Revisiting “When Should the Game Change?”
About two years ago, I wrote a post, When Should the Game Change?, in which I discussed how each person can examine his circumstances, goals/objectives, and risk tolerance to set an asset allocation and portfolio management style aligned to satisfy his parameters. It might be helpful to read/reread that post before continuing on to this post.
The explosive portfolio growth during COVID (March 2020 – October 2021) followed by the rapid drawdown (November 2021 – November 2022) led me to reflect further on what I wrote then. Even after the >80% drawdown was complete, I decided that, for me, the game had to change. In this post, I will explain the personal circumstances and preferences behind the need for adjusting the level of aggressiveness and risk management style for my portfolio. I will also share how I chose to implement the changes. This is just a personal example that’s not intended to be mimicked by others; however, my example might still provide food for thought to others even though their parameters are different from mine.
Shifting Parameters
When I decided to leave the workforce in my late-30s, I knew that I would either need to grow my assets in excess of my living expenses or eventually return to some income generating work that required me to exchange some of my time for money. My hope was that my investment returns would be enough to keep me financially free, but I was willing to take the risk that my plan might not work out as I hoped. Yes, I was willing to return to work if need be. Fortunately, my wealth continued to accumulate from only my investment returns. Eighteen years later, I’m now in my mid-50s, much wealthier, and much, much less willing to return to work. So, the parameters that should define how I manage my assets have shifted dramatically. In fact, the parameters did not change dramatically from one day to the next; they shifted more slowly over a longer period, and I failed to recognize that it would be prudent to make smaller adjustments along the way. The key takeaway here is that parameters often don’t change instantly so matching investment priorities and style can also happen with more frequent smaller adjustments over an extended time period.
Defining the Required Changes
Previously, I was solely focused on maximizing growth (i.e. maximizing long-term CAGR), but with this approach there would be increased volatility (large swings) with occasional huge drawdowns. In the period between 2017 and 2020, my entire net worth was invested in growth stocks. No real estate and very few other assets. In addition, the portfolio was leveraged with long-dated call options and short put options. Based on my own parameters, I knew that I needed to better balance wealth preservation with asset accumulation. Huge drawdowns on my entire net worth and returning to the workforce were no longer acceptable to me. Thus, I needed to make at least two changes. First, reduce my use of leverage, and, second, move some of my assets out of high growth/high volatility investments.
Implementing the Changes
It took some experimentation to arrive at the approach that I use today. At first, I changed my stock portfolio to include what I thought were some lower volatility stocks that I believed were uncorrelated with my growth stocks. The objective was to increase wealth preservation and lower volatility in exchange for a lower long-run investment return. However, after some time I realized that buying more stable, slow growing companies did not suit me as I am geared toward trying to maximize CAGR. It’s what I enjoy and it’s what I believe I’m good at. Interest rates had also increased so holding cash became an increasingly attractive option.
I settled on segregating my assets into two buckets:
Bucket 1: The growth portfolio with the objective of maximizing CAGR.
Bucket 2: Cash, real estate, and other investments which are used to provide cashflow and cash for my housing and other expenses to fully fund my lifestyle and other needs.
Bucket 2 currently consists of only cash (i.e. money market funds) earning an annual return of about 5.25%, but Bucket 2 will not always consist of cash only; it will also be used to buy real estate for personal use, cash for generating income for living expenses, cash for consumption, and perhaps other, non-growth stock investments. If interest rates decline, I will reevaluate whether investments other than money market funds will provide higher yields. Bucket 1 will consist of 8-12 growth stocks (as before) plus some cash that I am willing to reinvest in growth stocks. Bucket 1 will, of course, be vulnerable to volatility and occasional large drawdowns, but Bucket 2 will provide the security and stability to cover my expenses and fund my desired lifestyle. Occasionally, I will move cash from Bucket 1 to Bucket 2, but I never intend to move funds back from Bucket 2 to Bucket 1. Once Bucket 2 can perpetually fund all of my desired expenses, I will no longer need to transfer cash from Bucket 1 to Bucket 2. This approach of segregating the portfolio (Bucket 1) will also enable me to continue logging, monitoring, calculating, and sharing my investment journey with those who are interested in following along. In essence, I will be able to focus on maximizing CAGR on only a portion of my wealth whether that portion is 75%, 50%, 33%, or less. At the same time, I can rest assured that Bucket 2 will be there to meet all of my financial needs even if Bucket 1 has a huge drawdown which makes a huge drawdown so much more tolerable.
The opinions, thoughts, analyses, stock selections, portfolio allocations, and other content is freely shared by GauchoRico. This information should not be taken as recommendations or advice. GauchoRico does not make recommendations and does not offer financial advice. Each person/investor is responsible for making and owning their own decisions, financial and otherwise.