By: Dividend Sensei
This series has already looked at some of the most important aspects to good long-term investing including:
- Understanding the true nature of risk
- Keeping stock market volatility in context
- Having a realistic view of your own long-term goals
- Mastering your emotions to avoid costly mistakes
This article looks at the final piece of the puzzle, which is achieving what I like to call a “bunker portfolio”. One that is ideally suited to your needs, and more importantly can help you achieve the proper mindset and discipline to avoid making the kind of short-term, but very costly mistakes that have sunk the retirement dreams of so many investors. Or to put another way, a portfolio that is likely to hit your long-term return targets, but also lets you sleep well at night and thus not obsess over short-term market fluctuations.
There are three parts to building a bunker portfolio. The first is optimal capital allocation which depends on your: individual time horizon, risk tolerances, and return needs. For example while I personally don’t fear short-term market volatility, and thus my retirement portfolio is 100% in dividend stocks, many investors need to own a mix of cash and bonds to help smooth out their short-term returns. If this is the only way you can avoid panicking and selling at the exact wrong time, then it’s the right long-term call for you.
How does one determine one’s optimal capital allocation? Well there are two simple ways. The first is to talk with a financial advisor to discuss what allocations into cash/bonds/stocks makes sense for you. However if you take this route make sure that the advisor is a fiduciary, meaning they are legally obligated to put your interests first. Also inquire as to how they are compensated. The reason is that some advisors will offer a “free” consultation but then recommend high cost mutual funds that they receive kickbacks on. In contrast a fiduciary advisor who is paid only by a fixed-rate fee is one whose advice is far more trustworthy.
A cheaper and often simpler alternative is to use a target date fund or ETF, such as Vanguard Target Retirement Fund series. These are funds that are designed to offer instant diversification into a target allocation that meets the needs of most investors retiring by a certain date. For example the Vanguard Target Retirement 2025 Fund (VTTVX), has a 0.14% expense ratio, (very low), and is one of the best choices for investors looking for a totally hands off and automated approach to retiring within seven years.
The fund series is designed to follow a sliding scale of bond/stock allocation, including foreign/domestic holdings, based on your age and a statistically sound, (conservative), capital allocation strategy. For example at an investor age of 25 the portfolio is 90% stocks/10% bonds, but that eventually shifts to a 70%/30% mix of bonds/stocks for when you are already retired.
The fund I highlighted has a yield of 2%, a low annual turnover of 10%, and a minimum investment of just $1,000. The fund itself is a collection of low cost Vanguard index funds that looks like this:
- Vanguard Total Stock Market Index: 37.5%
- Vanguard Total Bond Market Index: 26.1%
- Vanguard Total International Stock Market Index: 25.4%
- Vanguard Total International Bond Market Index: 11.1%
However there are three problems with using target dated funds. First your retirement date may not line up perfectly, and so you will have to choose the one with the closest date to your target retirement date. Next the actual allocations can prove to be too conservative to help you grow wealth fast enough to avoid running of money during retirement. Finally, as is the case with most stock market index funds, these are market cap weighted which means that they ignore valuations entirely. That being said taking a look at retirement dated funds can provide a useful starting point for determining what ballpark capital allocation might make sense for your needs. Once you’ve determined what capital allocation is right for you, it’s time to move onto step two.