Part 1 - Portfolio objectives

From saving to spending

This post is part of an 8-post series on the construction of my portfolio.

For most of our working lives, retirement planning is simple: put money away for “later”. But somewhere past 50, later suddenly becomes now.

Retirement generally moves through three main phases - preparing, planning, and execution.

The planning phase is your crucial window to map out what income you actually need and where it will come from before you flip the switch. You might make a model like the one below to help you.

Eventually, you reach the execution phase: taking money out of the pot instead of adding to it. A big psychological and tactical shift.

If a portion of your retirement income comes from an investment portfolio you manage yourself, you are in the exact same boat as I am. This series documents how I am setting up my own portfolio and aims to share my personal journey, choices, and reasoning.

So, how am I doing things?

Main portfolio objective

My overall strategy is based on 20 years of retirement, starting around 65. Hopefully, the first 10 years I am healthy enough to do things that are enjoyable, and these will often cost money. For this first period my overall objective for the portfolio is simple:

Get a 6% nominal return with a reasonable risk, take out 4% as an income stream and leave 2% in to counter inflation. If I get a 5% or lower return, I take out 3% as income.

Just to put some numbers on this. Say my portfolio is €500 000 then a 6% return is €30 000. I take out €20 000 as income, and I leave €10 000 in. Of course, if you need €40 000 per year from your investments, you need a €1 000 000 portfolio. And so on.

Using 2% to compensate for inflation is critical. To continue the example, if you take out €20 000 with an inflation of 2% that will be €20 400 in year 2. In year 10 you are looking at €23 902. Adds up quickly. With 3% inflation these numbers are €20 600 and €26 095. Inflation is definitely something to guard against.

What does “reasonable risk” in my main objective actually mean? Two things:

1. Like most Europeans I have a fixed “floor income”. For me, it’s mostly social security and tax-efficient provisions I arranged myself. So I am able and willing to take some risk with my portfolio.
2. The risk needs to balance two opposing forces:
   • I need a good income to help me have a great first 10 years of my retirement.
   • If I run into a market crash and I am too exposed, it could become unpleasant. I do not want to be forced to transform a temporary portfolio loss into a permanent one. This might lead to a disastrous beginning of the next 10 years.

This is why I added the bit for a 5% or lower return. Should offer some protection from the much-feared Sequence of Return Risk. More on that later.

To make this measurable, I set a ceiling: the portfolio’s volatility should stay at or below 10%. I check this in part 7.

Just a personal note. I am adamant about spending money. As a retiree, I cannot keep saving for later. Later is now. It is time to spend because the first years of my retirement are probably my best. Writing that down is easy, but actually doing it is quite a mental leap. After decades of protecting and nurturing the pot, all of a sudden I have to violate it by taking money out. Feels like sacrilege. The shift is hard.

After that short rant, let’s take a look at an asset allocation that fits my objective.

Asset allocation

After looking at example portfolios, getting info from asset managers and reading blogs made by fellow retirees, I came up with the following allocation. I also tried to estimate the nominal returns per asset category. There is plenty of info available to do this, maybe too much.

Table: Asset Allocation and Estimated Nominal Returns

I found Portfolio Visualizer helpful to try out different asset allocations. This tool allows you to model portfolios via asset classes (not actual products, so you won’t get distracted) and test them. You only need a free account for this.

Please note that the returns are nominal and not real, so they do not take inflation into account. The contributions add up to 6.34% because of rounding; the exact total is 6.33%.

1. I used various sources to get the estimated returns, and I decided to check the final table with Gemini Pro. It called the result a highly realistic, slightly conservative projection for a diversified 75/25 stock-and-bond/cash mix. It also had a suggestion:

   Consider adjusting Gold’s nominal return to reflect historical inflation tracking (e.g. 2.5% to 4.0%).

   I did not make any changes; I like to be on the conservative side.

2. This allocation is different from the classic 60% stocks and 40% bonds. The main advantage of the 60/40 used to be the low or even negative correlation between stocks and bonds which reduced volatility. Having had bonds in the painful 2022, I have experienced firsthand how rapidly increasing inflation can break this model and give unpleasant outcomes.

3. I use short-term bonds as cash equivalent for max 10%. For another 10% I need bonds with a maturity longer than a year. These help to reduce risk in the first phase of my retirement.

4. I have 75% stocks with a tilt towards more stable stocks (low beta): 40% Dividend & Value and 35% Market. I fill the Dividend & Value part with dividend funds only. High-dividend stocks lean strongly towards value, so I get most of the value tilt without a separate value fund.

5. Market Stocks are to ensure that I have growth in my portfolio. For this category, the S&P 500, STOXX Europe 600 and MSCI Emerging Markets IMI are my point of departure.

6. The Cash Equivalents are an integral part of my portfolio and could be invested in other assets according to the strict rules. These are not an emergency fund. An important distinction. The target weight is 10%. In bad years I use it for withdrawals and to buy stocks, so it can drop to 2%. More on that in part 8.

7. Gold has a maximum of 5%. If it rises more than 10% above that (over 5.5%), I sell back to 5%. Between 2.5% and 5% I do nothing. Only if it drops more than 10% below 2.5% (under 2.25%) do I buy back to 2.5%. In practice, I will mostly trim.

Five extra conditions

I could create the portfolio above with 6 ETFs, and there would be nothing wrong with that. But I have five extra conditions:

1. Target Currency Allocation: 40% EUR

   Because I need Euros to pay the bills, currency is a thing. Especially the relation EUR/USD is important. In the last 5 years I have seen big swings in the EUR/USD currency pair that had a profound effect on my investments. My goal is to have 40% of my portfolio in EUR or EUR Hedged.

2. Target Regional Allocation: underweight US

   Two reasons I’m underweight the US in my regional allocation. First, concentration: MSCI World is ~71% US, top 10 (all American) is over a quarter of the index, and even MSCI ACWI only gets the US down to 63%. Second: one year into Trump II, US markets don’t feel as safe as they used to.

   But this important allocation decision deserves its own post.

3. Target Regional Allocation: overweight Asia + Emerging Markets

   I expect Asia + Emerging Markets to grow faster than Europe and the US over the next decade. Countries I most definitely want exposure to are China, India, Taiwan and South Korea.

Here is my target regional allocation:

Table: Target Regional Allocation

Note that allocating 30% to Europe but wanting 40% in Euro is going to create a problem. We need to come back to that later.

4. Distributions: at least 2%

   I want the portfolio to pay out at least 2% a year in dividends and interest. That covers half of my 4% income without selling anything, which matters most when markets are down. More on that in part 8.

5. Maximum 10 products

   Every extra fund means more to follow, more to rebalance and more transactions. Ten products is enough to meet all the conditions above while keeping the portfolio manageable.

This post only covers setting up the portfolio itself. There’s more to retirement planning than that - tax, what to leave behind, keeping the model up to date, an emergency fund, and being honest with yourself about doing things yourself. I touch on those five in a separate post. Of the five, tax is the big one.

What is next?

Before we go to the actual products to build this portfolio, we will take a look at the process of product selection in this second post. If you want to go straight to the actual products, go to the third post that selects products for our stocks allocation.