Whew, that’s a lot, right? It wasn’t just one mistake either. It was two mistakes, each costing me over $100,000. I made the first mistake in early 2018 and tried to learn from it. Unfortunately, I didn’t and ended up making the exact same mistake again in 2019.
The mistake? Not rebalancing my portfolio in line with my target asset allocation on a tight schedule.
It’s crazy to think that simply not rebalancing cost me this much from just two funds. To explain how this works we need to back up and talk about my rules for investing (some people call this an investment policy statement).
My Rules for Investing
The very last lesson of my free investing course (The Minimal Investor) focuses on creating your own rules for investing. Writing this out is a key part of investing on your own. It helps take emotion out of your decisions. If you’re in a spot where you’re wondering “should I sell this fund?”, looking at your own rules written during a clear-headed time can help you make an informed decision.
My rules for investing are relatively simple:
- Asset Allocation: Roughly 5% in speculative funds, 5% in REITs, 3 years in cash (since I recently stopped working), the rest a US Fund, Intl Fund, and a Bond fund.
- Rebalancing: Rebalance by buying new funds throughout the year, and limit selling to once every year. (this is where I went wrong)
- Fees: Always pick index funds over active funds. For the 5% speculative part I can pick anything.
- Taxes: Try to limit taxes whenever possible by holding all funds for at least 1 year (also where I went wrong).
This is a good start, but even in the last 3 years, these rules have been put to the test. The problem I ran into is this: what should I do if I have large short-term capital gains that would trigger rebalancing during the year?
The mistake I made was NOT selling those funds to rebalance. Instead, I let them ride it out for a long time horizon. It was my hope they would stay around the same value and I could sell them in the next year. Sadly that was not the case. Let’s take a look at both mistakes.
My 2018 Mistake – Bitcoin
Oh, Bitcoin. I first heard about Bitcoin back when it crossed $1/coin. I didn’t believe (and still don’t believe) that Bitcoin will be an amazing revolution. I do think Blockchain is an amazing technology though, and I believe there will someday be a killer app built on it, but Bitcoin is not that killer app (too much power draw, no technical upside other than currency, can’t run programs on its interface like you can for Ethereum). I strongly believe that someday someone will create something amazing with Blockchain that we all use in some way. I’m not sure what that’ll be, but I’m on the lookout for it.
When Bitcoin was just under $1, I signed up for an account on Mt. Gox. Mt. Gox was the big Bitcoin exchange of the day but recently went out of business after it was made public that they had lost hundreds of millions of dollars worth of their users Bitcoins (!). I jumped through all the hoops needed to buy coins there, but by the time I was approved to make trades, the price had gone up to over $2 each! I was sure I’d missed the gold rush and went back to my normally scheduled investing. 😭
Fast forward a few years to early-2017 and Bitcoin has hit $1,000 each. Around this time I decided to start putting about 5% of my portfolio into Bitcoin – about $50,000 at the time. This wasn’t because I thought it was a great investment, but because I thought there was enough momentum that the investment could pay off and I could make a little money. I put this amount in a little at a time, adding in $2,000 each week until I was up to 5% of my portfolio. During that time Bitcoin kept on going up.
The “problem” I ran into was that my $50,000 investment ended up doing far better than I ever hoped! By the end of January when Bitcoin peaked, my Bitcoin was worth about $170,000! Bitcoin was suddenly worth about 13% of my portfolio – far higher than the 5% I intended.
What I SHOULD have done at that point was to realize that this was breaking one of my rules for investing and sell enough to where Bitcoin was again only 5% of my portfolio.
What I ACTUALLY did was decide not to rebalance until I had held all of my Bitcoin for 1 year. By doing that I’d lower my tax rate on the gains from 24% (short term capital gains rate for our income level) down to 15% (our long-term capital gains rate).
Sadly, by the time I did sell, Bitcoin had dropped all the way down to under $4,000 – way off their $18,000 peak. Of the $50,000 I initially invested, I ended up selling for about $45,000, adding $5,000 in capital gains losses that offset some gains for the year.
So, what went wrong?
First, one of my “rules” was to rebalance yearly. Because of that, I wasn’t on the lookout for how far out of balance my portfolio was. I’ve since changed this to rebalance quarterly across my entire portfolio and monthly for my speculative investments (if I have any).
Secondly, I invested in speculative funds in the same style I invested in index funds. With 95% of my portfolio, I only invest in things I plan to hold for the rest of my life. Because of that, I don’t need to worry about when I buy or sell due to the time horizon. For speculative funds, you need to worry about both of these though! I didn’t think enough about trying to sell at a peak, and instead presumed things would trend up like the stock market. Individual speculative funds don’t behave like index funds (should be obvious by now).
Lastly, I let taxes influence my selling decisions. As nice as it is to sell in a lower tax bracket, I let the higher taxes scare me away from selling for a guaranteed payday.
My 2019 Mistake – Company Stock
This one needs a little background. About 9 years ago I joined a company called Code School. I was a relatively early employee and ended up leading a team that put out courses every month. A few years later Code School was acquired by Pluralsight ($PS), for which I received some cash and stock.
When you’re granted stock in a company that isn’t public, it’s impossible to value it. You can calculate the value of your shares based on the valuation of the company, but that’s an imperfect measure. Without a market to buy/sell those shares on they’re essentially worthless. You’re locked in.
In May of 2018 Pluralsight ended up going public – making my shares actually worth something! 6-months later I was able to start selling them and actually get some money in my pocket. In just one day all of a sudden 35% of my portfolio was now in a single stock.
But that brought up a dilemma: How much should I sell?! By my own rules for investing this is now my speculative investment, so should I sell all the way down to 5% immediately? Do I know more about this company than the market, and therefore I can better time the market than the public? How will taxes work if I sell $680,000 of stock immediately?
Startup stocks are notoriously volatile. They can just as easily double as they can drop by half. Having been at Pluralsight and watching other tech stocks closely, I knew one thing: If Pluralsight missed their earning target at any time, I believed the stock would drop a large amount.
This isn’t rocket science investing. Just about every company sees some volatility around the time of their earnings calls – either up or down. I had no insider information on if they would overperform or underperform on their next call, so I was in the same shoes as any investor.
What I landed on doing worked out surprisingly well, but it could have been much much better (hence this post). Here’s what I did with these funds:
For 2018, I planned to sell just enough stock so that our capital gains rate stayed in the 15% bracket. This meant that our income + sales from stock would need to be under $479,000 for 2018. Assuming our income was around $200,000 for the year (+/- a bit), that would mean I’d want to sell about $275,000 in stock for 2018. I gained control of the stock in mid-November and calculated out how much I should sell each day between then and the end of the year. Each day I’d log in and sell a little until that number was reached.
For 2019, I planned to do the same – sell as much stock as possible to stay inside the 15% capital gains bracket – now raised to $488,000 for 2019. The difference this year is that I’m not working ( 🥳), so I’d be able to sell quite a lot more. For simplicity sake, let’s say I had $400,000 to sell in 2019. Again I figured out when I needed to sell it by – but this time I wanted to sell it all by the first shareholder call on February 13. Based on my assumption, if they didn’t hit their numbers on that date, the stock would drop. Again I dollar cost averaged the sale of stock over January and early February, reaching that $400,000 sales number by mid-February.
My account looked pretty crazy. Seeing these numbers coming in and out every day was insane. I didn’t have a set time of the day I made these transactions. Sometimes I’d make them in the morning, sometimes right before the closing bell. Sometimes I’d be taking a break while skiing to sell some stock (that’s possibly the richest sentence I’ve ever said). By the end of February my account looked like this:
On February 13th, Pluralsight had their earnings call and it went well! The stock dropped a little but recovered. They had another earnings call in May that was about the same. After their July 31st earnings call though, the stock dropped 47% in a week. It was exactly what I feared would happen in February – I was just off by a few earnings calls.
This may seem like an analysis of Pluralsight, but that’s not my intention. It’s an analysis of ANY startup that’s constantly hitting their earnings targets then missing one. Investors seek growth, and hitting those growth targets over and over again is how most growth stocks rise in value. When that growth is put to the test, investors seeking a high-growth run for the doors. It doesn’t mean there’s no value, it doesn’t mean the company is in trouble. It could just mean the company missed one target. I don’t work at PS and have no inside information on why they missed this.
So what did I do wrong? That’s an incredibly tough one to say. For my 34,000 shares there are a few ways things could have gone:
- Sold immediately: At $21.62 this would’ve meant $735,080 in my pocket.
- Sold at the all-time low: At $14.84 that would’ve meant $504,560.
- Sold at the all-time high: At $35.49 that would’ve meant $1,206,660.
- Dollar-Cost averaged 30,000 shares from November 15 – February 13: $708,121 cash + $88,000 leftover stock.
The last one is what I ended up doing. I kept some of my shares to sell in 2020, which are now more than 50% off of their all-time high. These now makeup about 4% of my portfolio and are my “speculative investment”.
I like having some investment in the company I worked at for 8 years too. Even if it’s only ~4,000 shares, it gives me a connection to the work I’ve put much of my life into. I ran the numbers on some other options as well. I thought about buying puts to offset some of the losses in case PS did drastically drop in value. If I had millions in stock I might have gone that route.
Coming out somewhere in the middle between the all-time low and all-time high is exactly what I was going for. That’s the power of dollar-cost averaging!
So where did I go wrong? It seems like everything went well right? The issue is with that $88,000 in leftover stock I held. At one point that stock was up to over $175,000 – or about 8% of my portfolio at the time. If I was more confident in my investing rules I would have sold down to 5% of my portfolio and took advantage of the elevated stock price while I could.
What I Learned From This
There are a few things I’ve changed from this experience. The big ones are:
For speculative investments, it’s OK to base the exit around my portfolio allocation. When something grows out of proportion try to catch it fast!
Check my speculative investments monthly and compare them with my target allocation. This would help in both these cases above.
Be OK paying taxes on speculative investment gains. For both these cases, I didn’t want to sell because I didn’t want to pay more taxes. It’s OK to pay taxes on gains!
I’m still no expert in this. I have a feeling others in these same shoes could’ve generated much more wealth from my same experience. It’s also easy to look back knowing the stock would rise. If the stock had instead dropped every day? In that case, selling on day 1 would’ve been the way to go. No one has a crystal ball to know which route is the best route.
Take Blue Apron ($APRN). They IPO’d in 2017 and have been on a decline ever since. For investors in Blue Apron, their best bet was to sell immediately.
I honestly have no idea how you can tell if you’re at a company that’s going to grow or fall. What I do know are there are things that can help influence it. If the company has been practicing hitting an earnings target for years before they go public. If the company is constantly able to point to a direction (revenue, sales, product, etc) and achieve it. If a company consistently hits these targets. I don’t know about Blue Apron, but Pluralsight was hitting all of these – until for one earnings call they didn’t. Time will tell what happens for their next call.
While I no-doubt left some money on the table, I also limited my risk by selling in a time frame where there was a limited chance of things going wrong. The money from these sales was also redirected right back into the stock market. So even if I didn’t maximize my gains from the sale, the funds have since grown MORE through regular old index fund investing.
If you’re actively doing any kind of speculative investing my recommendation for you is this: have a pre-set number of triggers for when you’ll sell that you stick to. That might be stock price, percent of your portfolio, earnings call dates, or something else. Whatever it is, creating that plan when you’re level-headed is key.
What about you? Have you ever gone against your own rules for investing? How did it go?