Finance Friday: Investment Portfolio

Finance Friday: Investment Portfolio

Welcome to installment 2 of Finance Friday! A series of articles showcasing the personal finance tracking spreadsheet I developed over the past couple of years. I suggest you check out the first one as these will eventually begin to build on each other. As you may have gathered, many of the sheets are linked to one another. This sheet has helped me immensely with keeping track of my progress towards Financial Independence. I’m hoping that with these posts it’ll spark some inspiration for you all. It’s ideal that you develop your own sheets which in turn help you achieve your own goals! Today we’ll talk a bit about portfolio re-balance and then take a look at one of the sheets regarding investment allocation and tracking.

Part of most FI journeys will include making sure that your investments continue to work for you. One of the most important things along your path to FI is making sure that you stick to your investment strategy. You should only change it up only as necessary based on your risk tolerance as you age or your life begins to change. Being able to get a quick look into where you should be allocating new funds makes this nearly automatic and much easier to turn into a routine.

Re-balancing vs New Allocations

Just a note for any beginners before diving into the sheet. If you have one, take a look at your investment portfolio now and get an idea of the asset classes you’re touching. You can read a bit about asset classes here. If you’re just starting and need to figure out what your asset allocation should look like, have a look here. If you want to know what your current allocation is, you can do so using the Personal Capital app. Alternatively, you can manually find your funds/stocks asset classes by going to Morningstar. From here you can look up your fund/stock (asset), go to the “Portfolio” tab and look for the 3×3 square of “Holdings Style”.

You might be wondering how to handle the fact that most funds reach across several asset classes. For simplicity you can just take the one that’s in the majority (For Example: SWPPX above would be Large Cap). For more specific calculations, tune into future articles to see how I handle the spread for my sheet.

We Love Examples

Now, once you’ve found your asset allocation, you might be wondering why it’s important to track it. Your asset allocation is a fundamental factor in determining how much risk you’re exposed to in the market. Risk being the inherent volatility of the collection of your different funds or stocks. If you have a lot of shares in Small/Mid-cap funds/stocks you’re exposed to more risk due to less established companies. If you’re holding on to a lot of bonds, you’ll see less variation in your portfolio’s value, but not as much growth. Naturally, as your assets grow over time, your asset allocation will inherently become skewed towards the higher performers. This is because some assets will gain value more quickly than others.

Let’s say that I’ve figured out that I want my portfolio to be 50% Large Cap Assets and 50% Bond Assets. I have purchased 100 Shares of X Large Cap Company at 100$ per share – a $10,000 Value. I’ve also purchased 1000 Shares of Y Bond Index – another $10,000 value for a total of $20,000 in my portfolio. Tomorrow, X Company had some great news about their earnings, spiking the value up to $110 per share. (I wish this were always the case) Additionally, the value for Y Index went down a tad, dropping to $9 per share. My new portfolio value is still ($110 x 100) + ($9 x 1000) = $20,000.

Seems fine at first, right?

Nothing has changed with your portfolio’s value, but our asset allocation has changed! Your risk is now inherently HIGHER than it previously was. Higher risk isn’t necessarily a bad thing, but your portfolio is no longer aligned with your initial investment goals. Your asset allocation is now 55% (11000/20000) in Large Caps and 45% (9000/20000) in Bonds. So what can we do to get back to our desired Asset Allocation? This is what re-balancing your portfolio is. Do it on a basis you’re comfortable with. Personally I try to re-balance once or twice a year, but how often you do it is totally up to you.

In the general sense, re-balancing your portfolio is the act of selling shares of one fund and buying shares of another. This allows you to balance the asset classes to your desired percentages. In the case of my fake portfolio, we could re-balance it back to 50/50 by selling 10 shares of our X Large Cap. From there we would use those funds ($1100) to purchase 122 new shares of our Y Bond Index. ($1100/$9) Our new asset allocation is almost exactly 50/50 once again!

Issues with Normal Re-balancing of Your Portfolio

This seems all good and fun, but remember that there are some tax implications with selling off your funds when they’ve increased in value. What can we do to combat this if we’re in it for the long haul and want to re-balance often? The first thing to note is that you should feel safe to re-balance your portfolio within your Tax Advantaged Accounts such as your 401k as swapping around funds like this doesn’t trigger any taxes. One of the reasons why your 401k is so powerful! When it comes to your Taxable Accounts like an account you have with a broker like Vanguard or Charles Schwab we can put a spin on things. We do this by purchasing new shares in the under performing assets and leaving the high performers alone.

Using the example above again: Instead of re-balancing by selling, let’s re-balance by purchasing! Let’s say that I saved $1000 from my job last pay check. We’ll use those funds to purchase new Y Bond shares at $9 a pop bringing our Asset Allocation to $11000 X and $10000 Y. Our ratio is still a bit off, but I can take my next paycheck savings and even it up again in two weeks all without triggering any kind of tax implications.

I thought we were talking about Excel sheets, dude.

This is all relevant, promise! You can download today’s sheet here!

Looking at the top-left section of the Excel, we have a list of all funds in the portfolio. We track things like which accounts they belong to, what their cost basis is, and their current market value. In future installments I’ll be showing off how I automatically update this sheet every Sunday using Selenium/Jenkins.

There’s a section at the bottom-left where we see the distribution of asset classes collected using Morningstar. It also shows the relationship of Actual (Based on Market Value), Invested (Cost Basis Values), True Invested Value (Values based on my contributions, not including dividends), and Target (My desired Asset Allocation) Values. The values for asset class distributions for each asset are stored in a different sheet. That sheet will show up in a future installment.

Let’s Get To the Good Stuff

On the right hand side is the fun stuff and the reason why I went on the whole spiel above. Here we have a simple graph showcasing the relationship of the calculations above. This let’s me see how I’m doing with keeping my allocation aligned with my goals. In the bottom right portion is my favorite portion of the sheet. This is a small calculator which will allow me to figure out where I should make my next investment. Any excess cash will be used to invest in an asset class which is greater than $0.

I highly recommend you try it out for yourself to get a feel for what’s going on. At a high level, the the percentage allocation of each asset class is calculated based on when the “Amount to Allocate” is added to the total amount invested. So for example, let’s say I had a 100% allocation in Large Cap funds with $1,000. Next month I want to invest another $1,000, so the new asset percentage for Large cap would be 50% (1000/2000). Based on the Target Percentage, we calculate which assets need to be invested in to get closer to the Target. I’ve chosen to ignore negative values, because I wouldn’t want to sell off any funds (That’s what re-balancing is!). In this case, I would add more money to funds that need to be increased instead.

Closing Thoughts

As you age, keeping an eye on your asset allocation will become more and more important. In my current situation (Young with a high risk tolerance), I’m looking for a lot of growth and want to maximize my exposure to growth oriented assets. However, when I near my middle aged years or begin to have less room for risk due to a family or some other change in life situation, I’ll want to adjust my asset allocation accordingly. I highly recommend, if you don’t already, to set up some time every 6 months or so to take a stake of your finances and your living situation and make changes to your portfolios as you see fit.

I hope you got something out of this, if only the neat little allocation calculator. Good luck with your financial goals and happy Friday!

Leave a Reply

Close Menu