The markets continue to provide difficult options to investors. In the typical market conditions of the last 50 years I think a sensible portfolio allocation was not that challenging to pick. I would choose a bit more in stocks than bonds than the commonly accepted strategy. And I would choose to put a bit more overseas and in real estate.

But if that wasn’t done and even something like 60% stocks and 40% bonds were chosen it would seem reasonable (or 60% stocks 25% bonds and 15% money market – I really prefer a substantial cushion in cash in retirement). Retirement planning is fairly complex and many adjustments are wise for an individual’s particular situation (so keep in mind this post is meant to discuss general conditions today and not suggest what is right for any specific person).

I wrote about Retirement Savings Allocation for 2010: 5% real estate, 35% global stocks, 5% money market, 55% USA stocks. This was when I was young and accumulating my retirement portfolio.

Today, investment conditions make investing in retirement more difficult than normal. With interest rates so low bonds provide little yield and have increased risk (due to how much long term bond prices would fall if interest rates rise, given how low interest rates are today). And with stocks so highly valued the likelihood of poor long term returns at these levels seems higher than normal.

So the 2 options for the simplest version of portfolio allocation are less attractive than usual, provide lower income than usual and have great risk of decline than usual. That isn’t a good situation.

View of Glacier National Park (a nice place to go in retirement, or before retirement) by John Hunter

I do think looking for dividend stocks to provide some current yield in this situation makes sense. And in so doing substitute them for a portion of the bond portfolio. This strategy isn’t without risk, but given the current markets I think it makes sense.

I have always thought including real estate as part of a portfolio was wise. It makes even more sense today. In the past Real Estate Investment Trusts (REITs) were very underrepresented in the S&P 500 index, in 2016 and 2017 quite a few REITs were added. This is useful to provide some investing in REITs for those who rely on the S&P 500 index funds for their stock investments. Still I would include REIT investments above and beyond their portion of the S&P 500 index. REITs also provide higher yields than most stocks and bonds today so they help provide current income.

While I am worried about the high valuations of stocks today I don’t see much option but to stay heavily invested in stocks. I generally am very overweight stocks in my portfolio allocation. I do think it makes sense to reduce how overweight in stocks my portfolio is (and how overweight I think is sensible in general).

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Amazon announced they are opening major new offices in Arlington, Virginia and New York City. Each site will hold 25,000 new Amazon employees at an average salary above $150,000. Getting to that level with take many years, next year under 1,000 employees will be at each site.

I lived in Arlington for many years and own rental property there. The Amazon decision is likely to catalyze a much more rapid ascent of the technology sector in the DC area. The DC area has a strong foundation of internet technology to build upon, though many people are not aware of this. The Amazon move will likely help shift the perception of the DC area as government driven and the growth of internet technology activity in the area is likely to grow rapidly.

The 25,000 jobs (even with a greater than average salary of $150,000) isn’t the main impact of the announcement. The big news is the likelihood of Amazon’s highly visible efforts catalyzing more tech businesses (especially 5-7 years down the road when some of the Amazon people start creating their own startups). It isn’t that Amazon is moving into a barren tech landscape, there is already a strong base from which to launch a long term tech boost to the DC area economy.

The direct impact of Amazon’s employees renting and buying in and around Arlington is not going to be very strong for a couple years. Amazon plans to add 500 people to Arlington in 2019; 1,000 more in 2020 and 2,000 more in 2021. But investors already can plan for a strong future demand from Amazon and all the activity that Amazon’s growing presence will contribute to.

I am actually selling my house in Arlington (in this photo), with a very nice yard (explanation below).

The increase in housing prices in 2019 and 2020 will be primarily investor driven. In 2020, 2021 and going forward the impact of Amazon employees directly and all the extra activity spurred on will start to have an impact. Unlike the stock market where such a predicable strong investment future would drive prices up say 30-50% immediately, in real estate it is much more likely for the gains to be spread out over the long term.

If prices in housing increase in Arlington it is more likely they would increase say 10% in the first year and then an extra 3% (above what the increase would have been without Amazon’s move) each of the next 10 years. From a long term investors perspective this provides a great possibility for buying now (even after the news) and not having to pay a huge premium.

Rental housing prices are not likely to go up much immediately. And they will take longer to show up in the market, they will be much more closely tied to new job additions (from Amazon and others). So investors have to pay a higher price today (say 5-10% higher) and in the first 1 or 2 years probably see no higher rents than they would have otherwise. And even after 2021 those rents are likely to go up more slowly than prices of real estate.

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The number of USA households spending more than 50% of their income on rent is expected to rise at least 11% to 13.1 million by 2025, according to new research by Harvard University’s Joint Center for Housing Studies and Enterprise Community Partners.

The findings suggest that even if trends in incomes and rents turn more favorable, a variety of demographic forces—including the rapid growth of minority and senior populations—will exert continued upward pressure on the number of severely cost-burdened renters.

Under the report’s base case scenario for 2015-2025, the number of severely burdened households aged 65-74 and those aged 75 and older rise by 42% (830,000 to 1.2 million) and 39% (890,000 to 1.2 million); the number of Hispanic households with severe renter burdens increases 27% (2.6 million to 3.4 million); and the number of severely burdened single-person households jumps by 12% (5.1 million to 5.7 million).

Graph from the report. The blip of an improvement from 2010 to 2013 is due to the decline in home ownership which changed the makeup of the “rental population.” Moderate (severe)
burdens are defined as housing costs of 30–50% (more than 50%) of household income. Households with zero or negative income are assumed 30 to be severely burdened, while renters not paying cash rent are assumed to be unburdened.

Enterprise Community Partners argues for more government action on affordable housing. I am worried about such efforts being done in a sensible way but I do agree with the concept of supporting affordable housing. I would use zoning to require affordable housing construction along with market rate housing.

Doing such things well requires a government that is not corrupt and fairly competent which isn’t so easy looking across the USA (unfortunately). An example of somewhere that does this fairly well is Arlington Country, Virginia (which also has a good non-profit focused on affordable housing). Good non-profits can play a vital part in affordable housing over the long term.

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When you sell your primary residence in the USA you are able to exclude $250,000 in capital gains (or $500,000 if you file jointly). The primary test of whether it is your primary residence is if you lived there 2 of the last 5 years (see more details from the IRS). You can’t repeat this exemption for 2 years (I believe).

It doesn’t matter if you buy another house or not, that exclusion of up to $250,000 is all that can be excluded (you must pay tax on anything above that amount – taxed at capital gains rates for long term gains).

For investment property you can do 1031 exchanges which defers capital gains taxes. Otherwise capital gains will be taxed as you would expect (as capital gains).

When you inherit a house the tax basis will be “stepped up” to the current market rate. So if you then sell your basis isn’t what the owner paid for it, but what it was worth when it was given to you.

Related: Looking for Yields in Stocks and Real Estate – Your Home as an Investment – Home Values and Rental Rates

I continue to believe the choices for investors are much more challenging than they normally are, as I have written about several times. Though maybe soon, this will just be the new normal (in which case investors won’t have the fairly easy choices they have had for much of the last 100 years).

In previous posts I have discussed the value of real estate investments in this investing climate. Real estate is one way to cope with the challenges of extremely low yields today.

There are many advantages to city property, in the right city. When I was looking at my first house I looked for something that would be easy to rent out. The most important factor to minimize vacancy is high demand. If there is high demand, the worst you should face is the need to lower your asking price.

An additional consideration in buying condos (your only option in large urban centers like New York City, seen in my photo of the Empire State Building) are condo fees. Fees and taxes can make positive cash flow a challenge and they continue when the property is vacant thus creating more risk for the investor. Of course, in popular markets and good times rents are very attractive for owners and price increases can make them great investments.

During downturns rental property that is not in high demand can be vacant no matter the price. And those properties with some, but not overwhelming, demand will face the need for dramatic rent decreases to minimize vacancy (and large declines if you need to sell). My purchase was 3 blocks from a metro stop (close in to Washington DC). All housing near metro stops in DC have high demand and that close in to the city has even higher demand.

In over 10 years I have had maybe 2 months of vacancy – the first year I messed up; I was new to trying to rent places out and believed people were going to sign the lease because they said they would but then they backed out. I think I may have had 1 more month sometime, but maybe not, I can’t really remember.

I have considered tourist property but have decided against it so far. The rental yield are higher but you have higher vacancy rates, which is manageable, but also much more property management issues to deal with. In order to cope with that you need to hire a property manager, very carefully. You need to carefully check their experience, reliability and competence.

And even for residential real estate the hassles of dealing with the property management yourself may lead investors to use property managers. This cuts into the advantages of direct real estate investments and so if you are going to use property managers then looking at REITs has to be considered. I believe if you are sensible direct real estate investments would normally return more but the risks are significantly higher and the hassle is somewhat to significantly higher. Likely the decision on whether to use direct real estate investing is more about personal preference than just a decision on which option would be a better investment.

Brett Arends writes about the investment portfolio he uses?

This is another interesting portfolio choice. I have discussed my thoughts on portfolio choices several times. This one is again a bit bond heavy for my tastes. I like the global nature of this one. I like real estate focus – though as mentioned in previous articles how people factor in their personal real estate (home and investments) needs to be considered.

Related: Cockroach Portfolio – Lazy Golfer Portfolio – Investment Risk Matters Most as Part of a Portfolio, Rather than in Isolation – Looking for Dividend Stocks in the Current Extremely Low Interest Rate Environment

This is a startling piece of data, from The nagging fear that QE itself may be causing deflation:

The situations have many differences, for example, China is a poor country growing rapidly, Japan was a rich country growing little (though in 1990 it showed more growth promise than today). Still this one of the more interesting pieces of data on how much a bubble China real estate has today. Japan suffered more than 2 decades of stagnation and one factor was the problems created by the real estate price bubble.

The global economic consequences of the extremely risky actions taken to bail out the failed too-big-too-fail banks including the massive quantitative easing are beyond anyones ability to really understand. We hope they won’t end badly that is all it amounts to. Noone can know how risky the actions to bail out the bankers is. The fact we not only bailed them out, but showered many billions of profit onto them (even after taking billions in fines for the numerous and continuing violations of law by those bailed out bankers), leaves me very worried.

It seems to me we have put enormous risk on and the main beneficiaries of the policies are the bankers that caused the mess and continue to violate laws without any consequences (other than taking a bit of the profit them make on illegal moves back sometimes).

I hope things work out. But I fear the extremely risky behavior by the central banks and politicians could end more badly than we can even imagine.

Related: Continuing to Nurture the Too-Big-To-Fail Eco-system – The Risks of Too Big to Fail Financial Institutions Have Only Gotten Worse – USA Congress Further Aids The Bankers Giving Those Politicians Piles of Cash and Risks Economic Calamity Again – Investment Options Are Much Less Comforting Than Normal These Days

Dylan Grice suggests the Cockroach Portfolio: 25% cash; 25% government bonds; 25% equities; and 25% gold. What we can learn from the cockroach

I don’t really agree with this but I think it is an interesting read. And I do agree the standard stock/bond/cash portfolio model is not good enough.

I would rather own real estate than gold. I doubt I would ever have more than 5% gold and only would suggest that if someone was really rich (so had money to put everywhere). Even then I imagine I would balance it with investments in other commodities.

One of the many problems with “stock” allocations is that doesn’t tell you enough. I think global exposure is wise (to some extent S&P 500 does this as many of those companies have huge international exposure – still I would go beyond that). Also I would be willing to take some stock in commodities type companies (oil and gas, mining, real estate, forests…) as a different bucket than “stocks” even though they are stocks.

And given the super low interest rates I see dividend paying stocks as an alternative to bonds.

The Cockroach Portfolio does suggest only government bonds (and is meant for the USA where those bonds are fairly sensible I think) but in the age of the internet many of my readers are global. It may well not make sense to have a huge portion of your portfolio in many countries bonds. And outside the USA I wouldn’t have such a large portion in USA bonds. And they don’t address the average maturity (at least in this article) – I would avoid longer maturities given the super low rates now. If rates were higher I would get some long term bonds.

View of Glacier National Park, from Bears Hump Trail in Waterton International Peace Park in Canada, by John Hunter

These adjustments mean I don’t have as simple a suggestion as the cockroach portfolio. But I think that is sensible. There is no one portfolio that makes sense. What portfolio is wise depends on many things.

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Based on my thoughts on killing the Goose laying golden eggs in Iskandar Malaysia posted on a discussion forum. The government has instituted several several policies to counteract a bubble in luxury real estate prices in the region (new taxes on short term capital gains in real estate [declining amounts through year 6]), increasing limits on purchases by foreigners, new transaction fees (2% of purchase price?) for real estate transactions, requirements for larger down-payments from purchasers…

Iskandar is 5 times the size of Singapore and is in the state of Johor in Malaysia. Johor Bahru is the city which makes up much of Iskandar but as borders are currently drawn Iskandar extends beyond the borders of Johor Bahru.

The prospects for economic growth in Iskandar Malaysia in the next 5, 10 and 15 years remain very strong. They are stronger than they were 5 years ago: investments that produce economic activity (theme parks, factories, hospitals, hotels, retail, film studio…) have come online and more on being built right now.

Cooperation with Singapore is the main advantage Iskandar has (Iskandar is next to the island of Singapore similar to those areas surrounding Manhattan). It provides Iskandar world class advantages that few other locations have (it is the same advantages offered by lower cost areas extremely close to world class cities – NYC, Hong Kong, London, San Francisco etc.). Transportation connections to Singapore are critical and have not been managed as well as they should have been (only 2 bridges exist now and massive delays are common). A 3rd link should be in place today (they haven’t even approved the location yet).

A MRT connection to Singapore (Singapore’s subway system) should be a top priority of anyone with power interested in the future economic well being of Iskandar and Johor. Johor Bahru doesn’t have a light rail system yet this would be the start of it. It has been “announced” as planned for 2018 but not officially designated or funded yet.

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There are many asset allocation strategies; which often are pretty similar. In general they oversimplify the situation (so an investor needs to study and adjust them to their situation – though most don’t do this, which is a problem). In general, I think asset allocation suggestions are too heavily weighted on bonds, and that is even more true today in the current environment – of could that is just my opinion.

I ran across this suggested allocation in Eyewitness to a Wall Street mugging which I think has several good values.

• It focuses on low fee, market index funds. Fees are incredibly important in determining long term investment success
• It has lower bond allocation than normal
• It has more international exposure than many – which I think is wise (this suggested portfolio is for those in the USA, USA portion should be lowered for others)
• It includes real estate (some suggested allocations miss this entirely)

In my opinion this allocation should be adjusted as you get closer to retirement (put a bit more into more stable, income producing investments).

My personal preference is to use high quality dividend stocks in the current interest rate environment. I would buy them myself which does require a bit more work than once a year rebalancing that the lazy golfer portfolio allows.

I would also include 10% for Vanguard emerging markets fund (VWO) (for sake of a rule of thumb reduce Inflation Protected Securities Fund to 10% if you are more than 10 years from retirement, when between 10 and 1 year from retirement put Inflation Protected Securities Fund at 15% and Total Stock Market Index Fund at 35%, when 1 year from retirement or retired lower emerging market to 5% and put 5% in money market.

Depending on your other assets this portfolio should be adjusted (large real estate holdings [large net value on personal home, investment real estate…] can mean less real estate in this portfolio, 401k holdings may mean you want to tweak this [TIAA CREF has a very good real estate fund, if you have access to it you might make real estate a high value in your 401k and then adjust your lazy portfolio], large pension means you can lower income producing assets, how close you are to retirement, etc.).

The Lazy Golfer Portfolio (Annually rebalance the fund on your birthday and ignore Wall Street for the remaining 364 days of the year) contains 5 Vanguard index funds

• 40% Total Stock Market Index Fund (VTSMX)
• 20% Total International Stock Index Fund (VGTSX)
• 20% Inflation Protected Securities Fund (VIPSX)
• 10% Total Bond Market Index Fund (VBMFX)
• 10% REIT Index Fund (VGSIX)

Related: Retirement Planning, Looking at Asset Allocation – Lazy Portfolio Results – Investment Risk Matters Most as Part of a Portfolio, Rather than in Isolation – Starting Retirement Account Allocations for Someone Under 40 – Taking a Look at Some Dividend Aristocrats

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