A good starting point in our portfolio management discussion is a reflection of what we expect out of our portfolio. Enough detail of our family finance has been given in this blog but it suffices to summarize the relevant facts below:
Our current financial aspiration is to work hard and build enough wealth that will allow us to live a semi-retirement life well before the standard retirement age. Nowadays, we expect we will need to accumulate $1.5M to $2M in US dollars before we can have the gut to say goodbye to my still-growing corporate career and start our semi-retirement life with sufficient safety margin. Considering of what we make this far ($660,000 by the end of January 2007), and our healthy cash flow ($300,000/year from job and business income; $150,000/year after expense and taxes), we expect to be in that position in 5 to 10 years.
Even if I leave my corporate life in 5 to 10 years, I still expect to make some money from part-time consulting jobs, and income from our sideline business is likely to sustain, too. Therefore, we only need to withdraw from our portfolio in a very limited fashion until 15 to 20 years from now (and our hope is the portfolio will grow to $3M or more by then).
While we will not need to withdraw from our portfolio on a regular basis until at least one decade from now, there might still be some events down the road that may require us to withdraw on a one-off basis. Our liquidity constraints are quite limited:
• $50,000 liquidity in a week (e.g. medical emergency for extended family members, etc.)
• $200,000 liquidity in a month (e.g. down-payment for home purchase -- will we be a renter forever?)
Given the 15-20 year time horizon, and the fact that we can absorb some fairly significant investment loss by simply postponing our early retirement by one year or two, we can be fairly aggressive and risk-taking in portfolio management. On the risk side, we can accept annual loss of 10% of our portfolio without losing our sleep at night.
On the other hand, we also seek matching investment returns for our risk appetite. We expect 10% or more absolute return per annum on average for the next 15-20 years. (That is, to double the size of the portfolio every 7 years -- without injection of more principal.)
Both my wife and I were raised in China. While we are becoming world travelers, we do feel we will spend a lot of our retirement life (and hence retirement fund) in China. Therefore, it is important our portfolio provides some hedge against declining dollar value. Our hope is our absolute return denominated in Chinese Yuan will be 7% or higher after 15-20 years.
Aside from the no-brainer of preferring tax-advantaged growth (401(k), IRA, Roth IRA, etc.), we also hope our portfolio can allow us to time when we want to book any capital gains. Our upcoming early retirement, our business income and ever-changing tax laws will create tons of tax opportunities that, if used properly, will dramatically reduce our tax burden on portfolio appreciation.
To sum it up:
- Seek annual absolute return of 10% or more in US Dollar
- Seek annual absolute return of 7% or more in Chinese Yuan
1) Time horizon of 15-20 years before regular withdrawal happens.
2) Some liquidity needs: $50,000 in 1 week and $200,000 in 1 month.
3) Medium risk tolerance: 10% annual loss is acceptable.
4) Tax flexibility needed: being able to time the realization of most capital gains.
Next, I will explore how I should distribute my portfolio across different asset classes.