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Thursday, March 30, 2017

The Backward Portfolio

Posted by Tim Stobbs on October 28, 2008

I’ve got an idea.  One that I would appreciate some feedback on.  For lack of a better title I’m calling it the backward portfolio.

What if instead of the traditional portfolio where you put some money in stocks, bonds and cash during your entire investing life.  Then just adjust the amount of each type to be more conservative over time.  That you instead build your portfolio instead from highest risk to lowest risk over time.  So in the beginning you mostly pick your individual dividend paying stocks with some index funds with just a little bit of cash between purchases.  Then towards the middle you focus more on index funds.  Then in the last 10 years you start to pick up some bonds and during your last three to five years you focus on making a pile of cash.

So overall it would look something like this:

30+ years to retirement: 85% individual stocks, 10% index funds, 5% cash

15 year to retirement: 50% individual stocks, 45% index funds, 5% cash

10 years to retirement: 40% individual stocks, 35% index funds, 20% bonds, 5% cash

5 years to retirement:20% individual stocks, 20% index funds, 50% bonds, 10% cash

At retirement: 15% individual stocks, 15 % index funds, 60% bonds, 10% cash

The idea of this would be to maximize your equity portion of your portfolio when your young at 95% and so if you do make mistakes in individual stock picking you can recover from your mistakes.  This would also prevent people from having too much equity exposure towards the start of your retirement as you would be more focused on stabilizing and locking in your gains at the end than taking on more risk.  Obviously some equity is required in retirement to combat inflation concerns, but I’ve the overall rather small in retirement when you want to sleep well knowing your not going back to work because of a market drop.

Yet despite the positives of this idea I see a few holes.  First off, 95% equities can mean a not so good sleep at night factor for young people.  I’m not sure most people could handle that well.  Another issue that occurred to me was your investment knowledge when your young is often more geared to buying an index fund in the beginning  (because we all started off clueless at one point) until you have learned enough about stocks to be comfortable picking your own dividend paying portfolio.

I’m not planning on doing this tomorrow or anything, but rather it was just an idea in my head I wanted to see what others think about.  So would you ever try something like this?  Feel free to suggest other breakdowns.

Comments

11 Responses to “The Backward Portfolio”
  1. I think you are describing a traditional approach to investing. One used by professional advisors.

    Unfortunately, they also assume that the younger investors can stand the stress of “buy and hold” through severe downturns. This is not true for all of the younger investors and some of them sell at a loss.

    On another note. When the market moves down fast it will also move back up relatively fast. That is normal market behaviour.

    We are only down about 43 % so far. No worse than the 2000-2002 bear.

    CM

  2. Richard says:

    That’s an interesting plan – it has the advantage of letting you build up the large “safe” investments during your higher earning years, while giving your early investments time to grow.

    But, it’s based on one big assumption – that an early investment that’s 100% in individual stocks or index funds will have a higher growth rate than later diversified allocations. Being able to rebalance a portfolio that includes bonds may help increase the returns (especially over the last couple of years). Ideally you could find several uncorrelated equity classes that all have good long-term returns on their own – as Stocks for the Long Run mentions, this may be easier to do with industry diversification than with country diversification.

  3. porpoise says:

    This is pretty much how I am approaching investing right now. I am 31 years old and am almost 100 percent in equities. This approach is not from some analysis like above but from the belief that over 30 years stocks will be the best option for me. As I age I will become more risk averse and start adding to bonds, etc.. (i assume). The market downturn is disconcerting, however, I regret not having free cash to make timely purchases. I do think that most people my age would not be able to handle this strategy.

  4. Its a good idea in the tax sense. You stack your portfolio to be tax efficient during your prime earning years and then tax inefficient when you are not making income.

    Question is do you have the fortitude to go all equities?

  5. I think all depend on risk tolerance of a person. Someone who cannot see his portfolio going down might need more fixed-income securities there.

    Personally, I use my age as reference on how much money I should put on fixed-income securities vs. stocks/index. For example, since I am not at 30s, I put 30% toward fixed-income (bond, money market), etc) and 70% toward stocks/index. The number is not so difference with yours.

  6. Canadian Dream says:

    Richard,

    Yes I agree that rebalancing from some bonds might provide a better return over the long haul. That would be something missing from this method. I suppose you can skip the DRIP on the stock picks and then pour that dividend money back in as method to rebalance.

    Porpoise,

    I’m in the same boat with wishing I had more cash right now.

    Thicken,

    Good question. No, I don’t think I could pull this off myself. I don’t have the personality to handle all equities right now. I know I could handle a fairly large % of equities, but I don’t think I could drop my safety blanket of bonds entirely. It’s my very own sleep at night factor.

    Tim

  7. Kevin says:

    I agree with Canadian Money, this seems to be a slight variant on the conventional wisdom of starting with an aggressive stock/bond allocation at a young age and making it gradually more conservative over time. In fact your breakdown is very close to the old saw of “age% in bonds”. Am I missing something?

  8. Canadian Dream says:

    Kevin,

    All portfolio’s have the same basic idea of getting more conservative over time. The issue with ‘age % in bonds’ is it assumes that you are retiring around the normal age of 60 to 65.

    If you want to pull off retirement at 45 you would likely have a bit too much equity instead of bonds at that point.

    Tim

  9. Cash Canuck says:

    There is a graph in the 4th edition of Stocks for the Long Run that displays the basis for this approach.

    The jist of it is that with a long time frame it is more risky NOT to be in stocks than in them. As the time frame shortens, the lowest risk asset mix moves more towards fixed income.

    This makes me breathe a sigh of relief about the current market situation.

  10. Potato says:

    I think that’s a good approach, and at 29, what I’m following myself (98% equities at the moment). I think I’m even more equity-happy, since I don’t anticipate having any* bond exposure until <10 years before retirement (with a 10+year time horizon, I’ll take my chances with equities).

    One minor point is that I’d start with index funds then move to picking individual stocks (if at all) — at the beginning, you won’t have enough capital to properly diversify if picking, and index fund accounts (e.g.: TD e-series) often have lower/no transaction fees vs. brokerage accounts.

    * – ok, I lied: there are major purchases, like a car and a house, in the <5 year timeframe that I had been starting to save for in cash/fixed income. I not-quite-recently-enough (i.e.: before the October stock market brutalization) flipped that over into the market, but new savings are going back into the cash pool since I can only be _so_ aggressive as these dates approach (I also haven’t gotten into leveraging).

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