the portfolio.  Assets can range from stocks, bonds, savings accounts, CDs, real estate etc. and how you blend those together is your asset allocation.  For your first portfolio, you should focus on the basic building blocks stocks and bonds.  Stocks are your risk or horsepower while the bonds serve as your airbags. You can add complexity later but this is where all asset allocations start.

What’s My Blend?

For this part of the discussion, I will go away from the analogy of a car and use pizza dough as my example.  If you have ever made dough then you know it’s dry and wet ingredients mixed together to make some yummy goodness.  To make our portfolio we will think of stocks as our dry and bonds as our wet and the ratios of the two are key to a great pizza dough and investment portfolio.

There are some rules of thumb out there that talk about 100 minus your age should be the percentage of stocks in your portfolio.  I think this is a little too conservative and changes too quickly for my liking.  I don’t think a 25-year-old should be in 75% stocks.  Rather than looking at absolute ages, we should talk about career phases. I break it down into three phases-acceleration, coasting and slowing down.  Acceleration is the first part of your career where you are working to climb the ladder or establishing yourself in your career, coasting is the middle part where you don’t need more money and don’t really care to put in the 80 hour weeks to get to the next level, and slowing down is before and into retirement.  The timing and percentages in each of these phases can be adjusted to your goals and risk-taking desires but this is where I would start.

 Career PhaseStocksBonds
AccelerationEarly, Establishing90%10%
CoastingMid, Established70%30%
Slowing DownLate, Retiring Soon50%50%

The Dry Rub

After we come up with a Dry to Wet ratio then we work on the ratio of the dry ingredients.  For pizza dough, this is flour, yeast, salt, and sugar and for the stock portion of our portfolio, this is domestic and international stocks.  We can get fancy with small cap, REITs, alternatives etc but for your first portfolio just KISS. Domestic stocks provide the bulk of the work but with our growing global economy it is foolish to ignore the rest of the world.  This split is a diversification strategy that helps buffer some of the ups and downs of the economy.  When one is up the other might be down or flat and then a couple years later the opposite.

Keeping with the KISS theme we will go with a 2/3 – 1/3 blend for our dry ingredients.  2/3 in the domestic stock market and 1/3 international stock market.  There are plenty of other suggestions out there that will go higher or lower on the domestic side but with more multi-national organizations and complicated supply chains, this is the split that makes sense to me but like I suggested above you can tweak as you see fit.  So how does this look in table format?

 Career PhaseStocks - DomesticStocks - Int'lBonds
AccelerationEarly, Establishing60%30%10%
CoastingMid, Established46%24%30%
Slowing DownLate, Retiring Soon33%17%50%

Where To Buy The Ingredients?

With pizza dough, you have endless options on how to gather and build your dough before putting on the toppings.  You can completely D.I.Y. by buying the flour, yeast, salt separately or you can buy a pre-built option like a betty crocker pizza mix bag where you just add water or you could go with the Trader Joe’s pre-made dough that is already mixed and ready to use.  These same options are available for your starter portfolio. Each has its pros and cons so the answer is not simple and straightforward. I will lay them out for you and then you can decide for yourself.

D.I.Y. (3-Fund Portfolio)

This is one of the most common recommendations by personal finance bloggers and got popular with the bogleheads website.   You can go to any major financial institution and pick 3 mutual funds or ETF’s with low expense ratios and allocate them based on the ratios above. Below are tables based on ETFs from Schwab and Vanguard.

InstitutionTicker SymbolDesc.Exp. Ratio
Schwab
SCHBSchwab Multi-Cap Domestic (Stocks)0.03%
SCHFSchwab Multicap Int'l(Stocks)0.06%
SCHZSchwab Multi Bond0.04%
Vanguard
VTIVanguard Total Stock Index Fund0.04%
VEAVanguard Int’l Index Fund (Stocks)0.07%
BNDVanguard Total Bond Fund0.05%

Sounds simple enough but what happens a couple of months or years from the date of purchase when the stock fund grows more than then bond fund and more specifically the domestic fund grew more than the international fund? Well you need to rebalance to get back to your desired asset allocation.  This requires selling some of the stocks and buying more of the bonds or you leave this for when you are investing new money into the portfolio to help with rebalancing.  

ProsCons
Low Fees
Diversified
Keeps you engaged
Manual Rebalancing
Manual Tax-Loss Harvesting

Pre-Mixed Bag (Target-Date Funds) 

Now if you are starting off and feel intimidated by the idea of buying individual funds, keeping track of the ratios, and rebalancing then there are is another option available … Target-Date Funds (TDF).  TDFs are designed based on your estimated retirement age and work backwards to decide a ratio based on how far you believe you are from retirement.  Historically these had high expense ratios and didn’t have the best allocations and glide paths (this is how the fund changes the allocation as you get closer to retirement) but with competition and some help from computers these have actually improved.  Below are some reasonable options from Schwab and Vanguard.   

InstitutionTicker SymbolDesc.Exp. Ratio
Schwab
SWYMXSchwab Target 2050 Index Fund0.08%
SWYJXSchwab Target 2055 Index Fund0.08%
SWYNXSchwab Target 2060 Index Fund0.08%
Vanguard
VFIFXVanguard Target 2050 Fund0.15%
VFFVXVanguard Target 2055 Fund0.15%
VTTSXVanguard Target 2060 Fund0.15%

As you can see the expense ratios are slightly higher but not unreasonable for an easy set it and forget it type situation.   The one benefit that goes away is tax-loss harvesting.  This is where you can claim capital losses on your taxes during downturns or market fluctuations and carry them forward to years where you have a capital gain.  

ProsCons
Diversified
One Fund to Purchase
Set It and Forget It
Auto-rebalancing
Limited Flexibility
No Tax Loss Harvesting
Slightly higher fees 

Pre-Made Dough (Robo-advisors)

Finally, we get to the Robo-advisors which have become very popular over the past decade. Companies like Betterment and Wealthfront opened the door but now most large financial firms have a Robo-advisor option The concept is based around the idea that a computer can figure out your asset allocation and execute trades when needed.  They can also automate the process of tax-loss harvesting.  These companies usually charge a service fee in addition to the expense ratios from the funds. Some also offer a tier with access to a financial advisor to help plan your whole portfolio.  

InstitutionExpense RatiosAdd’l FeeFee with Advisor
Schwab Intelligent0.15%0.0%0.28%
Vanguard Personal Advisor0.05%0.3%
Betterment0.12%0.25%0.40%
Wealthfront0.0%0.25%NA

The one benefit that I have seen with Robo-advisors is the gamification of investing.  Most purists will say that investing should be boring and if you get excited then you are likely gambling not investing but I think this is different.  By making the process of adding money easy and creating an app to change dials it keeps investors engaged and hopefully investing more. Is it worth the extra fee? It depends on your personality and if you require an incentive or motivation do things like a diet or workout then this might fit your personality. I have a large portion of my taxable account in Schwab Intelligent because I don’t care to do tax-loss harvesting manually.   

ProsCons
Diversified
Auto-rebalancing
Tax-loss Harvesting
Gamification
Higher Fees
Complex Portfolios
Less Flexibility

Conclusion

There you have it! 3 different ways to set up your 1st portfolio with a little primer on asset allocation and modern portfolio theory.  Now don’t think you have to only pick one of the 3 options.  Personally, I utilize all three at the same time with TDFs in my 401K, Robo-advisors for my taxable accounts, and DIY for my Roth IRA.  You can start tweaking as you get more experience with investing and feel comfortable with different asset classes.  

I hope this helps you get started!

–Dr. Linus 

8 comments

  1. Great. Now I’m thinking about pizza and it’s only 9am!

    Nice primer for asset allocation. Now just have to kill 3 hrs till lunch.

  2. mix and matching with DIY and robo advisors for TLH can be a little tricky. When the left hand doesn’t know what the right hand is doing, easy to have an accidental and extra costly wash sale.

    Good analysis and analogies 👍

    1. I’m still waiting for my first wash sale. I keep reading about it on blogs but haven’t heard of anyone actually getting hit with one. Schwab doesn’t use the traditional ETFs for their Robo so maybe it’s just different enough to avoid the wash sale.

  3. Fantastic post. Must have taken forever to write.

    Personally I’m 46 and still 100% stocks. I don’t see any reason to give up a few percent return on any of my portfolio. I just use time to reduce risk and accept the volatility. I also have some worthless Silicon Graphics 2003 bonds in my portfolio that show that bonds are not always safe. Then again, sometimes airbags blow up in your face and break your nose.

    1. Thanks! I love the part about airbags blowing up in your face. Being an ER doc, I see plenty of injuries caused by seat belts. Safety mechanism are not always safe and bonds are not the golden ticket given our rate hike environment.

  4. If you’re doing a sale in a taxable account with scwhab that washes with a buy in your IRA at Vanguard, you’ll get no notice. However it’s still your responsibility and you are still liable for it.

    Its kinda like cheating on your taxes, you’ll get away with it until you don’t. But if you know the robo advisors funds are substantially different from the rest of your unmanaged portfolio, you’re fine.

    I looked into it with betterment and there was too much overlap with what I already held elsewhere …

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