Micromanaging Your Portfolio: A Cautionary Tale

ByDavid Champion Hours Categories Investing & Taxes
Comments 34 Comments
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In a recent post I shared how my net worth has held up against five years of retirement funded entirely by portfolio withdrawals. The good news was that my liquid net worth had increased since I retired, and by a respectable 6.3% to boot. The bad news was that, after adjusting for inflation, it had gone down by 13.9%!

4-Fund (Revised)

I noted that despite a protracted stretch of high inflation, I hadn’t given myself a raise. I changed my behavior instead, foregoing frivolities like frequent meals out, the latest outdoor gear and an expensive new car (I bought a used Subaru instead).

Ending on an upbeat note, I added that these adjustments hadn’t diminished my standard of living in a meaningful way. Without noticeable hardship, I had protected my portfolio from the ravages of inflation.

In today’s post I’ll take a deeper dive into the impact five years of withdrawals has had on my investment portfolio. I’ll do so by way of four insightful charts. These will reveal some troubling details; not least the damage caused by a couple of costly mental errors.

Related: Am I as Rich as I Think?

Tax Me Now Or Tax Me Later?

Like many preparing for—or already in—retirement, my savings are spread across three broad categories of tax treatment: Roth IRA (tax-free), Traditional IRA (tax-deferred) and bank and brokerage accounts (taxable).

There are different schools of thought concerning the best order to tap these in retirement. Conventional wisdom suggests depleting taxable accounts first. The idea is to allow tax-advantaged money to grow, while at the same time reduce interest and dividends in taxable accounts sooner than later.

A counterargument is that this approach sets you up for higher tax bills down the road, when you will be forced to take bigger withdrawals from Traditional 401(k)s and/or IRAs. This will happen either when you run out of taxable money, or you are forced to take RMDs. At that point, those bigger withdrawals will be taxed at the regular income tax rate.

A compromise would have you draw from taxable and tax-advantaged accounts simultaneously, thereby spreading the tax burden over the course of your retirement.

Having retired at 53, I chose the first strategy. This was something of a no-brainer. I couldn’t touch the tax-advantaged money prior to 59.5 anyway, at least not without paying a steep penalty. There are ways around this, but they are complicated and inflexible. In any case, having a taxable account rendered the point moot.

Related: The Benefits and Drawbacks of Taxable Accounts

My Taxable Portfolio

My taxable accounts consist of cash in checking, and traditional investments (i.e., ETFs and mutual funds) in a brokerage account.

The first functions as an operating account. Because it earns no interest, I transfer just enough there from brokerage monthly to cover the sum total of my current month’s expenses; things like my mortgage payment, credit card balances, utility bills, and the like.

Rat Poison?

I should mention that I also own Bitcoin (BTC), a digital asset Warren Buffett has famously likened to rat poison. Though BTC is technically a component of my taxable portfolio, I exclude it from this analysis because its volatility adds too much noise to the signal.

I should also mention that I do not own BTC for ideological, political or any other non-financial reasons. BTC is algorithmically-enforced scarcity, and its design permits the instantaneous and frictionless transfer of value. I use it as a hedge; a small bet against USD hegemony (color me paranoid).

Related: Should Bitcoin ETFs Change Your Investment Strategy?

The Bank of Mattress

I can’t know for sure at what point in the future I will run out of taxable money, but I can make a pretty good guess. How? By subtracting my monthly expenses until their sum total overtakes my taxable account balance.

Mattress money burn rate
Mattress Money Burn Rate

The red line in the chart plots monthly subtractions from my taxable money, assuming that money had never been, and will never be, invested in income-generating assets like stocks, bonds or real estate. Think of this as cash I store in my mattress. (Why this is useful will become clear in the next chart.)

From March 2019 until September 2024 the line is bumpy. That’s because it reflects my actual spending which, as you might expect, varies from month to month.

After September 2024, the line starts to smooth out. From here it plots subtractions I expect to make in the future. I estimate these by taking the average of the previous 12 months’ subtractions. I exclude outliers in these forward estimates; like buying that used Subaru in September 2023 (you can see a marked step-down in the line here.)

At the mattress-money burn rate, the chart indicates I will have depleted its contents by August 2029. In fact it will likely be sooner than that given the probability a few more unexpected expenses will crop up along the way.

The Investment Premium

Of course I do not store my money in a mattress. Rather, I invest it in financial assets whose performance will (I hope) beat the mattress-money burn rate over time.

Actual Burn Rate
Actual Burn Rate

The blue line plots the actual balance of my taxable money, month over month, since March 2019. (Note that I’ve truncated the chart, such that it no longer extends to the date the mattress-money line reaches zero.)

The wilder gyrations in the blue line reflect the fact that my taxable portfolio tracks the performance of the assets it is invested in. Starting around February 2020, for example, the value of my taxable account dropped precipitously. This was a direct result of the pandemic stock market crash.

The blue line tells me that I am beating the mattress-money burn rate (so far, at least). For this I give myself a little pat on the back.

Diversification on Steroids

Following is the actual composition of my taxable portfolio in March 2019, the month and year of my retirement:

  • Cash (8%)
  • Energy Select SPDR Fund – XLE (8%)
  • SPDR Gold Trust – GLD (7%)
  • Vanguard European Stock Index Fund ETF – VGK (10%)
  • Vanguard Financials Index Fund ETF – VFH (8%)
  • Vanguard Global ex-US Real Estate Index Fund – VNQI (11%)
  • Vanguard Real Estate Index Fund ETF – VNQ (8%)
  • Vanguard Total Stock Market ETF (9%)
  • Various Brokered CDs (29%)
  • WisdomTree Chinese Yuan Strategy Fund – CYB (2%)

There is only one word I can think of to describe this portfolio—nuts! It reflects the flawed rationale that if diversification is good, more diversification must be better.

By definition, mutual funds and ETFs hold diversified portfolios of stocks, fixed-income, cash and/or other instruments. Indeed, built-in diversification is the main point of owning mutual funds and ETFs in the first place. Funds that track indexes, like the S&P 500, feature even broader diversification than the sector-specific funds that dominate my erstwhile taxable portfolio.

Diversifying the diversified just muddies the water. It exposes you to opaque costs and management fees, notably on actively-managed funds. Rules governing REITs—like VNQ and VNQI, for example—require them to pass the majority of their taxable gains to shareholders. The same is true of GLD (although for subtly different reasons).

All this amounts to more taxable income, and therefore needless drag on portfolio returns.

Simplification

Just over a year ago, I took the long-overdue step of simplifying my taxable portfolio. My brokerage account holdings now comprise just three ETFs and one mutual fund, allocated as follows:

  • Vanguard Total Stock Market ETF – VTI (23%)
  • Vanguard Total International Stock ETF – VXUS (26%)
  • Vanguard Total Bond Market ETF – BND (26%)
  • Vanguard Federal Money Market Investor Fund – VMFXX (25%)
4-Fund Burn Rate
4-Fund Burn Rate

To the chart I’ve added a new, gray line. Holding all other things equal, this line plots what the performance of my taxable portfolio would have been had I started retirement holding the simplified, 4-fund portfolio. (These returns assume monthly rebalancing to maintain equally-weighted fund allocations.) The upshot is that my taxable portfolio would be worth 8.6% more than it is today.

To what extent this difference can be attributed to tax and fee drag, I don’t know. I do know these were contributing factors, and likely not insignificant ones.

Related: 5 Reasons to Simplify Your Investment Portfolio

Fear Factor

While overdiversification, some of it in suboptimal investments, likely damaged the performance of my taxable portfolio in retirement, I made another mistake that proved far costlier.

4-Fund Burn Rate (Revised)
4-Fund Burn Rate (Revised)

The green line—what I call 4-Fund (Revised)—illustrates the effect of this mistake. (Recall the blue line represents the actual value of my taxable portfolio over time.)

Panic

In August 2020, when the S&P 500 index recovered from a 34% decline to its pre-pandemic peak, I bailed to cash. Except for GLD and brokered CDs, I sold all the mutual funds and ETFs in my taxable account.

Note that I did not sell at the bottom of the market—that would have been a far costlier mistake. Rather, I sold at the point the market recovered its pre-pandemic peak. Nevertheless, the effect this had on my taxable portfolio is so stark it jumps off the chart.

Had I a) started my retirement holding the 4-fund portfolio, and b) not cashed out in August 2020, the value of my taxable account would be represented by the green line, not the blue, in the chart.

It was not until September 2021 that I began to plow idle cash back into the market, eventually replicating more or less the composition of my pre-selloff portfolio.

Rationale

Why did I bail to cash? The short answer is I freaked out. I was a recent retiree who relied entirely on portfolio withdrawals for living expenses. In August 2020, the month I sold, the future was still very uncertain. For all I knew, the head-snapping recovery of Q2 2020 was the last death throe of a market teetering on total collapse.

But the ensuing four quarters were among the best in stock market history; the S&P 500 rose more than 30% during that period. Meanwhile, my sidelined cash languished.

Related: Put Your Money Fears in Perspective

Takeaways

What have I learned from this exercise? For one thing, trying to micromanage my investments is a bad idea. To correct this, I’ve massively simplified the composition of my taxable portfolio. Except for occasional rebalancing, I intend to leave it alone going forward.

Though not nearly as messy as was my taxable portfolio pre-simplification, my tax-advantaged portfolio also reflects a misguided tendency to over-diversify. I am currently in the process of simplifying it, too. Happily, I made no changes to my tax-advantaged portfolio in reaction to the pandemic crash.

By far the biggest lesson I take from this exercise, however, is one whose magnitude I did not fully comprehend until doing the research for this post; the one that is illustrated by the yawning gap between the green and blue lines in the last chart.

The lesson here is that, when the future is uncertain, and/or the markets volatile, I must resist allowing fear to drive my decision-making. Practically speaking, this means holding sufficient cash to buffer my portfolio against the occasional, and inevitable, market plunge.

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[I’m David Champion. I retired from a career in software development in March 2019, just shy of my 53rd birthday. To position myself for 40+ years of worry-free retirement, I consumed all manner of early-retirement resources. Notable among these was CanIRetireYet?, whose newsletters I have received in my inbox every Monday morning for the last ten years. CanIRetireYet? is one of exactly two personal finance newsletters I subscribe to. Why? Because of the practical, no-nonsense advice I find here. I attribute my financial success in no small part to what I have learned from Darrow and Chris. In sharing some of my own observations on the early-retirement journey, I aim to maintain the high standard of value readers of CanIRetireYet? have come to expect.]

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34 Comments

  1. This is a great article that I needed to hear. We have been retired since June 2023 and will simply our portfolio in January. We do have one annuity that I will leave alone but the other funds will move into Vanguard. Also, our expenses are less than we anticipated. However, I have under estimated the stock market in my spreadsheet as you did above.

  2. David,

    This was interesting and well written – until I got to the end, I thought it was written by Chris! Thank you for this useful lesson on adhering to your investment plan (and portfolio simplicity).

  3. Very interesting. Did you develop your graphs yourself or are you using a tool to monitor your portfolio and generate graphs?

    1. Hi MKS,

      Those are simple line charts that I made in Microsoft Excel—that was the easy part. The hard part was gathering the data!

      Best,

      Dave

      1. Thanks – I was afraid of that! I guess that is part of the point of simplifying, makes data gathering easier.

        1. Hi Ken,

          I used a website called PortfolioVisualizer, specifically its “Backtest Portfolio” tool, to produce month-over-month returns for each of the hypothetical scenarios described in the article.

          Best,

          Dave

  4. Don’t beat yourself up over your first time panic reaction. I had a similar reaction to the Great Recession of 2008 the year just before I was going to retire. I sold off a bunch of investments in both my Taxable and 401-k. And, I worked another year. 🙄 Hindsight is a good teacher. Between 2008 great recession and pandemic, I learned more about developing a simplified, flexible investment plan with an adaptable budget. Although the pandemic produced other panics, I had innoculated my investments to have healthy results afterwards. Lessons learned from my first panic. Keep up your good reviews and simplifications.

    1. Thanks for the reassurance, Pixie! I don’t beat myself up (too badly, anyway). I am human, and even the best of us make mistakes. The real trick is not to repeat them.

      Best,

      Dave

  5. Thanks very much for this post. It takes courage to share one’s financial journey, foibles and all – and it really benefits the rest of us.

    Having been ER’d myself a bit longer than you (since 2002) I, too, have had the “opportunity” (one I wouldn’t wish on anyone) to see my own behavior during market meltdowns. I went into the Great Financial Crisis in 2008 holding a complex, globally-diversified slice-and-dice portfolio of mostly DFA funds, 60:40 fixed income:equities, that had been thoroughly backtested to show a maximum decline of 8-9% during market panics. But the actual decline in my portfolio at the trough was 23%. I didn’t panic and sell at the bottom, but I did eventually bail on the portfolio in favor of a much simpler set of 4 low-cost index ETFs.

    IMHO the issue goes beyond having a pile of cash with which to ride out market declines. One needs to duration-match one’s investments and to really understand the duration of what one holds. So for example a “classic” 60:40 portfolio has a weighted average duration of ~12 years – meaning it contains no assets to deal with spending needs for years 1-12. You have to layer in cash and short-term bonds to cover those needs, or suffer the consequences in years like 2022 when your stocks and bonds both tank in unison. Cullen Roche has a great article and chart that explains this clearly:

    https://disciplinefunds.com/defined-duration-investing/

    The only other comment I have is that if your taxable account portfolio is representative of your portfolio as a whole you’re overweighting international stocks (current global market cap is ~60:40 U.S.:Int’l), and also that a pure intermediate-term Treasury fund or ETF (e.g. VGIT) has historically offered better risk-adjusted returns and much better protection against stock market meltdowns than BND with its big allocations to corporates and excessively long duration. IMHO there’s no reason to hold anything but Treasuries – an opinion shared by the likes of William Bernstein, Rick Ferri and Jonathan Clements, among others.

    1. Thanks for your thoughtful reply, Kevin, and for sharing your own experience.

      Re: duration match, the fact that 25% of my taxable portfolio is currently held in cash has less to do with any particular allocation strategy than how well I sleep at night. For me that is about 1.5 to 2 years’ worth of living expenses. Another 25% of my taxable portfolio is allocated to BND, which has an average duration of about 6 years. The remaining 50% of my taxable portfolio is allocated to stocks, split evenly between US and non-US companies. I expect no major expenses in the foreseeable future, so I am comfortable with this allocation in terms of duration match.

      For better or worse, my tax-advantaged portfolio contains far less exposure to non-US equities than does my taxable.

      Best,

      Dave

  6. Thank you for the candid walkthrough on your journey. We all learn more from our mistakes than from our successes.
    I hope you follow-up with an article on the different schools of thought concerning the best order to tap into your savings to fund expenses.
    The A/B test comparisons you did would also prove valuable in a comparison of withdrawal order from the pre-tax / post – tax / cash or hybrid model.

  7. Similar story from a different perspective. I ER’d at 58 in Nov 2019.
    500k in nortgage debt.
    No pension, no inheritance.
    The portfolio was 90% in four stock etf’s. 10% Roth, 25% IRA and 65% taxable. The long-term plan since 2012 was to retire debt-free and live off rents and dividends. But to do that I had to reap the benefit of the bull for as long as possible.
    So I waited until Dec’19 to sell one rental and all of the taxable ETF’s . Despite having a written plan pulling these two triggers was very difficult for me. I struggled with it for a couple weeks until realizing I would deeply regret not following the plan if the market tanked. I would have to go back to work. So, after paying off the debt in Jan ’20 the next step called for reinvesting the remaining proceeds into more dividend payers but when the pandemic hit It felt really good knowing my retirement was secure. I didnt start putting the money to work until ARKK topped out in Feb ’21. Would a lump-sum in spring 2020 or waiting until Oct ’22 been better? Certianly. The next decision is when to start SS. All I know is it wont be next year.

    1. Thanks for sharing your story, JT. Different journey, for sure, but similar angst. Glad things worked out for you. Second-guessing our decisions is so easy with the clarity of hindsight, but probably not particularly useful.

  8. Thanks for sharing your journey in this post. To harken back to your past career, my HYSA is acting as my RAM to supply needs, and I plan to sell from taxable (HDD read) to backfill the HYSA bucket.
    (RE @ 56 this year) My taxable is a mish-mash of ETFs, single stocks, etc as I attempted/pursued different ideas along the way. Looking at it now, I realize a few ETFs in a simplified portfolio is ideal, but I can’t bear selling/paying taxes/reallocating. So, I leave it messy and have a plan to sell twice a year to backfill.
    I was wondering what led you to sell some of your positions to cash versus selling as needed to change the allocation through attrition.

    1. Hey Paul,

      Nice memory architecture metaphor! Re: your question, I assume you are referring to my decision in August 2020 to go entirely to cash? (If not please clarify.) That had everything to do with fear, and nothing to do with rebalancing my portfolio. I didn’t trust the financial markets to withstand the fallout of a pandemic whose lethality was not yet fully known.

      Best,

      Dave

    1. Hi Brian,

      Until/unless I am convinced there’s a better strategy, I intend to exhaust my taxable portfolio before I start IRA withdrawals. That will likely occur quite some time after I reach 59.5.

      Dave

  10. Dave,
    It is good to admit mistakes and learn from them. We all make mistakes and over and under think stuff. We retired Nov. 2020 which was due to not trusting the numbers and working another year to make sure? We have been slowly pulling money from an IRA to cut down on the RMDs later. A little bit every year as a ROTH conversion also. We have a larger cash bucket to minimize the total draw down. To date the overall numbers total are up $300,000 from retirement including the drawdowns. So learning from others and not panicking are the key. Could we have been more risky and had better returns, sure! But I like sleeping at night and wondering when the Mrs. will let me have another cheeseburger!! Plan for the worst, hope for the best and land in the middle!

    1. Pat,

      Well said. I couldn’t agree more with your sentiments. It is easy to second-guess a past decision with the benefit of hindsight, but of course impossible to know at the time the decision was made if it is the correct one. All the same, there are some guiding principles I took away from this experience; namely to keep things simple, and stay the course when markets get rough.

      Thanks for your comments,

      Dave

  11. David, thanks, this was a good read. Like you, I retired 5 years ago in my 50s (also after an IT career) and live off my taxable account. Question – how did you rebalance your taxable account into 4 funds? I face a similar challenge but the capital gains would be huge, so I want to avoid the taxes a rebalance would incur. Or where the gains relatively low since you cashed out after the crash?

    1. Thanks, Tom.

      Well, as you could probably tell by my current allocations—23/26/26/25—I have yet to rebalance the 4-fund portfolio in the ~15 months since I switched to it. Aside from topping off VMFXX (money market mutual fund) from time to time, I haven’t sold huge amounts of anything, so haven’t incurred consequential taxable gains.

      I suppose substantial capital gains is the price of doing business when you have large taxable account balances. I think I might like to have that problem 🙂

      Best,

      Dave

  12. David, thanks for an honest look at your experience over the first 5 years of early retirement.
    Like you we retired in March 2019, and we also had a overly diversified portfolio. We simplified our portfolio over the first few years of retirement, which I personally found difficult. I worked thru this feeling with research(a lot on this great site) and my spouse’s “keep it simple” financial mindset.

    Years later, like you, I’m so glad we made the change. Keeping it simple will also become more important as we age.

    Thanks again for a great post.

    1. Thanks for the share, Rick. Affirming to know others besides me have gone through a similar experience.

      Best of luck going forward,

      Dave

  13. Thanks so much for writing about your panic induced sell off. There’s a lot of people who did the same, but few talk about it. Totally understandable; I don’t know if I’d be so brave to do so. I’ve been tempted sell off several times, and what has kept me on course is similar writing by those who have sold and regretted it. You’re truly doing a public service by writing about it; hopefully many will stay the course you’ve paved.

  14. Thanks for the article Dave! Do you have any resources or good articles for how one could plan to minimize the tax hit that may occur if one wishes to simplify a portfolio that includes a bunch of individual stocks and move the $ into ETFs?

    1. Thanks, AF.

      You might want to look into strategies for tax-loss or tax-gain harvesting. Which strategy to use, if either, will depend on the particulars of your financial situation.

      Another thing you might consider is spreading your reallocation from stocks to ETFs over several years, thereby also spreading out the tax burden.

      Hope this helps.

      Best,

      Dave

  15. Good article, Dave!

    An investment quote I recently ran across, from the famed John Bogle: “Don’t do something, just stand there”.

  16. Selling based on emotion is usually counterproductive. If you sell based on gut feelings or fear, what exactly is the “signal” you will use to get back into the market? On the other hand, using a proper Trend Following approach with clear Sell/Buy rules eliminates that problem.
    Market timing using Trend Following works, but not in the way most people think: It’s impossible to consistently get out “at the top” and buy back “at the bottom”. What Trend Following does do over long periods of time is deliver approximately the same return as buy & hold with LOWER DRAWDOWNS (i.e. Risk). Given that you are buying and selling, it works much better in a NON-TAXABLE vehicle (eg IRAs).
    Here is a simple example of Trend Following at work using Portfolio Visualizer:

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