The Portfolio Allocation for Early Retirement

We’ve recently burned a lot of pixels scorching different portfolio allocation ideas.

Which ideas stood strong, and which flamed out?

Here’s where we stand:

  • An all-stock portfolio is (probably) loony for most investors most of the time.
  • Nevertheless, equities are the fuerte foundation of a portfolio built for maximum wealth.
  • P2P loans have a role in plumping up our total nut size and tamping down volatility.
  • Commodities are garbage unless we’re professional commodities investors, which we aren’t.
  • Gummint bonds will ruin us if we’re trying to grow wealth.
  • Residential real estate is a utility-yielding “investment” that is unlikely to spin off a ton of wealth but may nevertheless be useful for many investors.
  • Cash won’t give us much in the way of interest these days, but its liquidity can be helpful in weathering negative life events, and in exploiting mispricing and “special situations,” so we keep some on us at all times.

    The Portfolio Plan to Retire Early
    The Portfolio Plan to Retire Early
  • The “traditional” 60/40 stocks/bonds split is an effective portfolio allocation only by chance and is probably ruinous.

So, yes, fair Luchadores, we know a great deal now.

But there’s so much more.

Which brings us to the great unveiling of the FinanciaLibre-approved Portfolio Allocation Strategy System. Or, for brevity, what we’ll call “PASS.”

PASS fixes what ails most portfolio allocation guidance for those interested in early retirement and/or financial independence. Which is to say most portfolio allocation guidance is a big steaming turd of broken logic.

In The Beginning

We tend to see two kinds of portfolio allocation guidance.

The first tells us our portfolio allocations should be a reflection of our age. A 20-something’s portfolio should be stock-ier than an 80-something’s.

We’re accustomed to seeing tables and graphs that exhort us to allocate our portfolios by deducting our age from 100 (or another arbitrary number) and plunking the result into equities.

Example: I’m 35, so I should be 65% into stocks.

The second type of portfolio allocation advice focuses on “style” or “risk tolerance.” The basic idea is that, since some people are more comfortable with volatility, they can deal with the fluctuations of a portfolio more exposed to stocks. Others with more flaccid constitutions have to stick with slower-growth-lower-risk assets. For example: Every time the S&P 500 registers red, you suffer a mental break and hide under the house for a week, so you should only have 30% (or less) of your holdings in stocks.

Now, some of you out there are thinking that these sorts of allocation “rules” are good and sensible. And it’s true they have some nice features.

The age/stocks rule is helpful because it popularizes the notion that younger investors tend to need growth more than older ones. And older investors tend to need stability more than growth.

The “style” guidance helps people allocate so they don’t panic and sell a bunch of stocks for a loss every time the FOMC convenes.

That’s all fantastic and wonderful. But these sorts of rules are about as useful for most people, and especially for rippling Luchadores, as half a nickel stuffed sideways into a vending machine.


The trouble with the age-based rule is simple enough.

Not every single person who happens to be the same age is in the same financial situation. And since one’s financial situation is what portfolio allocations are all about, using one’s age is profoundly stupid. It’s a terrible proxy for financial development. It’s like assigning kids to different levels of math study on the basis of shoe size.

Instead of age, portfolio allocations should directly consider one’s “financial maturity” or “stage of financial development” rather than an unnecessarily coarse and misleading proxy. It’s not like we can’t easily understand our financial situation when we make portfolio decisions. We don’t need a proxy. We can use the real thing.

To wit: Not all 35-year olds have the same amount of money or are in the same stage of reliance upon their savings. Shouldn’t financial factors outweigh – and, really, displace – the consideration of how old someone is when allocating investments?

Polka Dot Suit

The problem with the “style” advice is that it makes investing sound like it’s part of the creative writing curriculum in middle school: As long as you express yourself, you’re doing great. That makes about as much sense as driving whatever speed you feel like, anywhere you go. School zone? 85-ish feels right.

It’s like picking out a pair of shoes without regard for what they’ll be used for: Whatever makes you happy, sweetie, even if it is the flesh-toned pumps to wear on your hiking trip.

No, Luchadores. No!

Investing isn’t about feelings or warm cuddles or mommy kissing your scraped knee. It’s about financial goals. It’s about using our doughy soldiers to facilitate our other life pursuits.

It’s a goal-oriented undertaking.

We don’t do power cleans and squats and incline press and pull-ups because each rep is like getting nuzzled by bunnies on top of a rainbow. We do them because they build muscle and strength and physical capabilities that leave us better off tomorrow.

Likewise, at its core, investing is all about forgoing a bit of consumption / pleasure today in order to have a better tomorrow.

“Style” investing gets that whole equation backwards. It tells us to relegate tomorrow’s outcomes to the back seat, while we prioritize our feelings today.

To be brawny Luchadores, we have to do the opposite.

Enter PASS

Ridiculous “age-based” and “style-based” allocation guidance gets us Luchadores pretty chafed.

And you know what’s really crazy about all this? It’s not just the Internet-special, dime-store freebie investing advice on the web that peddles this mule dung. People actually pay advisers for crap like this.

So PASS is here to save your day and your dough and your ass.

The basic analytical construct of PASS is divided into two components.

First, what is your current financial stage relative to your financial independence/retirement goal? This tells us, roughly, how much equities exposure you should have because it lets us know how badly you need growth versus how badly you need security.

Second, what is your individual patience profile? This helps us refine the analysis and zero on in a specific equities allocation that suits you.

Consider: A 30-year old with $1.2 million saved who, based upon the FL-Approved 3.5% Rule, needs $1.3 million to retire comfortably is much different from a 30-year old with net worth in the single digits and a lifestyle that makes the Kardashians’ look modest.

Further consider: Someone who absolutely cannot wait to retire is different from someone for whom an additional year or two of work is okay.

So, here it is. It’s simple. It’s economically logical. It’s based on empirical study and historical statistics. It’s a 4-step approach to making your portfolio awesomely allocated.

The following table summarizes the 4 steps in one handy chart. Each step is detailed below.

Early Retirement Portfolio Allocation Tool
Early Retirement Portfolio Allocation Tool

Step 1

Determine where you are on the road to financial independence in percentage terms. You’re comparing your current net worth to the amount of money you need to retire comfortably.

Example: If your financial independence nut size is $1 million and you have a current nut of $500k, you’re 50% of the way there.

Look at the chart above. Your percentage tells you where you place in the “Worth as % of FI Number” range.

Step 2

Based on your percentage, determine what this means for your ideal equities exposure range. (Note: For purposes of this discussion, REITs and international stocks are included in our definition of “equities.”)

If your net worth is in the range of 0% to 60% of your financial independence number, then you’re a “Pup.”

If you have 60% to 80% of your FI number saved, you’re a “Fox.”

And if you’ve got 80%+, you’re a “Coyote.”

Where you fall in the range is important because it tells us how badly you need growth and how much risk (i.e., volatility) your portfolio can/should take on.

Here’s what your range means for you:

If you’re a wee Pup, you have a relatively long economic road ahead of you before you reach financial independence:

  • Your portfolio needs growth and can weather market volatility along the way.
  • Your portfolio should be heavily weighted toward stocks – in the range of 80% to 90% of your investable sum.
  • Why 80% to 90%? You need to grow as fast as you can, so you should have as much stock exposure as possible. But you also need liquidity, so you can’t go 100% (i.e., around 10% to 20% of your holdings will have to stay in cash) – more on this in a minute.
  • Also note: Respected economists like Jeremy Siegel would argue you should be at least 100% in stocks (and maybe up to 200%). So, if 80% to 90% seems high, understand that it really isn’t.

If you’re a Fox, you’re doing very well:

  • You still need lots of growth to get to your goal, but you’ve got more to lose than a Pup.
  • So you’ve got to pull back on your equities exposure – in the range of 70% to 80% of your investable sum should be in equities.
  • This range reflects empirical research underpinning things like the 4% Rule that show a ~75% stock allocation provides growth-oriented exposure to the market with reasonable downside protection. It also reflects the fact that, if you still need to obtain another ~30% of your FI number, you likely have around 5 years left before retirement. Stocks outperform alternatives 70%+ of the time in 5-year rolling intervals.
  • Hence, ~75% in equities: much less would not provide sufficient growth, and much more would not provide sufficient insulation against downturns or offer sufficient rebalancing opportunities.

Coyotes are in the home stretch. Maybe $200k is all that separates the wily Coyote from victory and a nice warm roadrunner stew. For los lobos:

  • The amount of growth required is relatively small, so the impact of a market downturn becomes greater.
  • Equities exposure should be relatively low – in the range of 60% to 75%.
  • This range reflects a reasonable stock allocation that, on the basis of empirical research, positions the portfolio to take advantage of the long-run benefits of equities exposure, but also is defensive enough that market downturns are not ruinous.
  • For those perceiving the 60% to 75% equities range is too high, recognize that, for all the anecdotal fear of stock losses, equities go up in value roughly 70% of the time on an annual basis.

Step 3

Now that you’ve got your equities range, we have to refine the analysis to zero in on specifically where in that range you should be.

Here you have to determine your “delay discounting preference.”

Now you say, “What in the shit, FL? Delay discounting preference? Don’t go all weird/useless/textbook-y on me here!”

You’re right. The words are nasty sounding, but the idea’s simple.

Delay discounting is a measure of how patient you are. And it’s more or less a preference thing. Whether you’re more patient or less (within a range) doesn’t mean you’re smarter or dumber, sexier or douchier. It just is.

The point is that everyone’s got a different outlook on how willing they are to wait for a payoff. And, as a corollary, how much risk they’re willing to take on to try to get the payoff as fast as possible.

Think of a racecar driver heading into the final lap of a race. Her fuel gauge is worthless because she’s nearly out of gas. Does she have enough fuel to finish the race without hitting the pits? She’s in the lead, so she knows if she’s got the fuel, she’ll win. But there’s a chance she’ll sputter out just short. If she refuels, her time will be slower; she won’t win; she’ll probably come in 3rd. What does she do? Her payout, etc. depends upon her willingness to be patient/refuel (and finish slower but guarantee placing) versus her willingness to chance a win and maybe come in last.

To which you say, “All this sounds a lot like that ‘style-based’ investing you bashed earlier, FL. What gives?”

To an extent you’re right since delay discounting consideration involves preference. But our delay discounting inquiry doesn’t focus on how you feel about action in the market (i.e., whether you worry when the market dips). Instead, it focuses on how patient you are with regard to retirement or financial independence. They’re very different questions since delay discounting really is asking not how comfortable you are with investment risk; it’s asking how comfortable you are in your current working/non-FI circumstances.

Here’s how delay discounting considerations impact Pups, Foxes and Coyotes:

If you’re a Pup, your delay discounting preference has about as much impact on how you should allocate as your hair color. Pretty much nada. If you’re an absolute sadist and want to delay your retirement for some reason, stick with 80% equities even if you don’t need 20% in cash as a safety net. Otherwise, it’s gotta be closer to 90% in stocks for maximum growth.

Foxes should consider their delay discounting preference a bit more deeply since the stakes are higher. One way to think about your preference is to consider how deeply you detest your working life. If it’s not so much, then you’re relatively patient. If working makes you physically ill, stick with a stock allocation at the higher end of the 70% to 80% range since you’re the racecar driver for whom finishing third is pretty much as bad as finding out you’re Peewee Herman.

For Coyotes, delay discounting is so important that it probably ought to be viewed differently than for Pups and Foxes. For Coyotes, it makes sense to think about absolute scale.

By this I mean, not only how close you are – in percentage terms – to your FI number, but just how big a nut you’re dealing with. If you were forced to – like, had to – retire with the amount of money you currently have, would you be able to purchase a reasonable lifestyle? If the answer to this is yes, then you should gravitate toward the lower end of the 60% to 75% equities range because significant value loss could be catastrophic – relegating you to more years of work when you could have just retired with a slightly cheaper lifestyle. If the answer is no, then you still need growth more than security, and you should gravitate toward the upper end of the range.

For Pups, Foxes and Coyotes: By considering your “patience,” you implicitly take into account how rapidly you’re accumulating new savings via employment, etc.

Step 4

With your equities exposure figured out, now determine what should be in your portfolio other than stocks.

Pups: Go with the fastest-growers you can get.

  • P2P loans comprising up to about 10% of your investable sum makes good allocation sense because of the high returns and 0.2 correlation coefficient with equities.
  • Commodities, physical real estate, bonds and cash are your worst enemies.
  • But, because of the importance of maintaining some liquidity, you have no choice but to keep cash. Do so in a high-yielding online savings account. Recall: At least a 6-month cash savings safety cushion is a good idea to weather unexpected life events.

Foxes: You’ve got awesome flexibility – with 70% to 80% of your holdings in equities, you can put 20% to 30% into other vehicles that will reduce volatility while still providing growth.

  • Go with low-correlation assets that complement stocks.
  • Up to 10% in P2P loans is great.
  • Adding up to 10% to 20% in physical real estate can further help dampen volatility and provide tax advantages.
  • Some fixed income can be used to round out the portfolio, with emphasis on quality corporate bonds.
  • A small cash buffer, as always, is important for liquidity, both to cover emergencies and to invest in unexpected opportunities.

Coyotes: With 60% to 75% in equities, you’ve got lots of room to play with.

  • The remainder of your portfolio should include up to 10% in P2Ps.
  • It should have up to 20% in real estate.
  • And it should include some select fixed income, particularly high-grade corporate bonds and/or municipal bonds (selection depends on your marginal tax bracket; if it’s a high one, which is often the case for wily Coyotes, munis can be very useful).
  • A small cash buffer should be maintained to cover emergencies and take advantage of “special situation” opportunities.


Most portfolio allocation tools are useless or even damaging for those who want to retire early. Not PASS.

It tells us how we should be allocated on the basis of financial indicators that really matter and are directly linked to money’s role in our lives. In upcoming posts, we’ll dissect the particulars of how to select the right sorts of equities and other portfolio components recommended by PASS for Pups, Foxes and Coyotes.

It should be noted that PASS, like “age-based” and “style-based” heuristics, is intended to give a starting-point for developing a portfolio allocation that works for you. Every individual out there has unique circumstances that will cause them to say, “Hey – I need more cash or real estate or whatever in my life because of x, y, z.” And that’s great. The point of this tool is to help form a rational foundation for allocation decisions, to help provide a starting-point allocation that is actually based on economics and financial considerations rather than stuff that’s about as helpful to portfolio allocation as astrology and shoe size. And it’s meant to be refined from there by its users.

The above strategy reflects in principle the allocation guidelines I followed during my haul to freedom from mandatory work – and explains, in part, how I managed to retire before age 35.

Notwithstanding the success I’ve had with this strategy, for a post like this, I feel obligated to reiterate the disclaimer that, though this sort of construct worked for me, it may not provide the same results for you.

Yes, it’s based on sound economic logic and empirical research, including a statistical history of the markets, different assets’ rates of return and different asset pairs’ correlation coefficients.

Yes, it’s sensible and reasoned.

Yes, it puts other allocation tools to shame.

But it’s being offered only as a thought-provoking starting point for your consideration. This is not tailored professional financial advice – not in this post or any other post on FinanciaLibre. It’s a tool to be used wisely by those wielding it.

Luchadores, tell me where you are on the road to financial independence, and how you’ve allocated your portfolios.


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