Jonathan Clements's Blog, page 332

Inject Discipline

THE CORONAVIRUS is prompting people to behave irrationally. They’re hoarding food, toilet paper and other goods. They’re risking their health—and that of those they know—by failing to limit their physical contact with others.

This irrationality has spilled over into the stock market. More than 30% of the U.S. market’s total value has been wiped out. It’s hard to argue that this is justified. The businesses represented by these stocks may be hit with short-term disruptions and a temporary reduction in profits. But nearly all will remain in business and thrive in the future.

The world is not coming to an end. The world’s population has faced bad times before—some far worse than the coronavirus—and yet the world continues to turn. This is not to diminish the hardship that will be suffered by many people, who will lose income due to temporary business closures and slowdowns, nor am I ignoring the tragic deaths of those who have and will succumb to COVID-19. But with time, we will conquer this disease and move forward.

While we’re waiting for good news on the coronavirus vaccine front, there’s already good news for investors. What’s that? There’s a vaccine available for every investment portfolio. It won’t eliminate all symptoms, but it can lessen the degree to which you suffer emotional and financial stress during uncertain times. The vaccine comes in a two-part injection.

The first shot is asset allocation. Asset allocation is the conscious effort to align your investments with a level of risk that you’re able, willing and should assume. That means selecting diversified investments so that you have an overall portfolio risk level that allows you to sleep at night and not worry about your finances.

There are many ways to define risk, but let’s consider one measure: standard deviation. Standard deviation is the deviation from the “mean” return over a specified timeframe. The higher the standard deviation, the greater the risk of inconsistent returns from year to year. Investors like consistency and predictability. In its absence, investors themselves become irrational and unpredictable.

When you invest heavily in the stock market, you get a portfolio with a high standard deviation—and occasional results like we’ve seen over the past month. Ask yourself this question and try to answer honestly: “Can you emotionally manage such declines?” If not, what maximum decline can you emotionally and financially manage? How you answer these questions will define your investment portfolio’s asset allocation vaccine.

This is an oversimplification, but a portfolio made up of 50% stocks and 50% in cash and bonds will basically have half the risk of a 100% stock portfolio. Sure, with a more conservative mix, you’ll likely earn less over the long run, but you will sleep better at night. What’s that worth to you? Set your asset allocation so you have the level of emotional comfort and stability necessary to stay invested through thick and thin.

Rebalancing is the second vaccine shot for your investment portfolio. Rebalancing is the conscious, deliberate and regular effort to realign your asset allocation back to your ideal state. It requires periodically harvesting some gains and adding the proceeds to asset classes that have not fared so well. Usually, rebalancing should occur annually or after times of extreme market action, like we’re experiencing today. It allows you to do something without harming your overall investment portfolio. Rebalancing provides the intellectual and emotional discipline we need to keep us moving in the right direction.

Assess your investment portfolio today. What changes should you make? A two-injection vaccine is available for your investment portfolio. Use it now.

After 30 years in corporate sales, Ray Giese, CFP, CCSP, MS, launched an encore career with his coaching practice, Career & Financial Pathways LLC . His goal is to help people align their purpose, passions and paycheck so they achieve financial freedom, while realizing greater personal and career satisfaction.

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Keeping Busy

LATE LAST YEAR, I described how Bill Gates used to take time out from his job running Microsoft to seclude himself for “think weeks.” For better or worse, many of us today are finding ourselves stuck inside, with more time on our hands than usual. If you’re growing weary of the endless news cycle, below are some ideas to help you make the most of this time.

Looking to build your personal finance knowledge? I can’t think of a more pertinent topic than risk management. Three books stand out:

Nassim Nicholas Taleb’s The Black Swan makes this simple but important point: Just because something has never happened before, or just because it hasn’t happened recently, doesn’t mean that it can’t happen.
Another classic on the topic of risk is Howard Marks’s  The Most Important Thing . Where The Black Swan goes deep on one aspect of risk, The Most Important Thing goes wide, providing the most thoughtful and readable work on this topic. If you would like to hear Marks’s thinking on the current crisis, I also recommend his latest memo.
A third book on the topic of risk is  When Genius Failed . This tells the story of a group of geniuses—at least on paper—who drove a hedge fund into the ground and nearly took the financial system down with them. Their crime: putting too much faith in statistical models of what “should” happen.

While this book is nearly 20 years old, the topic is timely. Recently, we have seen the U.S. stock market exhibit daily moves in excess of seven standard deviations. According to statistics textbooks, such moves should occur about once every billion years—and yet we’ve seen them happen four times in the past 10 days.

If you’d like to take some time to review and organize your financial life, here are some ideas:

If you have student loans or a mortgage, now may be an opportune time to refinance. Check out Bankrate to see what’s available.
If you have an IRA, this may be a good time to consider a Roth conversion.
Review your estate plan, especially the beneficiaries on your retirement accounts. If you have minor children, review the guardians named in your will. And be sure you have a health care proxy. If you don’t have an estate plan, take this opportunity to get started. Your attorney is at home with his or her laptop and will be happy to hear from you.
Review your disability and life insurance coverage. Do you have enough—or do you perhaps have too much?
For a pile of additional great ideas, I recommend Jonathan Clements’s  From Here to Financial Happiness and Ramit Sethi’s  I Will Teach You to be Rich .

If you’re feeling conflicted—wanting to be opportunistic while the stock market is “on sale” but also worried that it could go lower—I recommend a short article titled Reinvesting When Terrified by veteran investor Jeremy Grantham. This was written on March 10, 2009, just as the market was hitting bottom, though Grantham didn’t know it at the time. There’s a lot of wisdom in there that’s equally applicable to today, including this important truism: “Be aware that the stock market does not turn when it sees light at the end of the tunnel. It turns when all looks black, but just a shade less black than the day before.”

Looking to teach your children about finances? I recommend reading The Richest Man in Babylon with them. Its folksy tone belies its valuable message. It’s appropriate for kids of virtually any age.

If you’re looking to truly embrace Bill Gates’s concept of the “think week,” the following sites offer collections of thoughtful essays and papers—some finance-related, some not: Farnam Street, James Clear, Marginal Revolution and The Range Report.

If you’re tired of thinking about money and finances, a great online resource is Masterclass. For $180 per year, you’ll gain access to 80 different online courses. Learn about comedy from Steve Martin, writing from Malcolm Gladwell or tennis from Serena Williams.

Going stir crazy and looking for ways to get outside, if only virtually? You can visit the following great institutions from your laptop:

The San Diego Zoo’s live webcams
The Frick museum’s virtual tour
The Metropolitan Opera’s nightly shows

Also, Billboard magazine is compiling a running list of performances available online.

Adam M. Grossman’s previous articles include Harder Than It Looks, Manic Meets Math and  What Should I Do . Adam is the founder of  Mayport Wealth Management , a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter  @AdamMGrossman .

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27 Things to Do Now

TIMES LIKE THESE test the mettle of investors. Want to pass the test? Here are 27 things to do now:

Keep buying stocks. Remember your regret at failing to load up on bargain-priced shares in early 2009? Don’t make that mistake again.
If you’re panicked and tempted to dump stocks, talk to a friend or, alternatively, hire a financial advisor—one required to act as a fiduciary—to coach you through this decline.
Ponder what makes you happy. There are all kinds of things we suddenly can’t do—travel, eat out, go to concerts, attend sporting events. Which ones do you miss the most? Once life returns to normal, use those insights to guide your future spending.
If you’re still in the workforce, make sure you’re prepared for a period of unemployment. Having a large cash cushion is great. But having easy access to cash—through, say, a home equity line of credit or by pulling contributions from a Roth IRA—can be almost as good.
Rebalance from bonds to stocks. Even if you don’t have new savings to invest, rebalancing allows you to take advantage of the stock market’s plunge.
Avoid behavioral mistakes. Research has found we get perhaps twice as much pain from losses as pleasure from gains. Yes, this market decline has been unnerving. But for goodness sake, don’t sell and lock in your losses.
If you feel the need to speculate on individual stocks or market sectors, keep your bets small. Playing with a few percent of your portfolio is probably okay—as long as you’re comfortable with the possibility that the entire sum will be lost.
Control what you can. The financial markets may be chaotic, but your financial life doesn’t have to be. There’s so much that you can control, including how much you spend and save, what you pay in investment costs, your portfolio’s tax bill, how broadly you diversify, what mix of stocks and more conservative investments you hold, and—maybe most important at this juncture—your own emotional response to the market’s turmoil.
Don’t just continue your regular monthly investments into the stock market. Instead, see if you can find extra money to invest. You’re likely stuck at home, spending far less than usual. Put those savings to good use. Stocks are on sale, so stock up.
Don’t extrapolate recent returns. Just because the market has fallen doesn’t mean it’ll keep falling—or that it’ll come roaring back. Trying to guess the stock market’s short-term direction is a fool’s errand and a waste of mental energy.
Consider a target-date retirement fund. It’ll give you a broadly diversified portfolio in a single mutual fund. That means there’s only one share price to look at—and that price will move sedately compared to less diversified investments. A target-date fund will also do all necessary rebalancing for you. What fund should you buy? Check out the target-date index funds offered by Charles Schwab, Fidelity Investments and Vanguard Group.
Think about what’s happening in the economy. Yes, businesses around the world have come to a standstill and 2020’s corporate earnings will be horrendous. But the economic damage shouldn’t be permanent.
Try to ignore the daily market turmoil and the blathering of Wall Street’s talking heads. If you pay too much attention, there’s a risk you’ll convince yourself that you know something that’s unknowable—and make an investment bet you’ll come to regret.
Reassess your risk tolerance. Do you feel panicked about your stock market losses? This isn’t the time to be selling. But you should create a written record of what sort of portfolio you want to own—and then tell a friend or family member, who will prod you to follow through once markets have recovered.
Take tax losses. If you have underwater investments in your taxable account, sell them, realize the loss for tax purposes and then reinvest the money in other investments, so you maintain your stock exposure.
Refinance your mortgage. Thanks to the sharp drop in interest rates, many folks will find it’s worth refinancing. To calculate the savings, first find out how many years are left on your current mortgage. Next, compare your current monthly payment to the payment on a new mortgage of the same length, but at today’s lower rate. You can learn more here.
Keep your losses in perspective. While your stock portfolio may have been hammered, you likely have plenty of other assets that have lost little or none of their value, including your Social Security benefits, any pension you’re entitled to, your home, your holdings of bonds and cash investments, and your long-run income-earning ability.
Remember that lower stock prices should mean higher future returns. We don’t know when we’ll get that better performance. But for long-term investors, expected returns are now higher.
Convert part of your traditional IRA to a Roth. Yes, that’ll generate a tax bill. But thanks to the market decline, the tax hit will be far smaller.
If you aren’t yet invested in the stock market, you could hardly pick a better time to begin. Don’t have much money to spare? There are ways to get started with just a few dollars.
Clean up your portfolio. Do you have individual stocks and funds that you regret buying, but you’ve been reluctant to sell because of the tax consequences? You might find that the market plunge has turned your gains to losses, giving you the chance to rid yourself of unwanted investments.
Draw up a plan for what you’ll do if the stock market drop gets even worse. At what market level would you next rebalance? Would you increase your stock exposure above your target portfolio percentage? Whatever your plan, write it down and tape it to the refrigerator.
Change your mindset. Focus less on your losses and more on the opportunity. Become the seasoned investor you’ve always wanted to be.
Unless it’s your play money, avoid individual stocks and sector funds. We can be confident the broad stock market will bounce back. But there’s no guarantee narrower investments will return to favor.
Ponder what fun things you might do when the crisis is over. In your daydreams, you can visit all kinds of places—at no expense. Make tentative plans with friends and family. We all need good things to look forward to and, indeed, the anticipation is often the best part.
Be optimistic. On Thursday and yesterday, China announced that it had no new local coronavirus infections. If accurate, that means other countries should reach that point within two or three months, assuming we all take the necessary precautions.
Think about the person you’ll be in 10 years—and what your future self would make of your investment decisions today. Would he or she want you to take advantage of the bear market? I think you know the answer.

Latest Articles

HERE ARE THE EIGHT other articles published by HumbleDollar this week:

Rebalancing is one of the toughest things to do in all of personal finance, notes Adam Grossman. For many investors, the time to act has arrived.
What’s driving stocks lower? It’s all about the disruption to supply and demand in the real economy, says Peter Mallouk—and for that we need a health care fix, not financial incentives.
“Mr. Market is like a fish on a dock: When you try to get a hold of him—sploosh!—he’s up and away,” writes Bill Ehart in describing his recent investment moves.
Looking to ease into the stock market? Check out the approach used by John Lim.
“We can’t truly prepare for a financial crisis with a few trips to the grocery store,” argues Dennis Friedman. “Instead, that takes years of saving and investing.”
What should you do with your tax refund? Fill up that 401(k), stash dollars in a health savings account and pay off high interest debt, suggests Mike Zaccardi.
Amid the stock market plunge, Sanjib Saha has overhauled his portfolio, ditching unwanted investments, taking tax losses, rebalancing and buying a closed-end fund.
“Don’t underestimate the value of a cash cushion,” writes Dennis Ho. “It’s critical to prudent financial planning and, at times like this, an even larger buffer might be called for.”

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Fear Not, Bad News, Don’t Lose It and Four Questions.

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Like Old Times

AS OF YESTERDAY’S market close, the S&P 500 was down 25% from year-end 2019 and off 29% from Feb. 19’s all-time high. Worse yet, interest rates are near zero, with the 10-year Treasury note yielding a paltry 1.15%. In a few short weeks, the markets have turned from euphoric to disastrous—and there seems to be no end in sight.

At age 43, I consider myself fairly young. But as I watch the markets, what’s been most surprising to me is how many times I’ve seen this situation before.

I graduated in 1999 and was fortunate to land a job with a large insurer in Philadelphia. One of the first things I did was to begin contributing to an IRA. The S&P 500 returned 20% in 1999, so my savings grew nicely. I began to think this investing thing was easy and I was on my way to a comfy retirement.

Then the combination of the dot-com bubble bursting and 9/11 led to three straight years of negative returns: 2000, 2001 and 2002. My gains in 1999 were wiped out and then some. Fortunately, by 2003, the markets turned positive, with the S&P 500 gaining almost 30%, including dividends. Because I had a stable job and enough income to cover my expenses, I was able to continue contributing to my IRA during this period and benefitted from the depressed stock prices.

Over the next several years, the markets stabilized and had positive returns for four straight years from 2003 through 2006. Everything seemed fine again. By 2007, I had started a new job on Wall Street and was getting married in a few months. But almost immediately after joining my new firm, you could feel the economy was on shaky ground.

In 2007, stocks eked out a small positive return. But things got far worse in 2008, with concerns about subprime mortgages mushrooming into a full-blown crisis of confidence. I’m a long-term investor, but this was a tough time. With Lehman Brothers going bankrupt and dozens of companies getting government bailouts, it wasn’t clear who was going to survive or whether our financial system would continue to function. In 2008, the S&P 500 nosedived 37%.

Think about that: 37% of your savings gone in one year. My wife and I didn’t liquidate any of our holdings, but we did slow down our investing. Buying on the dip seemed like a gamble at best and suicide at worst. We continued to make contributions to our retirement accounts, but diverted our other regular savings into cash. Fortunately, at the time, we didn’t have a mortgage or kids, so we could easily adjust our spending. We lived in a modest one-bedroom apartment in Fort Lee, New Jersey. As long as we could pay our rent and cover our food bills, we would be okay.

In 2009, the markets snapped back, with a 26% total return for the S&P 500. That year would kick off a tremendous 11-year run, with the S&P 500 generating positive returns in every year except 2018. The compound average annual return for the S&P 500 from year-end 2007 to year-end 2019 was 9%. This means that, even with the 37% drop in 2008, a $100,000 investment at the end of 2007 would have grown to more than $284,000 by December 2019. If those numbers aren’t a testament to buy-and-hold investing, I don’t know what is.

That brings us to today. My personal situation is very different now. My wife and I have three young kids and a mortgage to pay. I also left the corporate world two years ago and started my own business. With near-term liquidity critical, we decided to move a good chunk of our savings into a money-market fund until the business becomes self-sustaining. This way, we have the comfort of knowing we’ve got a good amount of runway to fund our personal and business expenses without having to liquidate long-term investments.

You might think that, with the recent market selloff, I’d feel pretty good about our decision, but I don’t. Yes, a good bit of our savings has been spared from the recent market drop. But that same money also missed out on 2019’s 30%-plus stock market return.

Where does that leave us? In reflecting on the markets over my career, three important lessons jump out.

First, don’t be afraid to change your investment strategy as your life changes. Many market experts advocate holding stocks forever or buying on the dip. But there’s no one-size-fits-all strategy. How stable is your income or the company you work for? What does your cash buffer look like? Do you have disability insurance? How easy would it be to reduce your fixed expenses? Do others depend on you financially?

My financial profile changed dramatically from 1999 to today. While I was happy to buy on the dip in 2001, it would not be prudent for me to do so today. I used to have more than 90% of my savings invested in stocks. Today, I have much less. It was a difficult transition. But I’m okay with that change, because it’s the right strategy for me.

Second, don’t underestimate the value of a cash cushion. It’s critical to prudent financial planning and, at times like this, an even larger buffer might be called for. Be sure to revisit your potential cash needs over the next six to 12 months. Have a plan for where to get liquidity in an emergency. If you don’t have enough liquidity, consider building up your cash reserves in the next few months, by diverting your savings to cash investments or reallocating your portfolio.

Finally, don’t neglect retirement. Given current market conditions, it’s natural to focus on the short term. But as history has shown, markets eventually turn around. Even if it means cutting expenses elsewhere, be sure to continue taking advantage of the tax breaks that come with contributing to 401(k)s and IRAs, as well as any employer match offered by your company plan. Skipping just a few years of contributions early in your career could reduce your retirement savings by tens of thousands of dollars. During the depths of the financial crisis, my wife and I stopped eating out so we could continue contributing to our retirement accounts. Today, we’re thankful we did.

Dennis Ho is a life actuary and chief executive of Saturday Insurance, a digital insurance advisor that helps people shop for life, disability and long-term-care insurance, as well as income annuities. Prior to co-founding Saturday, Dennis spent 20 years in the insurance industry in a variety of actuarial, finance and business roles. His previous articles include Value for Your Cash, Waiting Game and End Game. Dennis can be reached via LinkedIn or at dennis@saturdayinsurance.com.

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Where’s My Refund?

WE LOVE to procrastinate. Have you done your taxes yet? IRS data show that nearly a quarter of Americans wait until the last two weeks of tax season to file. It often feels like that nagging task that grows more arduous each year, though the result for many is a juicy refund.

The average federal tax refund is more than $2,800, so it can pay to get your taxes done sooner rather than later. To be sure, instead of making an interest-free loan to Uncle Sam, it would be more rational to reduce the amount of federal income tax withheld during the year by giving our employers a revised Form W-4. We could then take the extra money in our paycheck and stash it in, say, a high-yield savings account, where we could earn interest, albeit at a paltry 1½% or so—and that rate is likely to shrink in the months ahead.

But most of us don’t operate that way. We like the forced savings that comes with having too much tax withheld. We like getting that large refund each spring. Chalk it up to mental accounting.

How are we using our tax refunds? Among those surveyed by GOBankingRates, 27% say they’ll use their refund to pay down debt. That makes sense. The Federal Reserve Bank of New York reports that Americans with a credit report are, on average, in debt to the tune of almost $52,000.

While my official title at work is market research analyst, I also conduct retirement and savings workshops for my colleagues, where I talk about a priority pyramid. First, contribute to the 401(k) up to the company match. After that, contribute to our company’s health savings account (HSA) up to the match. Next, pay off high interest rate debt.

Getting that free money from the employer match is great. But I know paying off debt can also feel like a huge win. Some other solid uses for your tax refund:

Contribute to a Roth IRA. You can do that not only for 2020, but also for 2019, by taking advantage of the prior-year contribution rule.
Put money in an HSA beyond what’s needed to get the employer match. As with an IRA, you can make your 2019 contribution up until April 15, 2020.
Shore up your emergency fund—a smart move given the risk of layoffs right now.

Finally, here are three tips if you haven’t yet filed:

Shop around for the best tax preparation site for your circumstances—which won’t necessarily be the cheapest.
If you have a complicated situation, see a professional. Don’t skimp. The last thing you want is a nasty-gram from the IRS.
To prevent identity theft, file electronically and use direct deposit. The IRS issues most refunds within 21 days of electronic filing.

Mike Zaccardi is a portfolio manager at an energy trading firm and a finance instructor at the University of North Florida. He also works as a consultant to financial advisors on an hourly basis, helping with portfolio analysis and financial planning. Mike is a Chartered Financial Analyst and Chartered Market Technician, and has passed the coursework for the Certified Financial Planner program. His previous articles include Scratching That Itch, Good as Gold and Keep On Keepin’ On. Follow Mike on Twitter @MikeZaccardi, connect with him via LinkedIn and email him at MikeCZaccardi@gmail.com.

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Spring Cleaning

AS THE STOCK market repeatedly hit new highs in recent years, my net worth reached levels I hadn’t expected. But instead of feeling good about it, I was getting annoyed. Most of my retirement dollars had been invested over the past decade at high stock market valuations. I could use a good bear market so that, in my few remaining years in the workforce, I bought stocks cheap.

I also worried that a prolonged downturn at the worst possible time might derail my early retirement plans. Indeed, the bull seemed unstoppable even a month ago. But the coronavirus has ended my wait.

The bull market’s demise hasn’t just been a psychological relief. It’s also allowed me to get my financial house in better order. I’ve been busy executing trades I’d planned for whenever a market plunge might occur.

What trades have I made? My investments needed a spring cleaning, so that’s where I started. Although I mostly invest in low-cost, broadly diversified index funds, a small portion of my taxable account was in a few narrower funds focused on technology, small-cap and value stocks. My original intent was to overweight some promising stock market asset classes, but I’ve come to realize they didn’t add much to my portfolio. Problem is, these holdings had climbed in value and I was reluctant to sell, because of the taxes it would trigger.

The market plunge changed that, allowing me to sell without generating big tax bills. I also took tax losses in a few other funds focused on dividend-oriented stocks and international markets, where I wanted to keep my exposure. I used the proceeds to purchase similar—but not substantially identical—funds. This allowed me to maintain my market exposure, while sidestepping the wash-sale rule.

With these trades out of the way, I turned my focus to my next task. Some background: I had set aside a small portion of my bond investments to switch to real estate investment trusts (REITs) at a future time, when the risk premium was more compelling. This move would increase my portfolio income in today’s low-yield world. I already had REIT investments through low-cost exchange-traded index funds. For a change, I was open to adding a time-tested, actively managed fund to the mix.

My preference was a closed-end fund (CEF). Why? Compared to regular mutual funds, CEFs have unique characteristics, making them attractive to income seekers. CEF managers don’t have to worry about paying off redeeming shareholders, so they have the freedom to make illiquid, longer-term investments. By contrast, a regular mutual fund may have to liquidate investments at an unfavorable time to meet investor redemptions.

This doesn’t mean CEF investors are stuck with their investments. CEF shares can be bought and sold on the stock market. This secondary market trading often causes the share price of a CEF to deviate from its net asset value, or NAV, which is the value of the fund’s holdings figured on a per-share basis. If investors buy a CEF at a discount to its NAV, that means their yield is higher than the yield on the CEF’s holdings.

CEFs often use a limited amount of leverage to boost their return. This leverage increases a fund’s expenses, because of the interest cost involved. It also makes the fund riskier. But I’m comfortable with the leverage, because it’s frequently used with real estate investments.

I researched funds such as Nuveen Real Estate Income (JRS), Cohen & Steers Quality Income Realty (RQI) and Cohen & Steers Total Return Realty (RFI). The fund I eventually settled on had survived the 2008 bear market and, over nearly two decades of existence, had often traded at a discount.

But when should I pull the trigger? The recent market plunge created the opportunity I was looking for. First, REITs were selling at a low price, pulling down the fund’s NAV. Second, my chosen CEF’s typical discount already meant it was a bargain—but the panic selling increased the discount even further. That was the icing on the cake.

Once that trade was completed, it was time to step back and review my overall asset allocation. Sharp market increases and deep plunges are both opportunities for one-off portfolio rebalancing. But I also realized that, although the market has dropped quickly, the magnitude of the decline isn’t that big a deal: At this point, we’ve simply given up the gains made in 2019. I moved some of my bond-market money to stocks, to bring my portfolio back into line with my target percentages, but I haven’t opted to overweight stocks—yet.

A software engineer by profession, Sanjib Saha is transitioning to early retirement. His previous articles include Working the Plans, Got Gold and Risky Option. Self-taught in investments, Sanjib passed the Series 65 licensing exam as a non-industry candidate. He’s passionate about raising financial literacy and enjoys helping others with their finances.

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Be Prepared

WHEN I WENT to the grocery store last week, it was packed with customers stocking up on essentials. Carts were filled with items that people couldn’t possibly consume in any reasonable period of time. It’s a scene that’s been repeated across the country.

A friend told me: “When people panic, they want things right away. When people see other people panic, they panic, too.” Like the coronavirus, fear is highly contagious.

I’m not panicking, and yet there are reasons I should feel unease:

Like many other Americans, I have money in the stock market. I don’t have a monthly pension, so I’m dependent primarily on my investment portfolio to fund my retirement.
I’m trying to sell my condo. My real estate agent told me we should lower the asking price by $20,000. The feedback I’m getting from my agent is that the coronavirus and the stock market decline are instilling fear in prospective buyers.
I’m about to remodel my new home. Every room in the house will be affected. This will probably be one of the biggest expenses during my retirement, and yet the project is starting just as global uncertainty is skyrocketing.

Why aren’t I more fearful? To be sure, there isn’t yet a vaccine to stop the coronavirus from spreading. But there are things we can control in our financial lives that can ease our sense of fear. Indeed, there are three reasons I’m not rattled by what’s happening around me.

First, I’ve saved for a lifetime. Without knowing that today’s pandemic would happen, I’ve been planning for this crisis since I graduated college. As a young adult, I got a feel for what it’s like to live paycheck to paycheck—and I didn’t like it. I made up mind that I wasn’t going to save for my dream car, a Fiat 124 Convertible Spider, but for my financial future. I’ve always prioritized saving over spending and I know how to live on less if I have to.

Second, after a lifetime of managing money, I have the confidence I can weather any financial storm that comes my way. I’m confident that I can patiently wait for the stock market to recover and for a buyer for my condo to appear, while at the same time remodeling my new house.

Third, I delayed Social Security. In a few years, when I turn age 70, I’ll have that larger payout, which will give me significantly more income. Between Rachel’s Social Security benefit and mine, we should have more than enough income to meet our fixed expenses.

One thing we should learn from this crisis: We can stock up on life’s essentials in a relatively short period of time. But we can’t truly prepare for a financial crisis with a few trips to the grocery store. Instead, that takes years of saving and investing.

Dennis Friedman retired from Boeing Satellite Systems after a 30-year career in manufacturing. Born in Ohio, Dennis is a California transplant with a bachelor’s degree in history and an MBA. A self-described “humble investor,” he likes reading historical novels and about personal finance. His previous articles include Bearing Up, Time to Shrug and Small Is Beautiful. Follow Dennis on Twitter @DMFrie.

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Six Lessons

“WHAT CHANGES have you made to your portfolio during this market decline?” That was the article request I received from HumbleDollar’s editor. Initially, I had reservations about taking on the assignment, afraid that my story would be misinterpreted as giving financial advice. What follows isn’t financial advice, but rather a highly personal account of one investor’s approach.

I’ve been quite cautious for the past few years. Written into my investment policy statement is Benjamin Graham’s advice to have between 25% and 75% of one’s portfolio in stocks. I’ve had close to 25% in stocks for the past few years. Confession: I allowed my stock allocation to drop to 19% in mid-February, an all-time low for my investing career.

Lesson No. 1: Following an investment policy statement is sometimes easier said than done.

Last year, I learned just how powerful a force FOMO—fear of missing out—really is. Having a very conservative asset allocation during 2019, when we saw 30%-plus stock market returns, was less than satisfying, to say the least. While I believed that my conservative positioning was prudent, given the numerous risks that I saw, that hardly made it easier to stay the course when the stock market was hitting new highs almost weekly. Doubts began to creep into my head.

Lesson No. 2: FOMO makes it hard to stay the course in protracted bull markets.

With that backdrop, what am I doing now in the midst of the first bear market in more than a decade? I have a plan in place to buy back into the stock market. That plan involves putting cash to work at designated thresholds below the S&P 500’s Feb. 19 all-time high of 3386. Those thresholds are set at down 20%, 25%, 30% and so forth, until the “doomsday” scenario of down 70%, which would put the S&P 500 at 1016.

Over the years, I’ve learned that buying into the stock market is never easy. For me, it helps to have an automatic system in place, so my emotions don’t get the better of me. And, yes, two triggers have already been reached, down 20% and 25%, and we’re almost at down 30%.

Lesson No. 3: Consider putting a system in place to rebalance or buy into stocks, particularly for times of heightened market volatility.

Why include an extreme scenario of down 70%? The short answer: Because I’m a chicken. I fully realize that such a system almost guarantees that I won’t be fully invested—which, for my portfolio, means 75% in stocks—by the time this bear market ends. For me, it’s about balancing two regrets: putting cash to work too quickly vs. putting it to work too slowly. Behavioral finance teaches us that we feel the pain of losses twice as much as the pleasure of gains. I’m trying to limit my pain—by limiting how much I have to invest in stocks.

Lesson No. 4: Asset allocation is all about balancing two potential regrets—being too aggressive in bear markets and being too conservative in bull markets.

What am I buying? Despite the bear market, U.S. stocks still aren’t cheap. Prospective 10-year returns remain close to zero in inflation-adjusted terms. By contrast, international stocks—and especially emerging markets—are far more attractive. That’s where I have been putting money to work.

Value stocks have been underperforming growth stocks for about a decade. Should the selloff continue, I plan to add to my holdings of U.S. value funds. Finally, the one sector bet that I am making—a small one—is in the oil patch. Dividends are attractive and crude oil prices are at decade lows. As usual, diversification is paramount, so I’m investing in oil producers using a low-cost, broadly diversified exchange-traded index fund.

Lesson No. 5: While it’s impossible to predict short-term market moves, it’s possible to estimate long-term expected returns in asset classes with a fair degree of certainty—which is far more valuable information for the long-term investor.

My last article was all about risk. I am fully aware that raising my stock allocation during a bear market is not without danger. But it’s consistent with my countercyclical rebalancing approach. I would rather embrace risk when it’s richly rewarded—that is, when prospective returns are high. As stock markets fall, prospective returns increase. It’s as simple as that.

Still, I also like to model how much damage could be done to my portfolio in a worst-case scenario. A 70% decline in the S&P 500 from its all-time high fits the bill. Using a fairly simple spreadsheet, I estimated my total returns should the market fall 70%, assuming I buy into stocks in increments, as described above. The doomsday scenario would be an overall decline in my portfolio of about 33%. That would certainly be unpleasant, but it’s something that I believe I could live with based on my age and risk tolerance.

Lesson No. 6: Always consider the worst-case scenario when investing. In other words, hope for the best, but plan for the worst.

I’ve talked before about the benefits of bear markets. I have no idea where the financial markets go from here. For all I know, we could have already seen the bottom. It’s also possible that we go far lower. The volatility we’ve witnessed in the past few weeks has been breathtaking and frightening—but with volatility comes opportunity.

John Lim is a physician and author of How to Raise Your Child’s Financial IQ, which is available as both a free PDF and a Kindle edition . His previous articles include Risk Returns,  Crash Course ,  12 Financial Sins  and  12 Investment Sins . Follow John on Twitter @JohnTLim .

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An Ill Wind

WHAT IN THE WORLD is happening in the stock market? The short answer: Investors are spooked by a supply and demand conundrum. Markets react very negatively to a significant disruption of either.

After the Sept. 11, 2001, terrorist attacks, stock markets plummeted because of a disruption in demand. In the weeks and months that followed 9/11, factories, businesses and services remained open and operating all over the world. The issue wasn’t a lack of supply.

Rather, the problem was that everyone stayed cooped up in their homes, reluctant to go about doing things that make an economy hum, like buying stuff. Americans wondered if there would be other terrorist events, if the government could put measures in place to prevent them from happening and how long it would take to feel generally safe. Over time, people returned to normal life, demand resumed and stock markets recovered, moving on to new highs.

The 2008 and 2009 financial crisis was the opposite. We all know the story: The big banks were reckless with their own money and their investors’ money. Before it was over, the financial system became paralyzed because of a lack of supply. The lending world had frozen. No one could get or maintain a loan to do nearly anything. Without a supply of funds, businesses began to fail, contracting the supply of all sorts of things. At the same time, Americans felt less wealthy and were consumed by a healthy dose of fear. That combination resulted in Americans not wanting to buy anything until they felt secure.

When the market bottomed on March 9, 2009, the S&P 500 was down 57% from its high. In this case, the crisis was eventually resolved by the federal government backing up banks (taking care of the supply side) and giving consumers tax breaks, lowering the cost of borrowing and providing many other financial incentives to consumers. That, along with other measures, finally stabilized the system and incentivized individuals to spend money (taking care of the demand side). Sure enough, stock markets recovered, moving on to new highs.

The cause of today’s bear market is a combination of both a supply and demand shock. Much like 9/11, this is driven by fear about our personal safety and that of our fellow citizens. Normal financial incentives aren’t going to resolve this issue. Imagine if, after 9/11, a major terrorist event happened every single week, with no end in sight? Would you start going to the movies, out to dinner, to work and on vacation? No amount of tax breaks or financial incentives would likely get the average American to do that.

The situation is similar today. Some very smart health care officials think things will get worse, but likely get better in a month or two. Some very smart health care officials think the rate of contagion will double every few days, that it can’t be stopped with the measures we’re currently taking and that the mortality rate may be 1% or even higher. If the latter scenario unfolds, this is the equivalent of a new terrorist event every week, without an end in sight. In a nutshell, this is a health care crisis with serious financial side effects. To alleviate the stock market turmoil, investors need to believe the coronavirus is contained and that there’s a path to defeating it. This can happen in several ways:

A vaccine is announced.
A cure is announced.
A treatment that can stem the effects is announced.
We find out millions of people have it. Strangely, this would be incredibly reassuring, because it would mean that far more people were infected than first realized. This, in turn, would mean many who are infected don’t get sick, which obviously means a far smaller percentage of those who are infected are dying. If we find the mortality rate is 0.2, for example, the markets could react very positively.
The virus runs its course quicker than expected.
The virus is seasonal.
All sorts of things not listed above that slow the spread of the coronavirus or indicate that it isn’t as deadly as feared.

Once stock markets see there’s a path to defeat the current trajectory of cases, they’ll also be buoyed by financial incentives, such as tax breaks, lower interest rates and so on. This is precisely why the U.S. market tanked after President Trump’s first address to the nation on the coronavirus. His address included largely financial solutions. Investors simply didn’t think financial incentives were going to work when the number of people infected and dying keeps doubling every few days.

It’s also precisely why the market reacted favorably when President Trump had his Friday press conference covering his action plan to contain and beat back the coronavirus. Investors believed the administration was focused on real actions to tackle the health care crisis, including a plan to test as many people as quickly as possible with a public and private partnership.

In other words, if investors see there’s a path to health, they’ll gladly welcome financial incentives that provide a path to restoring wealth.

In the meantime, expect wild market swings as we get new information, whether it points to a deepening health crisis or signals that we’ve turned a corner for the better. Some folks think this will soon pass, while others think millions will die. The market is taking every new piece of information and betting on who is right. Until we get conviction on one side of the argument, we will see more market turmoil.

This is going to be a tough paragraph to read, but it needs to be said. Let’s play out the worst-case scenario currently presented by some health care officials. Let’s assume the death toll is in line with some of the most frightening predictions. This would be horrible and every one of us would know someone who lost their life to this crisis. And as for the markets? Well, the other 326 million Americans, as well as people all over the world, will eventually do what every society has always done: go on with their lives. That is just the cold, hard reality. It’s how the human spirit works. And it’s ultimately what makes markets work. At some point, supply and demand reconvene.

What’s my position? I have no conviction that this will get better soon. I have no conviction that things will get substantially worse, either. But I am convinced that this will someday, somehow pass. And when it does, the markets will recover. There’s an opportunity here for the patient and the disciplined. Make sure you seize it.

Peter Mallouk is president and chief investment officer of Creative Planning in Overland Park, Kansas. Peter and HumbleDollar’s editor, Jonathan Clements, together host a monthly podcast. Jonathan also sits on Creative’s advisory board and investment committee.

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Luck of the Irish?

LAST FRIDAY at 7:16 a.m., I sent an email to HumbleDollar’s editor. We were discussing what this blog post should be about. This was before I got the news alert that S&P 500 futures were up bigtime, following the historic selloff the day before.

I concluded my email to Jonathan this way: “The market never gives you the big fat target you want. I’ve got great plans if the market behaves today like it did yesterday, or even if it’s flat. But since I’m drawing a bead on that, the market is likely to snap back hard and make me regret not moving yesterday!!”

Boy, was I right. Two exclamation points right. But later on Friday, I was totally wrong about how the market would react to President Trump’s press conference, which my company’s chief financial officer will never let me forget.

I’ve been around long enough to know I’ll never catch the bottom—if, in fact, Thursday was the bottom, which is a big “if.” Still, it stings to have put in a buy order Friday when the market was roughly flat but have it executed at a price 10% higher, since mutual fund trades don’t settle until the close.

Such is life.

Mr. Market is like a fish on a dock: When you try to get a hold of him—sploosh!—he’s up and away. What worries me now is that, after shooting higher with a quick flick of his tail, he’ll plunge back into the briny deep.

But that’s emotion talking. That’s ego. I should feel grateful that my experience has brought me to a point where I was not overexposed to stocks at the high—they were about 72% of my portfolio—and I had a predetermined trigger point to rebalance back to that level or higher. That trigger—down 20%—is right where my Friday buy order executed.

If the market is down again today, I won’t cry for potentially having bought a dead-cat bounce at Friday’s close (at least not much). Instead, I’ll consider step No. 2 of my plan: swapping some money within my 401(k) to a more aggressive target-date retirement fund. If things continue to deteriorate in the weeks ahead, I have other steps planned. If the market continues recovering, I can stand pat.

One of the things I’ve learned from Jonathan is that, when choosing a target stock allocation, we should take into account our future retirement savings. Here’s how that works: Let’s say you want 60% of your retirement money allocated to stocks. You have a $100,000 portfolio, including $60,000 in stocks. You still have 10 years until retirement.

In that time, you expect to contribute another $50,000 to your IRA or 401(k). If you define your nest egg as your current portfolio plus future savings, it’s actually worth $150,000. Calculated that way, your $60,000 in stocks really is just 40% of your retirement money. Result: You could put $90,000 into stocks today and still have an effective 60% stock weighting in your retirement portfolio.

Upon reading that last year, I made a plan to boost stocks to 76% of my current portfolio. Even though I’m age 58, that’s still pretty conservative, given the money I’ve yet to save. The shift was to be gradual. I wasn’t going to jump in with Mr. Market flying high.

But the opportunity has now presented itself. Which brings me back to Friday. What did I do? The market drop had taken my 72% stock weighting down to 70%. I sold my inflation-indexed bond fund in my IRA, which had been about 4% of my overall portfolio, and placed an order to add to my Fidelity Freedom Index 2035 Fund at Friday’s close. The move, along with the market’s bounce, brought my stock exposure to more than 73%.

Having survived the market pandemic, at least for now, I can worry about other things, like how to celebrate St. Patrick’s Day while social distancing. “Kiss me, I’m Irish”? These days, that seems more frightening than flirty.

William Ehart is a journalist in the Washington, D.C., area. Bill’s previous articles for HumbleDollar include No Sweat, Resolve to Rebalance and Durn Furriners. In his spare time, he enjoys writing for beginning and intermediate investors on why they should invest and how simple it can be, despite all the financial noise. Follow Bill on Twitter @BillEhart.

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