Portfolio Construction

A structured framework comparing Accumulation (wealth building over decades) with Decumulation (capital preservation, safe withdrawal rates, and drawdown mitigation).

1. Accumulation Phase

Time Horizon: 30–40 Years until Retirement

  • Long-Term Horizon Assumption: Capital is not needed immediately, allowing portfolios to ride out severe downturns.
  • Equity Return Dominance: Equities offer superior long-term growth, but carry extreme volatility—drawdowns can exceed 50% and take up to 14 years to fully recover.
  • Core 100% Equity Strategy: Split allocation 50% Large Cap Growth / Total Stock Market and 50% Small Cap Value to capture size and value factor premiums.
  • International Diversification Debate: U.S. megacaps are global multinationals. The diversity in interational stocks mostly comes from the fluctuations in the currency exchange rate rather than corporate non-correlation.
  • DCA (Dollar Cost Averaging) & Paycheck Contributions: Ideally direct new contributions toward underweight assets to rebalance naturally. This can be a lot of hassle, so just allocating the contributions according to the overall desired allocation is ok.
  • Rebalancing Advantage: Periodically trim top-performing assets and buy lagging assets, systematically forcing a "buy low, sell high" dynamic.
  • Rebalancing Thresholds: Execute rebalancing periodically (every 12 months) or via drift thresholds (e.g., when an asset drifts ±5% off target).
Objective: Maximum Compound Annual Growth Rate (CAGR).

2. Decumulation & Short-Term Savings

Time Horizon: Active Retirement / Short-Term Goal (< 5 Years)

  • What is a Decumulation Portfolio?: Once you've accumulated sufficent capital for retirement, you need to switch to a portfolio that emphasizes capital preservation (minimizing risk) and safe withdrawal rates (income generation).
  • Uncorrelated Asset Balancing: Combine uncorrelated assets and weight them to achieve the desired level of return and standard deviation. This is a very diversified, low risk portfolio with much smaller drawdowns that recovers much faster than holding only equities.
  • Uncorrelated Assets: The 4 basic assets used are equities, government bonds, gold and commodities. These represent the simpliest uncorrelated assets to invest in. Other asset classes may be uncorrelated but are not easy to invest in, like art or currency futures. Someday ETFs for these asset classes may become available with reasonable expense fees.
  • Fast Drawdown Recovery: Diversified portfolios like this recover from market drops much more quickly than holding only equities, typically within 3-4 years.
  • Rebalancing Advantage: Periodically trim top-performing assets and buy lagging assets, systematically forcing a "buy low, sell high" dynamic.
  • Rebalancing Thresholds: Execute rebalancing periodically (every 12 months) or via drift thresholds (e.g., when an asset drifts ±5% off target).
  • Generating Cash: To generate cash to live off of in retirement, sell assets that have exceeded their target allocations to move the portfolio back towards the targets. This can be done on a monthly, quarterly, or annual basis just depending on your preference.
Objective: Reduce Portfolio Volatility and Maximize Safe Withdrawal Rate.

Recommended Backtesting & Modeling Tools

Tools and References

Portfolio Charts

Tests macro asset classes using historical data back to 1970. Excellent visual metrics for SWR, drawdowns, and Ulcer Index.
Portfolio Visualizer

Comprehensive suite for correlation matrices, ticker factor regressions, tactical asset allocation, and Monte Carlo simulations.
Testfolio

Modern asset allocation backtester with customizable rebalancing parameters and leverage simulation capabilities.
Early Retirement Now SWR Tool

Comprehensive Google Sheet modeling Safe Withdrawal Rates across diverse inflation regimes and retirement horizons.
Paul Merriman ETF Recommendations

Pioneer of the "Ultimate Buy & Hold" portfolio, advocating simple 4-fund and 10-fund combinations combining Large Cap, Small Cap Value, and International factors.

Core Asset Class Overview

Equities

Fastest growing asset but has high volatility and large drawdowns. It's best to split your equity allocation between Large Cap Growth (or Total Stock Market) and Small Cap Value.

Bonds

Long-term treasury bonds are the bonds most uncorrelated with equities, and they generally have a positive return when taking in to account the dividends they pay. Think of bonds as an insurance policy against a recession. In recessions money moves to long-term government bonds because they are considered safe. In recessions the government will usually lower interest rates to stimulate the economy and bond prices are inversely proportional to interest rate (so bond prices go up). Corporate bonds are correlated with equities and are not great to hold as part of this type of portfolio.

Gold

Gold is an uncorrelated asset that appreciates over time, generally keeping up with inflation. It's a global reserve asset, meaning it doesn't act like a normal commodity. Governments consider it a safe store of value and will stock pile it in times of uncertainty.

Commodities

Commodities are direct inflation protection since, by definition, inflation is the increasing price of goods. Commodities are volatile and cyclical, so they are recommended only as a minor allocation. Picking specific commodities is a bad choice because you're making a bet on the price of a specific commodity (e.g. oil). Buying a basket of different commodities is an option but a lot of work. A few broad-based etf's exist have have head poor historical performance. Over the long-term commodities should keep up with inflation but are very volatile so should not be used for a large portion of the portfolio

Cash

Any cash needed for an emergency fund should not be considered as part of the investment portfolio. The only time a cash allocation makes sense is in retirement when you'll be withdrawing from the portfolio periodically for normal expenses.

How to Invest in these Assets

Exchange-Traded Funds (ETFs) as the Optimal Investment Vehicle

When constructing any of these portfolios, Exchange-Traded Funds (ETFs) are the preferred investment vehicle. ETFs combine the broad market exposure of index funds with the trading flexibility of individual stocks, offering distinct structural advantages over traditional mutual funds and stock picking.

Advantages over Mutual Funds

  • Superior Tax Efficiency: Due to the "in-kind" creation and redemption mechanism, ETFs rarely trigger capital gains distributions, protecting taxable accounts from unexpected tax bills.
  • Lower Expense Ratios: Broad index ETFs feature ultralow management fees (often 0.03% to 0.10%), far cheaper than active or traditional mutual funds.
  • Intraday Trading & Liquidity: ETFs trade continuously throughout market hours at real-time prices with limit/stop order flexibility, unlike mutual funds which only price once daily at market close.
  • No Initial Investment Minimums: Mutual funds often require $3,000+ minimums per fund, whereas ETFs can be bought for the price of a single share (or fractional share).

Advantages over Individual Stocks

  • Instant Broad Diversification: Purchasing a single ETF instantly grants exposure to hundreds or thousands of securities, completely eliminating single-company bankruptcy risk.
  • Self-Cleansing Mechanism: Index ETFs automatically rotate out declining companies and increase weighting in growing leaders without creating taxable sales for the investor.
  • Elimination of Stock-Picking Risk: Individual stock pickers take on massive uncompensated risk (earnings misses, disruption, bad management) that rarely outperforms broad market indexes over long horizons.
  • Time Efficiency & Simple Rebalancing: Managing 3 to 5 index ETFs requires only a few minutes per year to rebalance, eliminating the need to analyze dozens of corporate balance sheets.