Jonathan Clements's Blog, page 334

Manic Meets Math

“HOW BAD WILL it get—and how long will it last?” In my last article, I mentioned that many people had asked me those two questions. This past week, amid the continuing stock market tumult, some folks have been raising a third question: “Should I even bother investing in the stock market? It just seems crazy.”

It’s a fair question. On Monday, the market was up 4%, before dropping 3% on Tuesday. On Wednesday, it was up 4% again, but then lost 3% on Thursday and another 2% on Friday.

Think the stock market is crazy? You aren’t alone. Warren Buffett calls it “manic-depressive.” Howard Marks, one of the clearest thinkers when it comes to investing, has observed that investor sentiment tends to oscillate between the extremes of “flawless” and “hopeless.”

With the market’s extreme behavior over the past few weeks, it’s hard to refute these characterizations. So should we simply write off the market as crazy and unpredictable? To answer this question, it’s worth taking a step back and looking at what drives share prices. As I see it, there are three major factors:

Corporate profits, including expectations for future company earnings.
External events, including political news, economic developments and, of course, health scares.
Investor sentiment.

From day to day, the share price of each individual company reflects some combination of all three factors. In recent weeks, however, there’s no question that Nos. 2 and 3 have been in the driver’s seat. The coronavirus is almost entirely responsible for the market’s drop. But over the long-term, it’s No. 1—corporate profits—that has the largest impact on stock prices.

If that’s the case—if corporate profits matter most over the long term—then how much should we really worry about the stock market’s decline? To put it another way, is the market’s recent drop warranted or is this just the temporary, irrational result of widespread panic?

To answer this question, let’s look more closely at No. 1 and the math behind stock prices. To illustrate how this is done, I’ll use a simple example: Procter & Gamble, the maker of Pampers, Ivory soap and other household products. Today, P&G is worth about $300 billion. The question we want to answer is: Would P&G still be worth that same $300 billion if the coronavirus brought the economy to a standstill?

The textbook method for valuing a stock is known as discounted cash flow. To do this calculation, you total up all of a company’s estimated future profits, on the notion that a company should be worth the sum of all profits it could produce over its lifetime. Discounted cash flow analysis then applies a “discount” to each future year’s profits based on the principle that a dollar next year is worth less than a dollar this year.

Last year, P&G’s profits were about $10 billion. If we make some basic assumptions about future earnings growth, we can calculate the total value of P&G to be about $300 billion. This, mathematically, explains the current stock price.

Now we can answer the earlier question: What would happen to stock prices if the health situation got worse—if everyone were quarantined and the economy ground to a halt for the rest of the year? The math here is fairly easy. If P&G’s future profits add up to $300 billion, and we remove one year of profits—assuming P&G earns nothing this year—then the company should be worth $10 billion less. While $10 billion is a big number, it represents just 3% of P&G’s total value. In other words, based on the numbers and assuming an extreme scenario, the company’s share price should drop by just 3%.

If the economy did slow materially as a result of the virus, some companies would be affected more than others, but the general idea is this: The stock market value of any company represents all future potential profits—and thus any short-term losses should subtract just a small sum from a company’s overall worth.

I fully acknowledge that, at times like this, most investors aren’t sitting down and doing discounted cash flow analysis. For now, sentiment has taken over. But this math does explain my “don’t panic” view of the situation. No question, this is all very unnerving—and things could get worse before they get better—but I wouldn’t get caught up in the panic. I wouldn’t sell out of stocks, and I wouldn’t fear that all this will cause lasting or irreparable damage to stock market investments. Yes, the market goes to extremes in the short term. But over the longer term, I believe rationality will prevail.

Adam M. Grossman’s previous articles include What Should I Do, Don’t Tinker and  Adding the Minuses . 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 .

Do you enjoy HumbleDollar? Please support our work with a donation.

The post Manic Meets Math appeared first on HumbleDollar.

Bad News

I’M MANAGING my money with an eye to making it last another three decades. And yet, everywhere I turn, it seems somebody’s insisting I pay attention to what’s happening in the financial markets right now.

This isn’t just a coronavirus phenomenon. It is, alas, standard operating procedure for the financial media.

I understand the game. I’ve spent most of my career as a journalist, so I realize it’s no small undertaking to fill up a newspaper, the airwaves or a website every day. Daily market stories are not only reliable fodder, but also they grab readers’ attention. Still, couldn’t the media do just a little bit better?

I may be casting stones, but I’m not without sin. Over the years, I’ve written stories that have been bad for readers’ financial health. Watching, reading or listening to a financial journalist? Try slotting his or her reporting into one of seven categories, ranging from dangerous to enlightening:

1. Daily updates. The media’s constant recounting of the day’s market action isn’t just useless, it’s damaging. The breathless reporting about which way markets are heading, and which stocks are hot, plays to investors’ worst instincts, turning our multi-decade investment time horizon into an emotional time horizon measured in minutes.

In all this, Wall Street’s talking heads are eager co-conspirators. In return for a little airtime, they’ll happily parse the day’s market entrails, telling us what the market “thinks.” Ask yourself: How could these clowns possibly know what millions of investors are thinking?

The vapid commentary also fails basic math: Yes, billions of dollars of securities might be sold because investors spy reasons for pessimism in the latest economic data—but the exact same dollar value was bought by those who have reached the opposite conclusion. Want to know who never gets mentioned? The vast majority of investors, who didn’t buy or sell, and likely won’t do much of anything in the months ahead.

2. Trend stories. Instead of dwelling on today’s market action, reporters might detail what’s happened over the past year or the past five years. This is a tad better: Five years isn’t exactly long-term, but it’s a whole lot better than harping on today’s market gyrations.

That said, in reporting what’s happened over the past year or past five years, there’s the implicit assumption that this tells us something about the future. But what does it tell us? Depending on the reporter’s bias and the talking heads quoted, we’re led to believe that either the trend is our friend or a reversal is imminent. How about the possibility that past price movements tell us nothing about the future—and that future returns will depend on economic and other news that’s not yet known? Nah, you’ll never read that.

3. Market analysis. Instead of simply recounting what’s happened recently to share prices or interest rates, a reporter might go a step further, pontificating about the market’s valuations or its economic underpinnings. At least the reporter isn’t imagining that he or she can divine the future simply by looking at a chart of recent price movements, so this sort of thing deserves a C for effort.

Why not a B-? Problem is, investors are already aware of market valuations and economic data, so this information is likely fully reflected in stock and bond prices. Such commentary may help us to have a richer understanding of the issues that investors are grappling with and the risks we face. But it won’t tell us how markets will perform in the months and years ahead.

4. Portfolio building. Reading a story about how to put together the right mix of investments? That’s a sign that a reporter is emerging from the primordial financial swamp and starting to walk upright. He or she is grappling with what might make sensible long-term investments and how they could fit into an investor’s overall portfolio. To be sure, the reporter might foolishly suggest that the investments touted will beat the market averages. Still, it’s a heck of a lot better than pontificating about the stock or bond market’s direction.

5. Personal finance. The financial markets change every trading day, so there’s always a news hook on which the media can hang an investment story. By contrast, our need for insurance and an estate plan, or the importance of saving regularly, limiting debt and controlling taxes, doesn’t change much from year to year—if it changes at all.

Yet these are topics where financial journalists can add real value. The problem: They don’t have the immediacy of a market plunge, so editors are reluctant to run such stories, unless it’s a slow news day.

6. Big picture. We often think of our financial life as a series of buckets: career, house, credit cards, portfolio, student loans, insurance, estate plan and so on. But to be savvy managers of our own money, we need to look across these buckets and see the connections between them.

Should we pay off debt rather than stash money in a savings account? Should we raise the deductibles on our homeowner’s insurance because our growing wealth means we could easily afford a $5,000 deductible? Should we put less in the kids’ 529 plans because our own retirement savings are on the skimpy side? To be fair, it’s difficult for the media to tackle such topics in an 800-word article or a three-minute television segment. Still, this is the sort of journalism that can be invaluable to everyday investors.

7. Money and life. How can we get ourselves to make the sacrifices required today so we have a better financial life tomorrow? How can we revamp our finances so they cause us less worry? How can we use our dollars to make our days happier and more fulfilling?

We all want our money to enhance our life, rather than leave us with a gnawing sense of anxiety—and the media can help. Where to begin? Step No. 1: Stop telling me about today’s market action.

Latest Articles

HERE ARE THE EIGHT other articles published by HumbleDollar over the past week:

“Why do experienced investors bail out of stocks at times like this?” asks Bill Ehart. “Blame it on the narratives they come to believe. The further the market drops, the scarier the stories get.”
John Lim examines the stock market’s reaction to the coronavirus—and spies eight timeless lessons about risk. Lesson No. 1: The greatest risks are those we never see coming.
“If you’re tempted to reduce your regular investments in the stock market, don’t,” advises Robin Powell. “If anything, invest more each month. It isn’t fear that’s rewarded, but courage.”
Want the upper hand when spending your dollars? Jim Wasserman details two tricks that you can use to your advantage, whether you’re buying an antique table or a new home.
“If you determine you’re taking too much risk, you shouldn’t feel like it’s too late to make a change,” writes Adam Grossman. “If you sell some stocks now, you aren’t violating any investment dictum against selling low.”
February’s financial focus may have been the market swoon. But last month, HumbleDollar’s readers were also thinking about other issues. Check out the site’s seven most popular articles.
“I live below my means,” notes Dennis Friedman. “I can sleep at night knowing that, whatever happens with the stock market , I’ll have a roof over my head and food on the table.”
How about a government bond paying 3.5%? Yes, this is clickbait—but it does exist.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Don’t Lose It, Stand Your Ground, Four Questions and Rule the Roost.

Do you enjoy HumbleDollar? Please support our work with a donation.

The post Bad News appeared first on HumbleDollar.

Time to Shrug

WHAT I FIND surprising about the stock market isn’t its recent dramatic pullback, but how I’ve reacted. I simply haven’t paid much attention. It’s just been business as usual. I haven’t even looked at my portfolio or watched CNBC.

Such a calm demeanor is unusual for me. A few years ago, if I experienced this type of market decline, I would have made big changes to my portfolio. Yet this time around, I just shrugged my shoulders.

What’s changed in my financial life to cause this indifference to the stock market’s selloff? I credit three things:

1. Asset allocation. I now have a mix of stocks, bonds and cash investments that allows me to stay the course in difficult times. Asset allocation isn’t just about your portfolio’s long-run performance. It’s also about the short term—and how you react emotionally. It’s about balancing the need to meet your goals against how much risk you can stomach.

At age 68, my portfolio consists of 35% stocks and 65% bonds. I don’t need to take more risk to meet my goal of a comfortable retirement. In fact, I reduced my exposure to stocks when I realized my portfolio had reached my magic number.

2. Financial advisor. My investment portfolio is managed by a low-cost financial advisor. At times like this, it’s comforting to know that I’m not on my own and that I have somebody I can trust looking out for me. If I were on my own, I would have felt compelled to make changes to my portfolio.

But this time around, my advisor is in charge and it’s on him to make any necessary trades. The upshot: I don’t need to pay close attention to what’s going on with the stock market and I’m not tempted to tinker, because I’m not the one managing my portfolio.

3. Low fixed expenses. I live below my means. I don’t have a mortgage, car payments, credit card debt or an expensive cable bill. Result: I know that, even in a financial emergency, I can make ends meet. I can sleep at night knowing that, whatever happens with the stock market , I’ll have a roof over my head and food on the table.

When I recall the bear markets I’ve lived through, what I think about most are not the massive declines in the market indexes, but my futile attempts to protect my investment portfolio from losses. Those ill-advised portfolio changes are what haunt me today, not the bear markets themselves.

If this market decline is the start of a new bear market , I’ve learned my lesson: I’m determined to ride this one out. So far, I haven’t even flinched. It’s business as usual for me.

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. This is his 50th article for HumbleDollar. His previous articles include Small Is Beautiful, On My Mind and Turning the Page. Follow Dennis on Twitter @DMFrie.

Do you enjoy HumbleDollar? Please support our work with a donation.

The post Time to Shrug appeared first on HumbleDollar.

Double Your Money

IT’S COME TO THIS: I’m writing an article discussing the virtues of EE savings bonds. To be sure, I’m not currently planning to buy them myself. But they could make a fine investment for more conservative investors who are happy to sit tight for the next two decades.

Yes, the current yield on EE savings bonds is a mere 0.1%. But if you hold EEs for 20 years, the Treasury Department guarantees that your savings bonds will double in value, equal to a 3.5% annual rate of return. By contrast, 20-year Treasury bonds are currently yielding just 1.4%—and 10-year Treasurys are offering a tiny 0.9%.

Why not back up the truck and buy EEs like crazy? For starters, it would have to be a very small truck. Each of us is limited to buying $10,000 in EE bonds per year.

On top of that, you would need to commit to owning the bonds for 20 years to get that 3.5% annual return. Otherwise, you’re stuck with the 0.1%. If you’re a conservative investor who is happy to buy and hold, that’s an attractive return.

But when I think about bonds, I view them not as a way to generate yield, but as a complement to stocks. Their role in a portfolio is to both post gains and provide spending money when stocks are suffering. Let’s say the stock market is down 11% from its all-time high—as it is right now. You might sell bonds to generate spending money, and then use that spending money to, say, pay retirement living expenses or purchase stocks and thereby rebalance your portfolio.

Have a similar view of bonds? Like me, you may not find EE bonds so appealing, because you aren’t confident you’ll hold them for 20 years. In fact, if you sell within the first five years, you’ll pay a penalty equal to the last three months of interest.

All that said, I’m still half-intrigued by EEs. The fact is, over the next 20 years, I can’t imagine there will be a time when I have less than $10,000 in bonds, so why not lock in that 3.5%? Maybe I should buy the annual maximum, double my money and plan on having a really great $20,000 party in 20 years.

How great will the party be? That depends on how sprightly I am at age 77—and what happens with inflation over the intervening 20 years. At the current 2.5% annual inflation rate, that $20,000 in 20 years would have the equivalent spending power today of some $12,200. That should pay for a few bottles of Moet. Oh wait, there will also be federal income taxes owed. Let’s make that prosecco.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Don’t Lose It, Stand Your Ground, Four Questions and Rule the Roost.

Do you enjoy HumbleDollar? Please support our work with a donation.

The post Double Your Money appeared first on HumbleDollar.

Buying Power

IF YOU TOOK an economics class in high school or college, you might see its usefulness as limited to helping with your grade point average. But the basic ideas you learned can still be valuable. Take this introductory microeconomics question: In a typical transaction, who has more power, the buyer or the seller?

When I started teaching economics many years ago, I gave the nod to buyers. Invoking the notion of “consumer sovereignty,” I’d explain to students that buyers have the power to vote with their feet—by walking to another store. Buyers can also change tastes quicker than sellers can change their wares.

That was a long time ago, however, before the internet. Now the balance of power is more even and perhaps tipping the other way. If you don’t buy something, there’s somebody a thousand miles away who might, thanks to online shopping.  That said, we consumers still have two powerful cards to play, as we strive for the upper hand in getting the goods and prices we want:

Make yourself an elite customer. Think of it as a numbers game. When there are heaps of students seeking the services of a university, the university is free to pick and choose. That compels potential students to dress themselves up, participate in high school extracurriculars and do all sorts of primping to make themselves attractive customers.

If students, however, are already prime potential customers—perhaps they’re at the top of their class or they’re star athletes—what they have to offer as a client is now scarcer than the university’s number of open spots. These students, in effect, join a sub-group of potential customers that the school will now court, offering scholarships and other inducements to get their business.

This notion holds true beyond college. Offer to pay cash at the antique store and the seller is more likely to accept your low-ball offer. Bundle a bunch of remodeling projects into one job and contractors will bid more vigorously for your business.

Similarly, maintain a good credit score, and banks and other lenders will flood you with offers. The irony of today’s system: Those who don’t need a loan are more likely to be offered one—and at the best rates, to boot.

Expand the pool of sellers. The second strategy is to be flexible in what you want. Houses are a good example. Suppose you want a home with a certain amount of space, in a certain area and with certain amenities. If you make your list and demand them all, the list of potential homes can get very small. If, however, you divide your desires into “must-haves” (good school district) and “would be nice” (swimming pool), the number of available houses increases, giving you the ultimate power in the negotiation—which is the power to walk away.

Want to get a good deal? Before negotiating or before walking into a store, consider how to use these two methods. What would make you an especially attractive buyer? What’s your walk-away price? Know that, and you’ll have the upper hand.

Jim Wasserman is a former business litigation attorney who taught economics and humanities for 20 years. His previous articles include Weighty Decisions, Scenes From a Life and Changeup Pitch. Jim has published a three-book series on teaching behavioral economics and media literacy,  Media, Marketing, and Me. His latest book is Summa, a children’s story for multiracial, multi-ethnic and multicultural families. Jim lives in Granada, Spain, with his wife and fellow HumbleDollar contributor, Jiab. Together, they write a blog on retirement, finance and living abroad at YourThirdLife.com.

Do you enjoy HumbleDollar? Please support our work with a donation.

The post Buying Power appeared first on HumbleDollar.

Risk Returns

WE HAVE MUCH to learn about the coronavirus, but we already know a great deal about financial risk—and, indeed, recent weeks have offered a brutal refresher course. What insights can we draw from investors’ reaction to this awful epidemic? Here are eight timeless lessons:

1. The greatest risks are those we never see coming.

Some risks are predictable, such as stock market volatility. Others are less probable but widely known, like the possibility of a recession. But the most dangerous risks are those that catch us totally off guard.

This is what led to Harry Houdini’s demise. Reclining on a couch, he was unprepared for a sudden barrage of gut punches. It wasn’t just the punches that led to his burst appendix, but rather those blows coupled with the fact that he was blindsided. Similarly, the risks that have the greatest impact on financial markets are those no one expected, so we’re unprepared for them, both financially and psychologically. Think about Pearl Harbor, 9/11 and the current coronavirus epidemic.

2. Uncertainty amplifies risk.

While everyone is now aware of the coronavirus, its impact—both on human lives and on the global economy—is still a huge question mark. When a risk is quantifiable, it can be properly discounted by markets. But what do we do when there’s so much uncertainty?

A rational approach might be to assign probabilities to various outcomes, and then weigh the economic impact of each. Needless to say, this is an onerous task. Instead, the human brain defaults to what Nobel prize winner Daniel Kahneman calls “system 1” thinking. We make an instinctual judgment, which is usually satisfactory for simple problems, but which can lead us astray if the problem is more complex.

In fact, faced with an uncertain but threatening situation, we often assume the worst. This approach helped us survive as a species. Is that a lion or just the wind rustling the tall grass? If we assume it’s a lion and we’re wrong, there are little or no consequences. But if we assume it’s just the wind and we goof, well, our genes—however brilliant at calculating probabilities—just didn’t get passed on. Such system 1 thinking leads people to sell stocks first and ask questions later.

3. Once spooked, our fear spreads.

Assessing the damage inflicted by the coronavirus epidemic on the global economy is only part of the story. The impact on our investment psyche is no less important. The longer we’re fearful, the greater the chance that we do permanent damage to our “animal spirits.” This increased risk aversion could have a long-lasting impact on stock prices. In fact, studies in behavioral finance have shown that fearful thoughts can translate into reduced risk-taking, even in unrelated areas of our life.

4. Complacency leaves us vulnerable.

The swift market reaction to the coronavirus was due, in part, to a previously lax attitude toward risk. The U.S. is in the longest economic expansion in modern history and we’ve enjoyed one of the greatest bull markets of all time. But beneath the surface, there are numerous financial risks that investors have been blithely ignoring, including an expensive U.S. stock market, global trade wars, an upcoming presidential election, enormous government debt, overleveraged companies, exceedingly low and negative interest rates, and an inversion of the yield curve. Yes, we have faced all sorts of risks in the past and gotten through them—and chances are we will get through the coronavirus epidemic, too. But it’s when risks are not being priced into markets that markets are riskiest.

5. “You can’t predict,” says Howard Marks. “You can prepare.”

If we couldn’t have predicted a “black swan” event like the coronavirus outbreak, what’s an investor to do? According to Marks, co-founder of Oaktree Capital Management, we can’t anticipate every risk. After all, if we could, they wouldn’t be risks. But by being cognizant of the investment climate—including where we stand in the economic and market cycle—we can prepare our portfolios for the unforeseen.

The most practical implication of this is something I call “countercyclical rebalancing.” Here is how it works: If our long-term asset allocation is 60% stocks and 40% bonds, not only should we rebalance from time to time, but we might also consider over-rebalancing. In 2009, investors were being paid a lot to assume stock market risk, which is another way of saying that expected stock returns were higher than normal. Countercyclical rebalancing would mean taking on a little more risk by, say, shifting to 70% stocks and 30% bonds.

Fast forward to 2020. Investors today are being paid far less for assuming stock market risk, especially in the U.S. A countercyclical investor, who would normally hold 60% stocks and 40% bonds, might shift to 50% stocks and 50% bonds. By lowering our stock allocation, we lower our portfolio’s expected return, but we lower its risk level even more.

You might call this market timing, but I think of it as risk management. There are times when the market pays us more for taking risk, such as 2009, and other times when it’s paying far less, like today. Note that this is very different from selling all stocks and going to cash. That’s true market timing—not something I advise.

6. It isn’t easy to buy when there’s “blood in the streets”—or coronavirus in the air.

The adage “buy low, sell high” is deceptively simple. The problem: When markets fall substantially, it’s almost always for a very good reason. While it’s easy today to look back at the stock market’s mouth-watering opportunities during the depths of the 2008-09 financial crisis, those were extremely scary times. Bank after bank was going belly up. The well-known investment expert Mohammed El-Erian relates calling his wife to pull out as much cash as possible from the ATM, fearing the banks might not reopen.

I don’t pretend to know what coronavirus will do in the months ahead. Will this pass like prior pandemics, such as SARS and H1N1? Perhaps. Will it wreak as much havoc as the measles virus, which is estimated to have wiped out 200 million people worldwide? No one knows—and that’s terrifying. Being a buyer of stocks is never easy, but it’s particularly difficult when there’s “blood in the streets.”

7. Volatility isn’t just noise.

Well-meaning financial experts tell us that stock market volatility isn’t really risk, but rather just noise. This may be true if you’re a machine. What if you’re human? Not so much.

In his book Misbehaving, Nobel prize-winning economist Richard Thaler explores the difference between “econs” and humans. Econs are perfectly rational beings that maximize their utility and have complete self-control. In a world of econs, market volatility is just noise.

But we humans experience volatility—and especially falling prices—very differently. We get far more pain from losses than pleasure from gains. Yes, the S&P 500 soared 28.9% in 2019 and is down just 7% in 2020, but I doubt many investors are comforted by that fact. Real humans also suffer from recency bias: What has happened lately seems like the most likely scenario going forward. In short, market volatility is risk because it feels risky.

8. Our risk tolerance collapses when we need it most.

Saying we’d be comfortable seeing our portfolio decline 30% is one thing. Actually experiencing it is entirely different. This is why risk tolerance questionnaires are all but useless. We simply don’t know ourselves that well.

I consider risk tolerance one of the thorniest concepts in finance. A key reason: Our tolerance is dynamic. Studies have shown that it rises with bull markets and declines along with share prices. The only way to really know how much risk we can tolerate is by living through market cycles. If we’re about to embark on a bear market, we should come out the other end with a better understanding of our true tolerance for risk. It could be a wonderful silver lining—if we have the presence of mind to pay attention.

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 Crash Course, 12 Financial Sins and 12 Investment Sins . Follow John on Twitter @JohnTLim .

Do you enjoy HumbleDollar? Please support our work with a donation.

The post Risk Returns appeared first on HumbleDollar.

February’s Hits

IT MAY HAVE BEEN a short month, but a lot happened here at HumbleDollar during February. Over the 29 days, readers visited almost 348,000 pages—a record for the site. What were folks reading? Here are February’s seven most popular articles:

It’s been more than three decades since the Japanese stock market hit an all-time high. The extraordinary market carnage holds five key lessons for investors, says John Lim.
For 35 years, Dennis Friedman lived in a one-bedroom, 789-square-foot condominium. He reaped nine crucial financial benefits.
John Yeigh wants to convert IRA money to a Roth. But he also needs to tap his IRA to pay living expenses, and the result is heaps of taxable income. His solution: borrowing against his home.
Is gold an unproductive asset with terrible long-term performance—or a great way to diversify a portfolio? Sanjib Saha wrestles with the question.
What should investors do amid the coronavirus, economic uncertainty and wild financial markets? Here are five thoughts.
“Traditionally, retirement was a 30-year period following a 40-year working career,” notes Robert Lindstrom. “But what if you were able to redistribute some of those 30 years?”
John Yeigh may be retired, but he has little use for bonds. His recommendation: Keep three-to-five years of portfolio withdrawals in cash—and the rest in stocks.

Meanwhile, February’s most widely read newsletter was Nobody Told Me—it ranks as one of the most popular pieces in HumbleDollar’s history—followed by Great to Gone.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Don’t Lose It, Four Questions and Rule the Roost.

Do you enjoy HumbleDollar? Please support our work with a donation.

The post February’s Hits appeared first on HumbleDollar.

Take Courage

MY LAST JOB in mainstream journalism was in 24-hour TV news. When a big story broke, we dropped everything. The viewers, we were told, were only interested in one story. Today that story is COVID-19, better known as the coronavirus. Next week—perhaps even tomorrow—it could be something completely different.

Human beings are finely attuned to what we see as immediate threats. It’s how we evolved. But it isn’t always helpful. The reality: The chances of any of us catching the coronavirus, let alone dying as a result, are extremely small. To be sure, we should take precautions and avoid unnecessary risks. But worrying about the coronavirus is a waste of time and energy.

What about the impact on our investment portfolios? Stock markets fell heavily last week, and there’s no shortage of market “experts” warning of further “turmoil” to come. But the simple fact is, they just don’t know. Yes, coronavirus could develop into a global pandemic. Or it could blow over in a matter of months. Predicting what impact all this might have on the economy and the financial markets is all but impossible.

So what should we do? An important principle in investing is to focus on what we can control and let the rest go. You have no control over the coronavirus or the markets. Unless you’re a professor of epidemiology, don’t kid yourself that you have any unique insight into how the virus might develop. Moreover, from here, markets could go sharply up or down for reasons totally unrelated to COVID-19.

All that said, if you’re anxious about the markets—which is an entirely natural reaction—try asking yourself three questions. First, will you need money from your stock portfolio in the next five years? Second, do you feel very uncomfortable with the level of risk you’re taking? Third, has your life situation changed substantially since you put your investment plan in place?

If the answer to all three questions is “no,” stop worrying.

What if you answered “yes” to one or more questions? Making major changes to your portfolio during periods of market volatility is best avoided. But your portfolio should reflect your upcoming need for cash, how much risk you’re comfortable taking and any major changes in your life’s circumstances. Take the time to think about what sort of portfolio you ought to be holding, and then—either on your own or working with an advisor—figure out how best to make the investment changes you need.

One final comment: If you’re tempted to reduce your regular investments in the stock market—or to stop them altogether—don’t. Keep drip-feeding your money into stocks. If anything, invest more each month than you currently do. After all, stocks are cheaper now than they were. It isn’t fear that’s rewarded in the stock market, but courage.

Robin Powell is an award-winning journalist. He’s a campaigner for positive change in global investing, advocating for better investor education and greater transparency. Robin is the editor of The Evidence-Based Investor, which is where a version of this article first appeared. His previous articles for HumbleDollar include Why We Try, Good for You and Better Than Timing. Follow Robin on Twitter @RobinJPowell.

Do you enjoy HumbleDollar? Please support our work with a donation.

The post Take Courage appeared first on HumbleDollar.

No Sweat

I’M STRUCK by how calmly I’m taking this fast-and-furious coronavirus selloff. The human toll is getting worse every day, and the economic and other consequences could be catastrophic. But I’m not tempted to sell. I’m also not in a hurry to buy the dip, though admittedly my pulse quickened Friday afternoon when the market was down 15% from its Feb. 19 high.

There’s absolutely no way to know what will happen first: Whether I’ll regret not buying the dip or Dustin Hoffman will knock on my door in a biohazard suit. Why am I feeling so serene—at least so far? There are three reasons:

I’ve learned a lot of hard lessons over a long investing career. I’ve been there, done that, reaching out my greedy palms for falling knives. Heck, I grabbed the Sword of Damocles with both hands in 2008-09 and thought I was a genius. Turned out that buying Goldman Sachs and Morgan Stanley on margin in the middle of a financial crisis wasn’t the right play. Go figure.
I’m a man with a plan. I am fully invested in a global portfolio in accordance with my predetermined risk tolerance, diversification strategy, age and circumstances. When the market falls is a really bad time to decide you can’t tolerate as much risk as you thought.
Market pullbacks just aren’t the same when you’re mostly in target-date funds. This is the first downturn since I put most of my portfolio in them. When I started writing this piece, I was thinking about my asset allocation targets, and rules of thumb for rebalancing and dip-buying. But then I remembered that the good folks at Fidelity Investments and Vanguard Group, who oversee my target-date funds, are doing almost all of it for me. They aren’t sweating it. Automated systems are using inflows and outflows of money from investors to keep my target-date funds at a set ratio of U.S. stocks, foreign shares and bonds. Right now, my funds are buying the dip for me.

We invest long-term in stocks to capture historically robust after-inflation increases in corporate profits and dividends. But we also know that those gains are subject to gut-wrenching plunges that scare many out of the market.

Why do otherwise sensible and experienced investors bail out of stocks at times like this? Blame it on the narratives they come to believe. There are stories to explain every market decline. The further the market drops, the scarier the stories get. Soon, people are babbling about the end of the world. The financial media will even trot out seers who have been predicting catastrophe their entire careers—and suddenly we imagine they were right all along. But just as “this time it’s different” is a bad attitude when the market is levitating, it’s a dangerous thought on the way down, too.

Are you thinking, “The market’s headed much lower, and this time it isn’t going to recover within a few years”? Or are you telling yourself, “When I look back a dozen years from now, the market won’t have tripled, as it did from its Oct. 9, 2007, peak through Feb. 19, 2020”? Of course, such thoughts could prove correct.

But them’s sellin’ words—the kind uttered by many a poor man over the centuries, but not too often by successful investors. If you really want to know the right time to hit the bunker with masks, bullion and automatic weapons, subscribe now to my newsletter for $99.99, and I’ll throw in my…. Oh, never mind. Wrong blog.

On the other hand, the agitation you’re feeling—and that tingle I got Friday afternoon—may not be fear, but greed. Maybe you want bragging rights, to be able to say you sold near the top and bought near the bottom. You think you’re smarter than the average bear and you want to prove it. You’re all about oscillators and moving averages, and for some reason you just started using your discount broker’s spectral analysis tool, whatever that is.

Bernard Baruch, who made millions with adroit market moves and later advised two presidents, Woodrow Wilson and Franklin Roosevelt, said it well: “The main purpose of the stock market is to make fools of as many men as possible.” In other words, fear and greed are both emotional reactions that are hazardous to our wealth.

I could cite a raft of statistics on the depth and duration of historical stock market selloffs, as well as recovery times and subsequent returns. For instance, the Dow Jones Industrial Average rose 26% in the year after the flu pandemic of 1918-19 peaked. That influenza killed tens of millions around the world, including nearly 700,000 in the U.S. If the Dow’s performance then provides you with some comfort today, fine. But it may be a useless factoid.

My point: Don’t try to game this out.

A year or two ago, as I thought about future selloffs, I gave myself the flexibility to modestly increase my target stock allocation—currently 72%—if the U.S. market sold off about 20% or more. One way I could accomplish that is by swapping some money from a shorter-dated target fund into a longer-dated one—going from, say, a 2030 fund to a 2035 fund. As of Friday’s selloff, it’s officially on my radar. But even if I do it and make a nice profit, it’s not the kind of thing I can brag about at parties. Can you imagine the reaction? “Check out that guy, he’s a target-date fund trader.”

My trading days are done. Partly as a result, my retirement days are getting closer.

William Ehart is a journalist in the Washington, D.C., area. Bill’s previous articles for HumbleDollar include Resolve to Rebalance, Durn Furriners and Oldies but Goodies. 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.

Do you enjoy HumbleDollar? Please support our work with a donation.

The post No Sweat appeared first on HumbleDollar.

What Should I Do?

AMID THE PAST WEEK’S stock market downturn, many people are asking two questions:

“How bad will it get?”

“How long will it last?”

I can’t answer these two questions, and nor can anybody else. But I have an answer to a third question: “What should I do?” Below are seven thoughts:

1. Ask financial advisors what they recommend at a time like this and most will offer the same advice: “Don’t panic.” While I agree, that doesn’t mean there’s nothing you can do.

It’s easy to have become complacent, especially after the long bull market that we’ve enjoyed, so I would use this decline as an opportunity to stress-test your investment strategy. What would the impact be if the stock market continued going down from here? Between 2000 and 2002, and again between 2007 and 2009, U.S. shares lost about half of their value. If that happened again, what would it mean for your financial goals—and your state of mind?

2. If, after conducting a stress test, you determine you’re taking too much risk, you shouldn’t feel like it’s too late to make a change. If you sell some stocks now, you aren’t violating any investment dictum against selling low. Far from it. Though the S&P 500 is down 13% from its high last week, it’s still 5% above where it stood a year ago.

3. This period of market turmoil also provides an opportunity to observe the power of diversification in action. You can see it at two levels. First, the performance of bonds over the past week illustrates why they are, in my view, the most effective tool for diversification. Though the yields are paltry, and in some cases no better than a savings account, bonds can do something that cash can’t: They can rise in value. Over the past seven trading days, while the S&P 500 has lost 13%, an index of intermediate-term Treasury bonds has gained 2%.

Second, you can see the importance of diversification within the stock market. So far in 2020, the S&P 500 is down almost 9%, but there’s a lot going on within that 9%. Among the 11 industries that make up the S&P 500, some are faring much better than others. Utilities, real estate and technology stocks have experienced only modest declines, while energy companies have suffered wrenching losses. This is why I always recommend owning both stocks and bonds, and why I think the best stock market investments are total market index funds, because you get exposure to all 11 industries.

4. If you’re still in your working years, and saving from every paycheck, recent events shouldn’t bother you. In fact, counterintuitive as it may seem, you should view the market drop as a positive development. While you no doubt hate to see your portfolio’s value decline, market downturns can end up bolstering your wealth if you’re a net saver. In fact, if you’re early in your career, you should hope for a prolonged stock market downturn, so you can invest a heap of money at cheaper prices.

5. Many of the headlines I’ve seen this week have been in ALL CAPS, with all kinds of dramatic statements: markets tumble, pandemic risk rises, fastest decline ever, yields collapse and more. If you’re reading these headlines, recognize that news organizations don’t gain readers by speaking calmly. Also keep in mind the classic study demonstrating that more information doesn’t necessarily lead to better decisions. The bottom line: Don’t feel there’s any need to follow the news 24/7.

6. A few weeks back, I talked about the danger of narratives. People love to tell stories, because they’re more interesting and easier to remember than facts and figures. That’s especially true at times like this. The coronavirus is new and not yet well understood, so everybody can paint their own picture, without much fear of contradiction.

Some are pointing out that the coronavirus is far less deadly than the flu that comes around every year, while others are focusing on the higher mortality rate. Some say this couldn’t possibly be as bad as the 1918 Spanish flu pandemic because medical care is now better, while others counter that air travel—which has more than doubled over the past 15 years—causes disease to spread more widely. My advice: Beware of all these stories. While there’s a kernel of truth in each of them, no one can gauge exactly what impact the coronavirus will have on the global economy or on financial markets.

7. While we don’t know how bad things will get with the coronavirus, I recommend consulting past stock market downturns to get a sense for the potential investment impact. Here’s what history tells us: Since the Second World War, there have been 12 bear markets resulting in market losses averaging 32.5%. From the market bottom, it has, on average, taken just two years for the stock market to recover. Right now, the stock market’s decline seems scary. My advice: Strive to maintain some perspective.

Adam M. Grossman’s previous articles include Don’t Tinker,  Adding the Minuses  and  Believe It or Not . 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 .

Do you enjoy HumbleDollar? Please support our work with a donation.

The post What Should I Do? appeared first on HumbleDollar.