Table of Contents
Introduction & Overview
Using the current USAA career starter loan, available up to $36,000 at a low .75% APR, I intend to invest $30,000 of the $36,000 loan. I will build my portfolio using the $30,000 of investing money to build my portfolio and set up my retirement life in the long run. In addition, I intend to put $6,000 into my investment per year once I commission into the Air Force. I have decided that I want to retire at the age of 65 and am estimating that I will die around the age of 98. Likewise, I also want to have three quarters of my last paycheck each year of retirement. I used the average salary of an Air Force O-6 to determine what I would be making out of retirement. Based on this, I determined that I will need approximately $75,000 each year of retirement. Using all of this information, I used TVM and discovered that a portfolio return of 7.70%. I set inflation in the rate section of TVM at 0% rather than the normal -3%. I did this due to the fact that I believe that I will invest intelligently while also becoming a more conservative investor as I get older.
Asset Allocation
In determining my assets allocation, I looked at my personality and life goals for retirement. In order to do so, I used the Charles Schwa “Investor Profile Questionnaire”. In the risk assessment, I kept in mind my goal of having a long-term investment with growth potential while also staying relatively conservative to lower the volatility compared to the overall stock market. I also noted that the USAA loan needs to be paid off within five years after graduation. Consequently, having a larger percentage of the loan invested in stocks will help me reach my retirement goals is a necessity, having some investments in bonds to have some cash readily available is a benefit.
As seen in the figures below, the Charles Schwab assessment helped me to build an asset allocation breakdown tailored to my personal goal. After determining my assets allocation from the questionnaires, I utilized the 15×15 Portfolio Risk-Return Calculator Excel Spreadsheet. I inputted my target return of 7.70% and manipulated the asset class min and max cells to replicate the asset class allocations that I came up with in the questionnaires. However, after doing so, I determined that I needed a more aggressive investment strategy than indicated in the questionnaire in order to reach my target return of 7.70%. The calculated Asset Allocation and VaR based on the risk allocation pie charts can be seen below.
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My portfolio expected risk came out to be 13.9%. Although this risk is higher than I anticipated, I have room for it due to the fact that I am a young investor. My portfolio VaR is -15.2%. My portfolio VaR is the best outcome that I can have in my worst investing year of a 20 year span. My portfolio Beta is 0.89, meaning that my portfolio is slightly less risky and sensitive than the overall market. Finally, my portfolio WAER is .27%. I expect my portfolio WAER to decrease for my individual contributions as I plan to utilize low expense TSP funds in the future.
Asset Location
For my asset location, in deciding what to shelter from the IRA and TSP, I fist put in bonds and the U.S. due to the fact that U.S. stocks should go in before my international stocks. My asset location breakouts are shown below.
Mutual Funds
In the future, I intend to take advantage of the military Blended Retirement System, where the TSP matches up to 5%; consequently, I decided to choose a few TSP funds for my portfolio. However, not being able to utilize TSP funds until after graduation effects how I invest my loan now. I would like to utilize TSP funds in the future due to the fact that they have very low expense rates and no minimum investment required. In contrast, USAA’s mutual funds almost always have higher expense ratios and many of these funds require a minimum $3000 investment.
Because I only have $30,000 to invest right now, TSP funds will prove to be a great advantage in the future due to the fact that I can take my $6000 yearly contributions and begin placing this capital into TSP funds based on my asset allocation. In addition, I can use a Roth TSP so that I can be taxed now rather than later in life. This is an advantage as the capital that I plan to take out for retirement will be far greater than what I am putting in now. However, in order to meet my asset allocations, I needed to select mutual funds and ETFs outside of the TSP to satisfy the asset allocation for emerging market stocks and junk bonds. In deciding which mutual funds to use, I looked for funds that were cost effective in that they had low expense ratios, taxes, and fees. The two charts for the specific funds for my loan investment as well as the chart for my annual contributions are below.
• Vanguard Small Cap Index Inv (NAESX):
- Pro: Low turnover of 0%, low fee level, & well diversified holdings
- Cons: Minimum investment of $3,000, high expense ratio of .17%, & market and inflation risk
Fidelity® International Enhanced Index (FIENX):
- Pro: Low turnover of 70% & relatively low expense ratio of 0.59%
- Cons: Minimum investment of $2,500, currency exchange rate risk, & market risk
Vanguard FTSE Emerging Markets ETF (VWO):
- Pros: Low turnover, low expense ratio of .14%, & no minimum investment (ETF)
- Cons: High level of volatility
G Fund
- Pros: Low expense ratio, no minimum investment, earnings fully guaranteed by U.S. government, & avoids exposure to credit risk
- Cons: Inflation risk, low rates of return, affected when U.S. statutory debt limit is reached
F Fund
- Pros: Low expense ratio, no minimum investment, & very low risk
- Cons: Can only invest in bonds, credit risk, market risk
C Fund
- Pros: Low expense ratio, no minimum investment, & well diversified
- Cons: Market & Inflation risk
S Fund
- Pros: Low expense ratio, no minimum investment, & well diversified
- Cons; Market & Inflation risk
I Fund
- Pros: Low expense ratio, no minimum investment, & well diversified
- Cons: Market & Inflation risk
Discussion of How the Funds Fit Together
When looking at the mutual funds and ETFs that I selected for my portfolio, they all fit together very well. In particular, the funds selected for my TSP complemented each other due to the fact that they are used together for a lifecycle fund offered to TSP participants. The Fixed-Income fund, F Fund, works well with the C (U.S. Large), S (U.S. Small), and I (International) Funds due to the fact that stocks and bonds don’t always trend in the same directions. Thus, having these funds together helps reduce the volatility of my portfolio when compared to stock heavy funds. Likewise, the C, S, and I Funds cover different areas of the stock market with very little overlap. This is an advantage due to the fact that different segments of the market do not always trend in the same directions.
While the C fund covers large blend investments, the S fund covers small blend funds and thus provides increased diversity to my portfolio. Similarly, when other TSP funds have higher levels of risk, the G fund fits well due to the fact that it is designed to protect and preserve an investor’s money while also offering a source of liquidity. Next, the iShares High Yield Bond ETF fits well due to the fact that it diversifies my bond investments. While the F fund exclusively consists of quality bonds, the iShares ETF exposes my portfolio to Junk Bonds. The addition of Junk Bonds exposes my portfolio to different boxes within the fixed-income style box, providing more diversification to my portfolio. Finally, the Vanguard Emerging Markets ETF fits well with the other funds I selected due to its low expense ratio that stays on theme with the rest of the funds I selected.
Because I cannot currently invest in TSP funds as a cadet, for my loan investment, the mutual funds and ETFs that I selected were similar in comparison to the TSP funds. Besides the much higher expense ratio, the USAA Money market fund acted in a similar manner to that of the G fund. Similarly, the iShares US Aggregate ETF is similar to the F fund due to the fact that they both have low expense ratios and both invest in quality bonds according to the fixed-income style box. In addition, the Vanguard Small Cap Index is very similar to the S Fund because both have low expense ratios and primarily hold small U.S. equities; however, the S Fund uses the Dow Jones Index while the Vanguard Small Cap fund uses the CSRP U.S. small cap index as its benchmark.
Because these two funds use different benchmarks, they will not always move along the same trends and consequently provide a source of diversity to the portfolio. Conversely, The Vanguard 500 Index Admiral behaves similar to the C Fund because both have low expense ratios and both track the S&P 500 as a benchmark. Finally, the Fidelity International Index fund is most similar to the I Fund as both funds track the MSCI EAFE Stock Index as a benchmark. However, the Fidelity international fund has a much higher expense ratio.
Conclusion
In looking at the portfolio that I have assembled, as seen in my WAER, I believe that I have done a very good job at adhering to my goals of lowering the costs of holding the funds by choosing funds with low expense ratios, fees, and taxes. Likewise, I feel that I have developed a solid asset location strategy that will allow me to avoid even more costs in the future. Finally, for the most part, I did a good job at selecting funds that would diversify my portfolio so that I could mitigate investment risk and volatility.
Work Cited
“G Fund: Government Securities Investment Fund.” TSP: Contribution Limits, www.tsp.gov/InvestmentFunds/FundOptions/fundPerformance_G.html.
