Thoughtful advice on portfolio construction

[Andy Dufresne]

Hi all,

Very long time reader of the forums, even before I registered (about three years ago). My situation is somewhat unique and complex, thus necessitating a long write-up … nonetheless, I'd very much appreciate your input as to how to shape my investment portfolio; if you have questions, do ask!

I would say I am fairly knowledgeable about investing, and have a good idea about various asset allocation plans - from PP through Bogle, Buffett, etc. However, I am now in a new permanent situation (see below), and I believe its good to have my thought process challenged.

Background & Facts

I am in my early 40s; I was badly injured in an accident and cannot resume work - likely permanently.

I am married + an infant and will likely end up with another child or perhaps two. DW is much younger and is currently a homemaker, although she could potentially rejoin the workforce in about 10 years' time.

We live outside the US/EU, in an expensive urban area, which I do not anticipate us leaving.

Currently we have no debt, no real estate and no car. We are generally thoughtful about spending. Although I would not consider us in any way Jacob frugal, we are ERE-aware, and our savings rate prior to the accident was about 50% without really playing much “defense” .

Annual spend - I do not have a sufficiently large dataset post accident to be certain, but a conservative figure would be 60,000-65,000 (all sums in this post are in USD and net of taxes). We live very comfortably, and there is most definitely some room for savings, but my condition does impose some additional expenses (e.g. treatments, special equipment, taxis).

Current liquid assets - about 200,000 - 40% in cash, 45% in individual stocks (mostly blue chip - e.g. BRK.B, V, MA), 15% in a liquid 401K-type I can use with no tax penalty. I cannot say I am a good investor in individual stocks. I stated my career very late and by the time I got around to investing the party in the markets was well under way.

Future pension - in about 25 years' time - about 30,000 per year. This is a defined contribution fund, so the figure will likely decrease somewhat as the actuarial assumptions change to reflect longer average lifespans.

Future inheritance – likely in 15-20 years. Will receive mostly real property as well as some stocks and cash, worth approximately 1,000,000.

Income & Assets arising from the accident

While the various legal proceedings may take years, assume the following (again, all sums net of taxes):

1. Lump sum # 1 of 250,000-350,000 in late 2019;

2. Lump sum #2 - likely to be received only in 2021 or 2022 – 1,000,000 to 1,400,000;

3. Annual disability pension #1 (until death) - between 40,000 and 65,000 (unclear, will only be known in 2019);

4. Annual disability pension #2 (until age 67, contingent on me not working or my death) - 20,000 to 60,000 (will only be known in late 2019 or early 2020; can be converted into lump sum, which I may do, although the conditions are unknown).

5. Both pensions are indexed to the local CPI.

My initial thoughts

1. At worst, pensions should cover all or nearly all ongoing expenses; at best, a sizeable surplus would remain.

2. I plan on purchasing an apartment in 2019-2020 for about 600,000 to 700,000 with the capital I currently have plus the smaller lump sum and either additional ongoing savings or a small short term mortgage (later covering with part of the larger lump sum payment). Should this happen my annual expenses would drop by about 20,000, to 40,000-45,000.

3. I do not anticipate making any further significant purchases until my child(ren) is/are of age, so roughly 20 years. Even if I were to purchase a vehicle, I would likely be entitled to buy it tax-free, so the cost would be realtively low and I would hold the vehicle for a long period of time.

4. Assuming that my annual pensions and smaller lump sum are on the lower end (i.e. 60,000 and 250,000) and that I purchase an apartment for 700,000, I ought to be left with roughly 750,000 to 850,000 for investing (representing 16 to 21 years of expenses), as well as an additional 20,000 annually, which I could either consume or invest.

5. I will have medical coverage (both state and private – included in the expenses).

Asset Allocation Observations

1. I should be in the position of not needing to touch any of the principal and allow it to accumulate and compound for a good amount of time, and perhaps even adding a modest sum annually. Higher pensions and/or lump sums will further increase my buffer and/or my principal. Thus, logically, I should expose my principal to more volatile asset classes, i.e. stocks, to garner the additional return over time.

2. I may be able to get an exemption on interest payments of up to roughly 75,000 per year, making bonds, at some point, attractive (both local and US bonds, as there is generally no withholding on bond interest payments).

3. I prefer to move my portfolio from individual stocks to indexes / ETFs – I will likely slowly liquidate my current holdings when I purchase the apartment or, if I have sufficient cash, do it slowly over time.

4. No exposure to US estate tax, so I need to find non-US domiciled ETFs (e.g. Irish) with reasonable costs and sufficiently similar exposures to ETFs like VTI.

5. I am not interested in becoming a landlord or running any business, so the public markets are, as far as I see, my only option.

That’s about it … would dearly love to hear your thoughts about an initial asset allocation and how you would change it over time. Also, how gradually you would invest the larger lump sum once its in my hands. I am particularly interested to hear from retired folks / folks that have not added to their portfolio via work for a long time.

Many thanks!

Andy

[Andy Dufresne]

Bump … anyone?!?

[Dream of Freedom]

You need enough cash to live until disability pensions start rolling in. With the rest producing some current income might be a good idea since you probably don't have an income outside of maybe insurance. So maybe have a mix of bonds, preferreds, REITs, and dividend stocks? After you have an income, capital preservation would likely become your number one priority since it would dificult to replace any money lost. It sounds like you might be a good candidate for the permanent portfolio.

[slowtraveler]

I think Golden Butterfly is much easier to hold than permanent portfolio, less fear of missing out.

I'd turn automatic dividend reinvestment off to avoid wash sales on anything as you shift out of stocks to indexes.

[Seppia]

With the conditions you lay out, I would focus on "playing defense".
Your financial outlook seems fairly safe and sound, so in your situation I would mostly think about limiting the potential downside rather than increasing the upside.

I think purchasing an apartment is a good move in a vacuum, but the allotted money seems fairly high to me unless you live in Sydney, HK, Tokyo or Singapore.
If you do, why not consider moving?
Owning a house is in my opinion a good defensive strategy because it cuts costs of living, but buying too much house is definitely unwise as it takes away from productive assets without really adding any benefit.

[JamesR]

You might want to be careful about making assumptions about an inheritance. How would it affect your plans if you didn't get one?

[Tyler9000]

Hi Andy. Cool name!

1. I should be in the position of not needing to touch any of the principal and allow it to accumulate and compound for a good amount of time, and perhaps even adding a modest sum annually. Higher pensions and/or lump sums will further increase my buffer and/or my principal. Thus, logically, I should expose my principal to more volatile asset classes, i.e. stocks, to garner the additional return over time.

The one thing that jumped out to me is this. I hear what you're saying about being in a very good position with the pensions an that it might free you up to take more risk with your investments. However, in your situation with a very restricted ability to work again I'd personally be a bit more defensive and think about it in terms of money you really can't afford to lose. Pension funds can go broke, inheritances can vanish, and ultimately only you are responsible for your financial future. With fewer backup options, you might want to be a little more measured about risk than your typical early retiree.

Now that doesn't mean I wouldn't invest in risky assets at all, as things like stocks are important ingredients to any properly balanced asset allocation. I just wouldn't necessarily get overly aggressive with your retirement portfolio, as IMO your primary goal should be sustainability rather than growth.

[Andy Dufresne]

Hi all,

First of all - merry Christmas!

Second, many thanks for the thoughtful replies! As nearly all of you have pointed out capital preservation is paramount, so I find myself in the strange position that my risk tolerance is low (like an 60+ year old who is retired) but my investment horizon is still substantial. I also agree that I cannot count my chickens before they have hatched re inheritance / size of pensions / liquidity of pension funds.

@Seppia - as you correctly pointed out I want to fix my housing spend and I do think it does diversify away some of the risk, which I define as meeting my living expenses.

@Augustus - you balked at the cost of living, the fact is that while I live thousands of miles away from all of the cities Seppia mentioned, property on my street goes for about USD 1,000 per square foot and housing is generally very expensive where I live, but rents are rising at a quick rate as well, and I would rather cap my exposure once I am financially able to.

@Dream Of Freedom @slowtraveler - will look into PP and Golden Butterfly more closely.

@Tyler - thanks for the compliment

My main takeaway from all of your input thus far is that I will need to do things gradually, meaning that as the situation clarifies and I have better clarity/certainty on the various sums (i.e. I get them), my tolerance level may shift, but that I need to be defensive minded.

Happy for more comments!

Andy

[prognastat]

A lot of it depends on your tolerance too, I'm about 95% in stocks and with the recent adjustment my NW went down over 60k in just 3 months.

That can be rough and if you can't get through that without panicking and making stupid decisions you might want a portfolio heavier in bonds to smooth it out some and decrease the odds of panic.