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A New Twist on 60/40 Asset Allocation

A New Twist on 60/40 Asset Allocation

What is a 60/40 asset allocation? I’ll take a quote from an article on my favorite online finance wiki, investopedia:

For many years, a large percentage of financial planners and stockbrokers crafted portfolios for their clients that were composed of 60% equities and 40% bonds or other fixed-income offerings. And these portfolios did rather well throughout the 80s and 90s. But a series of bear markets that started in 2000 coupled with historically low interest rates have eroded the popularity of this approach to investing. – “Why a 60/40 Portfolio is No Longer Good Enough

With that in mind, I’ve found a delightful free tool called Portfolio Visualizer that I’ve been using to backtest various asset allocation strategies.

Today I’d like to share a few basic ones to provide some food for thought. Each of these portfolios is modeled for annual rebalancing, meaning assets would be bought and/or sold each year to retain the original allocation percentages.

Portfolio 1: 100% Allocation to US Stocks

Using this tool, you can see that if in 1972 you invested $1,000 in US stocks, it would grow to be worth $78,509 at the end of 2016, representing a compound annual growth rate (CAGR) of 10.18%. You would have had to endure a drawdown of 50.89%, from November of 2007 through February of 2009. During this crisis the portfolio would have gone from $43,886 down to $21,551.

Portfolio 2: 60/40 Asset Allocation of US Stocks and Bonds

Most people don’t have the iron stomach needed to hold onto their stocks while their portfolio drops by 50%.

Enter the 60/40 asset allocation.

A traditional allocation in the investment community is (or has been) 60% stocks 40% bonds (in this case I used Intermediate Term Treasuries). The thought being that if stocks are going up, bonds are going down, but also that if stocks are going down, bonds will go up. If you did this 60/40 allocation starting in 1972, again with $1,000, the 2016 value would be $58,011, the CAGR would be 9.44% and the 2008 drawdown would have been around 28%.

So you give up $20,500 in exchange for some peace of mind.

Portfolio 3: 60/40 Asset Allocation of US Stocks and Gold

I think that US debt has nowhere to go but down. And I’ve never been particularly fond of loaning the government money, through treasuries or otherwise, so I thought: what if one replaced the 40% allocation to bonds with my favorite yellow metal?

With this allocation the $1,000 invested in 1972 would grow to $85,886 by 2016, the CAGR would be 10.40% and the maximum drawdown would have been 30% back in 1980-1982.

So over the 1972-2016 timeframe, a 60/40 asset allocation of US stocks and gold would have performed better than either 100% US stocks or a 60/40 US stock and bond portfolio.

You can always cherrypick allocations in hindsight that will outperform. But I think it is an interesting datapoint in the case for gold.

How I Avoid a Tax Refund

How I Avoid a Tax Refund

I’ve written about how I hate tax refunds.

I want to share three ways I avoid getting one.

I’m not a tax advisor, CPA, or attorney. I’m just sharing what I’ve done in the past as an individual subject to United States taxes.

This isn’t tax advice.

In my experience there are two steps to avoiding a tax refund.

Step one is to have an accurate prediction of how much tax I will owe (or get refunded) at the end of the year and (this is the key) knowing this information before the calendar year ends when I can still do something about it.

The second step is to take action to influence how much tax will be owed at the end of the year. All while being careful not to owe too much.

It’s important to know the maximum one is allowed to owe in federal taxes and the state level as it could change.

In past years it was $1,000 at the federal level. If one were to owe more than $1,000 in taxes there would be penalties.

Step One: Know How Much Tax you will Owe (or be Refunded) in Advance

Most people don’t look at their taxes until the next year.

For example, right now, most people probably haven’t even looked at their 2016 taxes yet. When they do and they realize they will be getting a $2,000 tax refund, well there is nothing they can do now, except file their taxes as soon as possible to get the refund check.

But if one were to assess his or her tax situation in June of 2016, there would still be half a year to make changes.

So how do I predict how much tax will be owed at the end of the year?

There are several ways.

Use Last Year as a Proxy

At a very basic level, one could use the past year as a proxy.

Ask yourself, did I get an income tax refund last year? If so, ask, am I going to be making the same amount next year? Will I have the same or similar capital gain/loss. Will I be making similar charitable contributions?

If one’s tax situation last year is likely to be very close to what it will be this year then it makes sense there will be a similar tax refund.

This isn’t a very sophisticated approach but it is a start.

In order to make an accurate prediction of how much income tax will be owed more a more detailed and comprehensive approach is needed.

Use Income Tax Calculators

Last year I put together a complicated spreadsheet that basically enabled me to calculate my income taxes during the year.

But rather than reinvent the wheel manually like I did–it would have been better to use the prebuilt tools and resources available to calculate taxes due.

One could experiment with the TurboTax W4 Calculator. Armed only with a copy of the most recent pay stub, as well as some other information, like charitable contributions, capital gains/losses, one can tweek allowances to avoid getting a refund.

Turbotax also has something called Taxcaster.

I wish I had known about these last year.

They key is having tools available to predict how much tax one will owe (or have overpaid) during the current tax year, while a person can still make changes.

Another strategy I’ve used is to start my taxes in December. By December 2016 I had filled out most of my tax information in Turbotax.

Sure, I didn’t have 1099s, W2s or many other tax documents, but I can look at pay stubs to figure out how much my W2 will be, I can look at my brokerage statements to see gains and losses.

This allows me to make decisions when I can still influence my 2016 taxes.

Step 2: Take Steps to Avoid a Tax Refund

Once I have a good prediction of how much of a tax refund I’ll get based on income, charitable giving, capital gains, and other tax situations it’s time to do something about it.

Strategy One: Increase Allowances on the W-4 Worksheet

Increasing allowances on a W-4 reduces the amount of tax withheld from each paycheck.

The tools referenced above enable one to tweek withholding allowances to make sure some money will be owed at the end of the year.

If the max I’m allowed to owe at the end of the year was $1,000, I would try to owe around $500 or so.

This provides some wiggle-room, because despite best efforts, the tax situation could change and I’m only able to estimate what I think my taxes will be Maybe I’ll decide to give a big $1,000 check to the charity in December, or maybe I’ll suffer a large realized stock loss I wasn’t anticipating.

These are things that a taxpayer might not realize are going to happen until later in the year.

Strategy Two: Convert IRA Money to a Roth IRA

I think taxes will be higher in the future than they are now.

So when it comes to retirement accounts I prefer paying taxes upfront (when I think they’ll be lower) and then having that money grow tax free over the course of 40-50 years, and then be able to withdraw it tax free.

Thus I prefer a Roth IRA over a traditional IRA (and Roth 401ks over 401ks).

But employer’s tend to do company matching to a 401k which is pre-tax money. I’ve been in several jobs that had a 401k and upon leaving those employers I’ve rolled my 401k money into an IRA.

So if I know I’ve overpaid my taxes I will convert some of my IRA money to a Roth in late December.

This increases taxable income, but one can opt NOT to have taxes withheld during the conversion.

This tax is still owed of course, but the payment can be delayed until later in April.

So if I know I’ll be getting a refund I can use that as an opportunity to convert some of my IRA money to a Roth.

I did this last year. I was working a W2 job for a half a year, and then when my contract was up I had no job. So I’d been overpaying withholding taxes.

So I decided to convert a large portion of IRA funds to a Roth IRA to avoid getting a refund. If I had known I was only going to be working for half a year I would have increased my withholding allowances.

Strategy Three: Realize Some Capital Gains

You want to be smart about this.

I wouldn’t sell a winning investment just to avoid a tax refund, but if you’ve been thinking about getting out of a winning position anyway, doing so will increase your taxable income.

In the US short term gains are currently taxed as ordinary income.

Strategy Four: Give Money to Charity

This strategy doesn’t help avoid a tax refund, but it is invaluable if you have underpaid your taxes too much, because it is a way to avoid penalties (see page 51).

If I realize that I owe more than the penalty-free amount on my taxes, I’ll give some money to charity or make some additional donations or put some money in a Health Savings Account.

These contributions reduce taxable income and can be useful when avoiding penalties that can be assessed if too much tax is owed at the end of the year.

Similar to strategy one, you can also reduce your withholding allowances to have more tax withheld each paycheck, if you realize that you’ll wind up owing too much at the end of the year.

I Hate Tax Refunds

I hate tax refunds because they are an interest free loan to the government and I have better use for my hard earned money than the IRS does.

It’s vitally important to legally pay all taxes due and remain in compliance with all applicable tax laws. It’s just not worth trying to cheat the IRS.

But there are legal ways to reduce your taxable income and avoid getting a tax refund.

Avoiding a tax refund has nothing to do with cheating the IRS or evading taxes.

It’s simply a way to make sure you aren’t paying more than you’re legally required.

It’s also a way to make sure that you don’t pay the taxes you owe earlier than you’re legally required to do so.

The above strategies are merely things I’ve done in the past to manage my tax burden and isn’t advice.

But these ideas could spark some conversation when you speak to your licensed tax advisor and as you make your own tax decisions based on your own unique situation.

I Hate Tax Refunds

I Hate Tax Refunds

I hate tax refunds. Some people think, “I can’t wait for my tax refund so I can do X.” If you really don’t want to wait for your tax refund, take steps so you don’t get one.

See, a tax refund is just that, a refund. It’s not a bonus, new money, or an extra paycheck. An income tax refund is money you could have had earlier in the year, that you overpaid to the government, which is now being returned to you, without any interest.

The United States Tax System

First, a bit of a background on the tax system in the United States. has a global audience. I focus on the US with respect to taxes because I am subject to income taxes in the United States and have no experience with taxes outside the US.

While I’m not tax attorney, accountant, CPA or guru, I have been in charge of my own income tax returns since college and I have over 10 years experience doing my own taxes.

There are a myriad of tax situations. I’m just writing about my own experience through 2016 as a W2 income earner.

Income taxes in the United States are imposed at various levels. There are Federal Taxes, State Income Taxes (in most states but not all), and in some cases income taxes on an even more local level.

The US has a pay-as-you-go tax system. That means one is taxed throughout the year at a rate that assumes you’ll make the same amount each pay period.

So if one were to make $4,000 in January, the United States Internal Revenue Service (IRS) assumes you’ll make $48,000 ($4,000 x 12) and taxes will be withheld by one’s employer from each paycheck as if you were going to make $48,000.

But the US tax code is hopelessly complex (you can ask 3 different accountants a tax question and get three different answers all of which could be correct) and tax withholding doesn’t take into account changes in income, deductions, credits, allowances, or capital gains/losses.

As a result one could end up owing more or less in tax at the end of the year, once the myriad of factors that factor into an income tax return are known.

Why I Hate Tax Refunds

Imagine you go to a store and buy a shirt and you pay $100 for it. But the shirt really only cost $50. An honest storekeeper would give you $50 change at the point of sale.

But this store owner holds onto your $100 for over a year and then finally tells you that you overpaid and gives you $50 back.

If you didn’t realize you overpaid you might be glad, “Hey, I’ve got an extra fifty smackers!” But what if you needed that $50 a year ago to pay rent, or buy food, or to buy a pair of pants to go with your shirt, or better yet, save that money and earn interest on it. You’ve lost out on all kinds of opportunities for those funds.

Try to Be Rational

Now I get it, just like if you were to find a $20 bill in your couch that you thought you had lost, there is a certain emotional thrill of getting money back.

I also get that as humans, myself included, we’re very emotional creatures.

Sure, humans have the capacity for reason, but unfortunately and all to often emotion rules the day.

I quote my favorite playwright, Oscar Wilde:

Lord Caversham: No woman, plain or pretty, has any common sense at all, sir. Common sense is the privilege of our sex.
Lord Goring: Quite so. And we men are so self-sacrificing that we never use it, do we, father?

  • An Ideal Husband, Oscar Wilde

In the witty quote above, I think Oscar Wilde is basically saying that too few of us (men and women) use common sense or reason as often as would be ideal.

Rationally it doesn’t make sense to get a tax refund. A tax refund is money that has been overpaid that is being returned much later with no interest.

I strive to be a rational person. Not in the sense of being a robot, but rather having rational thoughts in the driver seat and emotions serving more of a supporting role, rather than using reason to justify my emotions.

It’s much more reasonable to avoid a tax return and be happy that one has the money throughout the year, rather than get the money in April.

My next article will provide ways in which I’ve avoided getting a tax refund in the past, so that I had more money throughout the year and I didn’t give the government an interest free loan.

Average Returns: A Fairy Story

Average Returns: A Fairy Story

Imagine if you will your fairy godmother appears and you’re given the opportunity to backdate one trade to five years ago.

You’re given 1,000 dollars and you’re presented with three investment choices.

For each option she tells you the annual gain or loss as well the average return:

Investment One

Investment Two

Investment Three

Now your fairy godmother told you the average annual return for each is 10%. So, one might be tempted to assume each investment will perform the same!

But you don’t get average returns so this number is not particularly useful.

Total Return

You want to choose the one that has the highest total return. Total return is just a fancy way of saying how much an investment went up (or down) from it’s starting value.

So you’d take the starting amount, $1,000, and add the gain or loss from the first year, second year, etc, and see how much the $1,000 is now worth after five years. The percentage increase from the original value to the ending value is the total return.

Total return would be 54.57% for investment one, 51.63% for investment two and lastly investment three has a total return of -4.96%, even though the average return for each was the the same: 10%.

Compound Annual Growth Rate

Investors typically want to know how an investment tends to perform each year. A useful way of seeing how an investment does each year in a way that smooths out up years and down year that is more useful than average returns is the Compound Annual Growth Rate (CAGR).

CAGR is calculated as follows:


I’ve calculated the CAGR for you below.

Investment One

Investment Two

Investment Three

So if the fairy godmother had provided the CAGR; it would have a been a useful number to determine which investment had the highest total return.

Why Do fairy godmother’s overcomplicate things?

Why wouldn’t your fairy godmother just give you an even $1,500 and call it a day?

I don’t know.

Cinderella‘s fairy godmother gave her until midnight to get back home. Why didn’t she give her a year to get back or just make the pumpkin turn into a carriage permanently?

Why weren’t the slippers made out of something more comfortable and durable than glass?

Cleary there is NOT a precedent for the pragmatic or straightforward. So don’t ask me to explain how fairy godmothers operate. But lest I upset the fairy godmother community I think the principle of don’t look a gift horse in the mouth also applies. After all, she’s hooking you up with the ability to backdate a trade.

You don’t get the Average Annual Return

At best the average return % isn’t useful. At worst the average return is rather deceptive–but that is the number that most mutual funds list.

While not without it’s limits, the compound annual growth rate is much more useful than average returns and it is something to keep in mind when evaluating an investment.

Average returns tell you very little while the compound annual growth rate shows you which investment would have had the highest total return.

Better Metrics for Value Investing

Better Metrics for Value Investing

My desire for improvement has lead me to search for better metrics for value investing.

My belief in the power of value investing is unchanged but the metrics I look at have evolved.

Most people instinctively want to buy things on sale to get a great deal. But for some reason there is an exception when it comes to investing–people tend to buy stocks that are expensive.

Value investing takes the principle of finding a great deal and applies it to the stock market.

The the goal of value investing is to find profitable companies trading at a discount.

I’ve written in the past about value investing metrics and how it is one of the ways I grow and protect my wealth.

But if I can find a better and more reliable way to find a great deal I’m going to use that method.

The first reason I questioned the metrics I had been using was an article by Jason Rivera: “Why The P/E Ratio Is Useless – And How To Calculate EV” which is an excellent read.

The second was a video by Simon Black of “How to identify the most compelling investments on the planet“.

Better Value Investing Metrics

So what metrics am I using to find great deals on stocks?

1) Enterprise Value to Market Capitalization (EV/Market Cap)
2) Enterprise Value to Free Cash Flow (EV/FCF)
3) Enterprise Value to Earnings Before Interest and Tax (EV/EBIT)
4) Enterprise Value to Owners’ Cash Profits (OCP)
5) Operating Margin
6) Dividend Yield
7) Return on Equity (ROE)

If you aren’t familiar with some of these terms, no worries, just click on the word to view the definition in the glossary.

The Metrics

Enterprise Value to Market Capitalization (EV/Market Cap)

This ratio indicates if a company has more cash than debt. I look for a value of less than 1, the lower the better.

If a companies EV or TEV is less than its market cap its means that the company has more cash than debt. And may be undervalued. Inverse is true as well.


Enterprise Value to Free Cash Flow (EV/FCF)

This is a more reliable metric than price to earnings (PE) (more on that in a subsequent article). It takes the enterprise value and divides it by free cashflow. I want this to be as low as possible.

A lower number indicates one is paying less for a stream of cash flowing into a company than compared to a higher number.

Enterprise Value to Earnings Before Interest and Tax (EV/EBIT)

Another metric that is more reliable than PE. It’s a way to double check the cost of a cashflow stream. The lower the better.

Enterprise Value to Owners’ Cash Profits

A third replacement for PE.

If EV/FCF, EV/EBIT, and EV/OCP are all low, that is several metrics that indicate the stock is trading at a discount relative to peers with a higher ratio.

Operating Margin

This is a measure of efficiently. A higher operating margin is better than a lower one.

Dividend Yield

A company can’t fake dividends. The dividend is money that goes directly to a shareholder and the yield is how much the dividend costs as a function of the share price. Investing in a stock with a dividend yield is also a way to collect income while waiting for the company’s share price to rise in value to reflect the fundamental indicators.

The higher the dividend yield the better–all else equal.

Return on Equity over 8%

This is another metric that indicates if a company is profitable. Relying on multiple metrics versus one or two provides multiple failsafes to increase the likelihood one is purchasing a valuable company at a discount.

The Stocks I Like Based on These Metrics

I list my Value Stock Picks, which are based on the value investing metrics I use.

Subscribers to the HowIGrowMyWealth Email nNewsletter know that I’ve been selling a fair amount of stock as a result of these refined metrics.

Some of that is profit taking, but these metrics have also enabled me to see problems with certain stocks that I otherwise thought were a great value.

HIGMW Email Subscribers also learned of my latest value stock picks back on the 2nd of February.

You can sign up for these free email notifications by filling out the form below.