VTSAX and No Chill

As I've been debating my ETF allocation, a regular suggestion has been to buy the Vanguard Total Stock Market Index Fund (VTSAX or ETF:VTI) - which holds all the publicly traded stocks of the United States - and buy nothing else.

Aka, VTSAX and chill.

To be sure, this is easy to implement, and it would be exceedingly tax efficient. Buying one fund and never selling is the height of simplicity. And since you're never rebalancing, you don't have to worry about tax costs eating into your gains over time (aside from pesky dividend taxes). Those are real benefits that I'd be stupid to dismiss.

It's also been difficult to beat. The U.S. stock market has been on an amazing run, and while I've been running backtests of different asset allocation strategies, it's been very hard to find strategies that outperform the market cap-weighted U.S. market. Especially in the years since the Great Recession, buying any asset other than the U.S. market has been an exercise in frustration. You have likely underperformed year after year after year. Value has been crushed. Ex-US stocks have gone mostly nowhere. Small caps have had mediocre returns.

Modern FIRE

During this period, the modern FIRE movement got its legs. Obviously, it existed before this great bull run, since the term comes from 1992‘s Your Money or Your Life. However, I believe this modern version with the blogs and internet forums has been aided by this incredible period of somewhat easy returns. Both Mr. Money Mustache and J. L. Collins began blogging in 2011, which was an amazing time to be buying U.S. stocks.

Both recommend VTSAX/VTI as the singular vehicle for investment. As the blue line in the above image shows, they've been 100% correct. Anyone who recommended anything else has been wrong.

But what about now?

Valuation

First, in the early part of the long bull market (interrupted occasionally by short and intense drawdowns), the U.S. stock market was fairly inexpensive.

For one, the S&P 500 had fallen to below its 200 month moving average. I repeat: below its 200 MONTH moving average. This had only happened before after the second crash of the 1970's and (if you extrapolate backwards) in the years following the Great Depression, both of which were incredible times to be loading up on stocks.

Secondly, in 2009-2011, it was possible to buy the U.S. market for CAPE ratios between 15 and 20. Today, however, it's near its second highest ever level:

An easy rebuttal: using the CAPE ratio for the past few years has been dumb. It's been warning for years that the market was expensive, but buying the U.S. market has been the winning trade. Admittedly, that's a fair critique. CAPE is an awful timing tool.

However, for anyone with a "buy and hold" mindset, stocks are long duration assets. That means that we stock investors shouldn't be focused on short term results. And focusing on a few years of outperformance is focusing on short term results. We need to look over time.

Over Time

In that vein, here's a chart that shocked me:

This is a comparison of three portfolios' performance since 1972 with a starting balance of $10,000. Dividends are reinvested, and the portfolios are rebalanced quarterly. The yellow line is U.S. Stocks, blue is a 60/40 portfolio (60% U.S. stocks, 40% 10-year Treasuries), and red is a 40/60 portfolio.

What do you notice?

For one, up to the end of April 2022, U.S. stocks have outperformed the more balanced stock/bond portfolios. Since 1972, U.S. stocks have returned 10.52% annually. 60/40 has returned 9.49%, which is clear underperformance. And when I see comparisons of the 60/40 portfolio to a pure stock portfolio, that's the framing I usually see.

However, that might not be the best framing. If you look at the box over the chart, that's the performance at the bottom of the 2008/09 crash. Notice that at that bottom, the pure stock portfolio had worse performance than the more balanced portfolios. That's 37 years of holding on to a volatile asset class only to be beaten by a much more conservative mix of stocks and bonds.

This makes it clear that we have to question our assumptions about the relative outperformance of one asset class vs. another. If you read my Update posts, you should know that I value my net worth at the end of the month, and I subtract out my freshly received salary. To me, I'm measuring what I've accumulated after all expenses are paid. It doesn't make sense to inflate my net worth if I'm about to spend it down.

I'm starting the view the stock market the same way. There's clearly some kind of cycle that happens over time, and measuring outperformance based on the results in the middle or peak of a cycle leads to lofty expectations. Yes, as of right now, U.S. market cap-weighted stocks are trouncing everything else. But that has been true in the past as well, and it didn't automatically mean that it continued into the future.

Will a pure U.S. stock portfolio's returns fall below a 60/40 mix after two decades ever again? I have no idea. Going back to the beginning of the 20th century, it appears that a pure stock portfolio does eventually pull away from that more diversified stock/bond portfolio. However, we don't know what time scale that requires. And we have to consider the specific events in the early 20th century that might have influenced that result, which we might not be so glad to repeat.

Market Cap Weighting Downsides

Part of the inescapable issue with VTSAX and all such indexes is the market cap weighting. The most valuable companies get the most dollars allocated to them. However, since market caps are driven by more than the business results, this can mean money allocated to the wrong companies at the wrong time. Looking at the largest S&P 500 holdings over time makes this clear: they were darlings for a time, and then they weren't.

Yes, yes, the indexes are eventually self-cleaning, and those companies will eventually become smaller and will get efficiently de-emphasized. Valuations eventually get sorted.

Without a second asset class, though, you just have to wait for that to happen, and you have to live with the volatility and year or decade long reshuffling to correct these imbalances. An upside of even a simple stock bond mix is that you can sell off the stocks as they get too expensive to put into something else. This makes the overvaluation of the market a benefit since it can be sold to buy something else.

That leads to the so-called rebalancing premium, whereby two assets together can outperform either one individually. You can’t do that with one asset all by itself.

We're All Making Bets

If you're buying VTSAX and chilling, you're making a series of bets:

• You are betting that the U.S. stock market is more or less efficient.
• You are betting that the U.S. is the best place to invest.
• You are betting that large cap stocks are basically where the majority of your money should be.
• You are betting that the downsides of rebalancing (taxes and complication) are significant enough to warrant putting all your money into a single asset class rather than diversify.
• You are betting that other asset classes aren't worth bothering with.
• You are betting on positive returns coming from earnings growth that justifies the current valuation.

It's easy to wave this all away by using words like "passive" and "efficient" and "indexing", but you're kidding yourself. You're making a very aggressive bet on one asset class.

It's one I'm not comfortable with. It is possible that I'm wrong. But since the future is unknowable, we have to consider a variety of future scenarios. You pays your money, and you takes your chance.

That’s a long post to say: I won’t be putting all my money into VTSAX. It's too concentrated in one style for my taste.

If you are, then you'll probably be ok. Just realize that the returns you're hoping for won't be smooth, and there may be long long periods of no growth or sideways choppiness that will be no fun. You'll probably also have times where other markets do better, which will tempt you to bail on your strategy.

If you're cool with all that, then enjoy your very simple tax-efficient U.S. stock allocation.

Asset Allocation Conundrum

When I decided to focus on a diversified ETF strategy, I hoped asset allocation questions were settled science.

Nope. Not even close.

Accepting Lower Returns

One aspect of this that's a hard pill to swallow is that it will likely force me to accept lower returns. When I buy an individual stock, my hope is that it will appreciate by 15% a year for the foreseeable future. Naturally, volatility won't make that a smooth ride, but generally 15% is the goal.

Expecting a 15% CAGR when you're allocating to a basket of assets is foolish. After backtesting various portfolio types, it's probably wise to expect a 4-9% CAGR. Some years will be better, but due to overvaluation and volatility, sometimes there's no escaping bad returns. There might be an extended period of 0 return.

If I can get 15% on a stock but only 4-9% on ETFs, then why get the ETFs? Well, it's because the stocks aren't guaranteed to work. Additionally, they expose me much more to my own thinking errors, behavioral mistakes, and biases. Perhaps my analysis is simply wrong or under-baked. Basically, I need some money set aside into broad buckets that will perform well enough in case my stock picking doesn't work out.

That's where asset allocation comes in, and - even accepting lower returns going forward - it's tricky.

Why Not Just Do Something Lazy?

So what would be the, you know, "Ah, screw it" portfolio?

As a baseline, there's J.L. Collins 100% allocation to VTSAX (ETF: VTI). Lazy and easy, and you won't feel a lot of FOMO (fear of missing out) since it's the whole U.S. stock market. It's also very hard to beat:

But what if you want some "hold onto your butts" assets for the scary times? Something like the Bogleheads' 3 fund portfolio fits:

For sure, lazy has a lot going for it. It would be easier for me to manage, and should I get hit by a car, it will be easier for my wife to manage. There are some portfolio varieties that just have too many funds in too many strange percentages. If it requires a computer to manage, then it's probably not the best choice.

And the lazy portfolios don't perform strangely. If you spend years envying the S&P 500, how long can you reasonably hold out before you just buy the S&P 500?

That said, are there ways to achieve slightly better risk-adjusted returns without it becoming too complicated?

International

I should have been prepared for difficult questions since I've been an active listener of Meb Faber's podcast. He has idiosyncratic views about asset allocation. For example, he argues effectively that a global allocation is not only valuable but even dangerously underutilized in many modern portfolios.

To make a long story short, being concentrated in one country in a market-cap weighted portfolio leaves you open to major country risk as well as valuation risk. There will be periods of underperformance, and there's the risk of a total country disruption that leads to a total loss.

What's hard to get over, however, is that international additions to a pure 100% US market allocation have been a performance drag in recent memory. It's one thing to know that allocating all your assets to a single country (even the US) can be risky, and it's another to actually allocate money to underperforming geographies:

Adding international exposure looks like a leap of faith based on the following ideas:

• The US is likely overvalued relative to international markets, which may lead to sustained international outperformance during times when the U.S. is working through overvaluation.
• The existential risk of single country concentration is high enough that putting up with potential lower returns is worth the risk. Countries don't stay on top forever, and whole country's stock markets have gone to 0.
• Adding international adds even more diversification.

With those ideas in mind, I will probably add an international component.

Drawdown Protection Portfolios: 60/40, Weird, and Permanent

If I want lower drawdowns in a lazy way, there's not much lazier than the 60/40 or 40/60 portfolio:

One of the accounts I follow on Twitter is ValueStockGeek. While occasionally, he'll put out some information on a specific company he's interested in, the most surprising content he writes is about his Weird Portfolio. I encourage anyone interested in this stuff to read what he's written on it, but long story short it's:

• 20% US Small Cap Value
• 20% International Small Cap
• 20% Gold
• 20% REITs (divided between US and ex-US)
• 20% Long term treasuries

It's his variation on Harry Browne's Permanent Portfolio, and it's more aggressive than Browne's risk-averse allocation (25% US stocks, 25% Long Term Treasuries, 25% Gold, 25% cash).

Notice the slow and steady return of the blue line (the Permanent Portfolio) vs the more jagged yellow line (the S&P 500), with the red line (the Weird Portfolio) somewhere in the middle.

Both alternative portfolios are trying to consider inflationary and deflationary environments, and how those periods impact the various components. When both portfolios succeed, they leads to lower but steadier growth with much gentler drawdowns. The Sharpe ratios are considerably higher than a pure stock allocation. The Permanent Portfolio's returns are low but with much lower risk, while the Weird Portfolio has more acceptable total returns.

Backtests point to something like an 8-9% return for the Weird Portfolio. In the Great Recession, the drawdown was higher than the Permanent Portfolio's, but it was much lower than a 100% stock allocation. Combine that with a 9% return, and it feels like a revelation.

My concerns with it however are:

• Small cap value outperforming over time is necessary for the growth to be satisfactory. It hasn't out-performed during this last decade, though its longer term record is very good:

• The drawdown protection via gold and treasuries has to actually work.

Nevertheless, I find it compelling despite my concerns and will integrate some of this into my own approach.

Other Compelling Portfolios and Final Thoughts

Look around enough, and you'll see all sorts of smart portfolio constructions. Take a look at the Ginger Ale Portfolio for one idea. For my taste, it's too many ETFs, but to each their own. Or stroll through the Boglehead forums to read intelligent debates about portfolio construction.

Nothing is guaranteed, and we have to make best guesses about our own psychology and how best to navigate an unknowable future based on the available research and how assets have behaved in the past. Avoiding blunders is paramount.

The strongest takeaways for me are:

• U.S. Market exposure is basically good enough on its own. It prevents FOMO and will probably perform well. It has risks though.
• Some "hold onto your butts" assets make sense.
• A tilt towards small cap and value makes sense.
• Too many assets gets unwieldy.
• Some international exposure is likely worth it despite recent underperformance.

This only begins to scratch at the surface of asset allocation decisions that someone could obsess over. I think I have a basic plan, when I make a decision I'll write more.

Applying for Another US Brokerage Account

Today I applied for another US brokerage account. In so doing, I hit one of those pain points for US citizens living abroad.

Right now, I have two brokerage accounts: I have my main Interactive Brokers account, and I have a Robinhood account, which was actually the very first brokerage I opened. When I first opened that Robinhood account, it was years ago when Robinhood was the hot new thing. I was vacationing in the US, and it was no problem to open the account. I began my stock purchases, and when I hit the $10,000 threshold for Interactive Brokers, I moved everything over there. Interactive Brokers has thus far been pretty great.

The problem with Interactive Brokers is they are bound by the laws of the EU as well as the US. Since they have my German address, which means I'm shuffled into their Irish - previously UK - subsidiary, I'm unable to buy any funds that are US-sourced. Under the MiFID II rules, brokers in the EU can't allow EU residents access to funds that don't follow these rules. This rules out all US funds, including ETFs.

Interactive Brokers does allow the purchase of European funds, but this is where my citizenship bites me. If I buy EU ETFs, I'll have to report them as Passive Foreign Investment Companies (PFIC) in my yearly US tax return. It's unfair and ridiculous, but it's the current legal reality, so I can't go that route.

Why now? I've been happily buying individual stocks for years now, but increasingly, I feel like I'm out of my depth. I've saved enough money in these stocks that the risk is starting to feel real. I've also learned a lot about investing, and what I'm learning is that the experts are experts, and even they have a hard time doing this.

Therefore, I would like to begin indexing in some form, but all my outlets in Europe are ruled out.

I could use the Robinhood account for this purpose, but I'm concerned about Robinhood's viability as a company. They also just raised their fee for an ACATS transfer. Robinhood also doesn't offer things like automatic rebalancing. Really, the whole app is very casino-ish.

I'd also like to cut down on the chain of transfers I have to do. If I want to buy ETFs in Robinhood, I'd have to: get paid, transfer the money to Interactive Brokers, convert from euros to dollars, withdraw that money to my bank, transfer that money to Robinhood. Each step can add days of waiting, and since my US bank offers a brokerage, I hope that I could open an account with them just to simplify.

Naturally, though, my application was not instantly approved. For some reason it triggered their extra diligence check. I'm worried that their research into me will not only result in being denied the brokerage but also result in my bank account being closed, which would be bad. Not quite disastrous but definitely bad.

Citizenship Worry

And so I'm once again staring into that bottomless well of worry about my continued relationship to the United States. These rules are unjust and unfair, and citizens living abroad should not have to put up with this. We are punished for living abroad. Congress could fix this at any time: enact Residence Based Taxation (RBT), create a PFIC exception for people living outside of the United States, create a FATCA exception for citizens living outside the United States. But they choose not to out of either inertia or ill will.

What's all the more frustrating about this is that I'm forced to lie. In filling out applications for banks, credit cards, and now this brokerage, I have to use an address where I don't truly live. I also can't name my actual employer, since this employer doesn't exist in the US. So I lie. But what's the alternative?

The United States compels its citizens to use its financial system no matter where those citizens reside, but they don't provide guarantees that the companies there will allow us. We must have a financial relationship with the United States, but when we do exactly that, we're breaking the terms of service or lying on our applications, and from then on, we're worried that we'll be found out and shut down.

In any case, I'll add an update here with the result. Hopefully, my worries are unfounded, and I'll have the new account in a week.

Update April 2022: Net Worth, Rough Month, Indexing, Covid

Rough Month. Ouch.

Our net worth declined by 11.42% in USD and 6.48% in EUR to $110,276 and €104,329 respectively. The euro loss was offset by the appreciation of the dollar relative to the euro. At the same time, our euro debt was reduced in value relative to the dollar.

This was our worst month financially since March 2020.

Stock Decline: Sleep Test and Indexing

Obviously, the main driver was the stock market declines. I wish I could say I bathed in glory and withstood the desire to sell anything. I wish I could say I wasn't scared. I wish I could say that the online chatter didn't influence my decisions.

I sold some stuff. I was scared. I let myself be influenced by noise.

That said, I tinkered rather than dismantled. I knew that at any moment, the whole thing could turn around, so it was unwise to go to cash 100%. So if my tinkerings were mistakes (as they almost certainly were), they will be small mistakes rather than absolute disasters.

One thing that's become abundantly clear though is that my overall portfolio is not passing the "sleep test". I am often worried about it. It is often gnawing at me, prompting me to take action in one way or another.

It's stupid. I'm saving money in order to improve my life, but if I'm stressing over it, then what's the point?

So I'm going to start indexing most of my new money. I'll start with about $7,000 and put most new money into that on a monthly basis. I intend to write more about this decision, but long story short is: I need a pool of money where I don't worry about individual securities. Right now, I have to worry about each individual name in my portfolio. Might this company perform poorly? Have I overweighted this company? Maybe this is a secular decline, and I'm missing it?

I hate all this. This worry is a negative in my life, and so far my stock picking ability has not shown itself to be superior, so it's an emotional negative for not much gain.

Covid Caught

As a backdrop to all this, I've caught the coronavirus. Last Friday, as the worst day of selling was ravaging my portfolio, I was sitting home alone having called in sick to work. I had the sinking suspicion that I'd caught it, but since I'm both vaccinated and boosted, all my self tests came back negative.

Only on Sunday did the test faintly show positive. Now I know why they say the self tests take fifteen minutes: the control line appears quickly, but it takes much longer for the T line to show up. If you just wait for the C line, you might miss the eventual faint T line, which tells you that you're positive.

My employer requested that I get a "Bürgertest" (a free fast test administered by an official testing center) and, if positive, a PCR test. Both came back positive, and so I'm at home at least until next Monday.

Financially, this is a set back. I was set to do some extra work for my employer that would have paid me a fair amount of money. Someone else will do that now. On the upside, at least I can't go out and spend money, but that's little comfort.

Ironically, I caught it at work, where a mini super-spreader event occurred. Restrictions have been lightened in the past few weeks, and we had a week and a half of vacation. Simultaneously, our thrice-weekly testing regimen was changed from PCR tests to antigen tests. Someone must have had a false negative and come to work, where they infected me and around 20 other colleagues. Go team.

Health-wise, this thing was awful. Saturday and Sunday were especially unpleasant with coughing, sneezing, runny nose, body aches and pains, a high fever, and an overall sense of fatigue and foreboding. It's gotten progressively better since Monday, but my voice is still froggy, and I'm still congested. If this is what it feels like with the vaccine, then what the hell does it feel like without it?

So far, my wife hasn't caught it, but unfortunately, it may be just a matter of time.

Final Thoughts

I don't know how to guess about May. But during May I'll be thinking about how to pass the sleep test. What actually worries me during drawdowns? What is so scary?

I'll also try and come up with an asset allocation plan that's simple and effective for my new indexing allocation.

Until next time, stay healthy, and remember that relationships are wealth.