The “Other 20%” of Successful Investing, Episode #19

This episode is a follow-on to a previous episode we did on the basics of investing (episode #5). In that episode, we explained the foundational principles to focus on first when it comes to investing, using the 80:20 rule (or Pareto principle) as a guide. In this episode, we take it a step further and share some of the additional things you can do to further improve your investment experience. We cover asset allocation, portfolio rebalancing, asset placement, and tax-loss harvesting. As you’ll see, when applied properly, these additional strategies can really add up in terms of their overall impact.

Outline of this episode

Starting with asset allocation [2:27]
Factors of asset allocation [5:42]
Bonds - not sexy, but they serve a purpose [9:38]
Bringing your portfolio back to your original target with rebalancing [13:24]
Asset placement for tax purposes [17:34]
The 3 buckets to focus on when thinking about asset placement [20:05]
Tax-loss harvesting [20:53]
Summary of the four key concepts and takeaways we covered [25:24]

Allocating your assets with diversification

In simple terms, asset allocation is the mix of investments you have spread throughout your various accounts. There are two main types of investments that make up your asset allocation— stocks and bonds— which we refer to as asset classes. Within each of those asset classes, there are many different subgroups, such as US and international stocks and bonds, certain types of stocks like real estate and technology, or stocks of large companies and small companies. There's an exhaustive list of what we call sub-asset classes.

Previously we talked about the idea of diversification and how rather than owning a handful of stocks and bonds, or stocks and bonds in just one country, you should own thousands of stocks and bonds all across the globe. By diversifying your investments over several asset classes, and not putting all of your eggs in one basket, you're able to reduce risk. It’s a smoother ride over time with less dramatic fluctuation on a daily, monthly, or yearly basis. On top of having a smoother ride, you'll also have potential to improve your long-term investment returns. So diversification is the only free lunch there is when it comes to investing

Hitting the reset button by rebalancing your portfolio

Going back to what we just discussed. Let's imagine that you went through and put together the right investment allocation for your portfolio. You set it on day one, but the next day the market moves, and now your asset allocation is no longer exactly how you initially set it. Over time as different investments perform differently, your portfolio will drift further and further away from your target and look less and less like that allocation you intended. This is where rebalancing comes into play.

Rebalancing is simply the process of bringing your portfolio back to your original target. In practice, it consists of selling some of the investments that have outperformed and buying more of the investments that have underperformed, in order to bring you back to your target investment allocation. In essence, it's a way to sell high and buy low, but in a disciplined and unemotional way without trying to make any guesses or predictions regarding the market.

The asset placement puzzle

When thinking about asset placement, you want to focus on three main investment buckets. Number one, your tax-free (or Roth) bucket. Number two, your tax-deferred bucket, like traditional retirement accounts. And number three, your taxable account bucket. Trying to piece together the right asset placement is kind of like a puzzle where you have an overall investment allocation, but you're trying to decide which pieces to own in which accounts so that your overall investments are as tax efficient as possible.

When it comes to asset placement, it's tough to quantify the potential benefit in a general sense because the benefit will vary from person to person depending on their exact mix of accounts, investment allocations, and types of investments. However, nobody enjoys paying taxes, and by being smart with your asset placement it allows you to maximize your overall after-tax return. As one of our clients joked, it'll help you do your civic duty of minimizing the amount of taxes you pay.

Resources & People Mentioned

Podcast Episode #5: The 80:20 Rule of Investing
Download our guide: The Toolkit for Optimizing Your Finances as an Employed Physician
Download our guide: The Financial Checkup

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