Build My Portfolio: Helping This Baby Boomer Doctor Reach His Retirement Goals

By David Taube :

This piece is part of a new, ongoing series here on theETFs & Portfolio Strategypage at Seeking Alpha.

The concept is for a money manager or RIA to field a hypothetical portfolio construction question from an SA user about how to best construct a portfolio that will help them meet their financial goals and then proceed to build an effective portfolio that will take their risk/reward profile into account. All participants in this series are real-world professional investors who are available to help individuals, companies, and financial professionals construct intelligent portfolios. To submit a question for a future edition of Build My Portfolio, email Rebecca at

This edition of Build My Portfolio features David Taube. David is CEO and CIO of Kalorama Wealth Strategies , LLC, a fee-only investment advisory and financial planning firm in Washington, D.C., which he founded in 2005. David specializes in the development and implementation of investment and retirement plans. He also assists clients with other aspects of their financial planning, including cash flow and net worth analysis, insurance review, tax analysis, and estate plan review. David is a Certified Financial Planning professional and a member of the Financial Planning Association, a CFA charter holder, with membership in the CFA Institute and the CFA Society of Washington, D.C. and formerly a CPA licensed in the State of Maryland.

David,I am a 56-year-old plastic surgeon who makes roughly $600k a year after taxes. I have fully paid off the mortgage on my house, which is currently valued at approximately $1.4M. I also own a second home in Napa valued at roughly $490k. After all expenses, I have roughly $150k a year to put into savings.My wife passed away four years ago of breast cancer and I have recently begun dating again with an eye on eventually getting remarried. I have three kids, the youngest of which is my 25-year-old daughter, who is currently enrolled in a top-tier law school. My two sons both followed me into medicine - one is in residency and the other is in private practice.In terms of money I already have put aside, I have always been 100% invested in stocks as my belief has been that since stocks outperform bonds in the long-run, as long as I had a lot of time, I was best off being fully in equities. I currently have $3.8M ($300k is in my Roth IRA; the other $3.5M is not in a tax sheltered account) spread more or less evenly across three American Funds Mutual Funds (all A-share class): Growth Fund of America, EuroPacific Growth Fund and the New World Fund.My long-term financial goals are as follows: Have enough money to help cover the cost of my grandchildren's private education as those costs continue to rise and doctors (i.e. my 2 sons) are assured less of a large paycheck. Retire by the time I'm in my low 70s - I have no desire to retire before then as I thoroughly enjoy work. Other family members of mine have lived to relatively old age - my grandfather passed away just a few years ago at the age of 100 and my parents are still going strong at age 78 with no real health problems to speak of. I have a great aunt that is also still alive and in excellent health for a 97 year old. It's safe to assume I will need enough to live for about 20 years in retirement. Please help me build my portfolio so I can achieve my long-term financial goals.Thanks!RichOrange County, California

Dear Rich,

Congratulations on accumulating a sizeable portfolio! Your decision to invest 100% in stocks with a long-term focus was very prudent, but as your time horizon gets shorter and the need arises to draw from your investments, you may want to reconsider this strategy. Most investors maintain an allocation to bonds to minimize the risk and volatility of the overall portfolio.

Along with maintaining a long-term focus, Kalorama Wealth Strategies believes that broadly diversifying among asset classes, and periodically rebalancing a portfolio comprise the three investment principles that can make an investor successful. Our philosophy also includes minimizing costs and taxes so that the investor will earn the greatest after-tax return.

Kalorama Wealth Strategies follows a globally-diversified investment strategy using multiple asset classes or investment styles. Portfolio construction uses a Strategic Asset Allocation with a target or neutral weighting for each of the asset classes or investment styles. Rebalancing tolerances are set above and below the targets as a guideline for when the allocation should be rebalanced. Portfolios are reviewed for rebalancing at least once a year and more often during periods of market volatility.

The overall investment strategy is based upon Modern Portfolio Theory ((MPT)) and the premise that asset allocation is the most important decision in determining portfolio returns, not market timing or security selection. It is time in the market, not timing the market . The goal is to invest in uncorrelated asset classes or investment styles.

By broadly diversifying the portfolio, each period the investor captures the returns of the top-performing asset classes. History and research have shown that by following this strategy (i.e., capturing the top-performing returns), the investor will outperform more narrowly invested portfolios with less risk (based on using standard deviation as a measure of volatility).

Periodically rebalancing the portfolio to maintain the asset allocation strategy forces the "Buy Low, Sell High" paradigm. The investor is required to sell over-weighted or outperforming assets and use the funds to purchase under-weighted or underperforming assets. Having a rebalancing discipline also helps to reduce the emotional investment decision-making that may create panic selling in a bear market and aggressive buying in a bull market.

Vehicles used to construct a portfolio include exchange-traded funds (ETFs) and actively-managed no-load mutual funds. ETFs are typically the sole vehicle used in taxable accounts, while mutual funds are used in tax-deferred accounts. For each of the asset classes and investment styles, we undertake extensive quantitative and qualitative analysis to identify the top performing fund and/or manager available.

The first step in building a portfolio is to determine the investment policy , which is how the overall portfolio will be split between equity (stock) and fixed-income (bond) investments. The next step is to diversify the portfolio within the broad stock and bond asset classes with a strategic mix.

The first decision is how much of the overall portfolio should be invested internationally. Depending on an investor's risk tolerance, we typically allocate 20% to 30% to international-only investments. The equity international investments are split between large-cap and small-cap companies in developed and emerging markets.

Based on our belief that investing in uncorrelated asset classes or investment styles will enhance long-term returns, we then specifically allocate 10% of the overall equity portfolio to the real estate and energy/natural resource sectors. Historically, these asset classes have had low correlations with other investments, thereby enhancing the risk-return characteristics of the portfolio.

The remaining equity portfolio is divided among domestic growth and value, large and small-cap companies.

An all-equity ETF portfolio may include the following funds:

  • Vanguard Large Cap ( VV )
  • Vanguard Small Cap ( VB )
  • SPDR Dow Jones Global Real Estate ( RWO )
  • Market Vectors RVE Hard Assets Producers ( HAP )
  • Vanguard MSCI EAFE ( VEA )
  • iShares MSCI EAFE Small Cap (SCZ)
  • Vanguard Emerging Markets (VWO)

With ETF portfolio holdings being based on a target index, major considerations for fund selection include the operating expense ratio, underlying index and holdings, and historical performance.

Investing in indexed-based investments is a zero-sum game. They all have the same zero-return starting point on January 1 so paying a higher expense ratio is a potential drag on performance. Due to their lower operating expenses, this typically leads us to Vanguard ETFs when they are available for an asset class or investment style.

In addition, the Vanguard domestic equity ETFs are based on MSCI indices, which represent a broader portfolio than Standard & Poor's index-based ETFs (i.e., 500 stocks for large caps and 600 stocks for small caps) and have out-performed both the S&P and Russell-based indices since their inception (based on compound annual returns). The MSCI index series also provides broader diversification for international ETFs.

For an investor with an allocation to bonds, the process is similar. We start by allocating 20% to 30%, split between developed and emerging market debt, primarily in sovereign issuers. For risk-tolerant investors, we may include up to 20% in high-yield and convertible bonds. The balance of the bond portfolio is divided among funds invested in U.S. Treasury and Agency securities, Treasury Inflation Protected Securities (TIPS), and a total return fund invested in multiple asset classes such as treasuries, corporate bonds, as well as mortgage- and asset-backed securities. Municipal bonds may be used if a high-income investor has a large taxable portfolio.

A bond ETF portfolio may include the following funds:

  • iShares BarCap 7-10 Year Treasury (IEF)
  • SPDR BarCap TIPS (IPE)
  • Vanguard Total Bond (BND)
  • SPDR BarCap High Yield (JNK)
  • SPDR BarCap Convertible Securities (CWB)
  • iShares S&P National AMT-Free Muni (MUB)
  • SPDR BarCap International Treasury (BWX)
  • PowerShares Emerging Markets Sovereign Debt (PCY)

Even though Vanguard has a limited selection of bond ETFs, low expense ratios still play a large part in the selection of investments on the bond side of the portfolio. For example, although the SPDR BarCap TIPS (IPE) ratio of 0.18% may only be two basis points lower than iShares BarCap TIPS (TIP), the out-performance for the past two years has been more than the expense differential. Again, lower costs would lead us to SPDR BarCap High Yield Bond (JNK) compared with iShares iBoxx $ High Yield Corporate Bond (HYG) (40 basis points versus 50, respectively), with significantly better annual performance in 2009 and 2010.

The benefit of combining assets whose expected returns are not highly correlated includes the potential for enhanced returns at the portfolio level. Broad diversification limits the impact on the total portfolio of losses in individual investments or asset classes. A globally-diversified portfolio containing many asset classes with different characteristics of return, risk and correlations decreases portfolio risk - or volatility - and provides the best opportunity for meeting long-term investment objectives.

Disclosure: Kalorama's client portfolios are long all of the securities and/or asset classes mentioned in this article.

Disclaimer Statement: This article is for informational purposes only and is not financial, legal, or tax advice. It does not constitute an offer by Kalorama or any of its representatives to provide any investment advice or service. All investment advisory services are offered through the presentation of Kalorama's Form ADV Part 2, personal contact with Kalorama representatives, and the execution by a client and Kalorama of an investment advisory agreement.

Please consult with your advisor before making any decisions.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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