Perspective, Gratitude, and Feeding the Bear

Well, it looks like some normalcy has returned to the markets. After 18 months of steady stock market gains in one of the lowest periods of market volatility in history, we are starting to experience some discomfort. The financial media has been their typical self and have done a good job of reporting just how normal (sarcasm) the downward swings are. Here are some actual headlines over the past week:

  • Dow Experiences Biggest Point Drop in History
  • S&P 500, Dow Suffer Biggest Weekly Decline in More than 2 Years
  • The Dow Jones Industrial Average Crash Raises One Question: Is the World Ending?
  • Market on course for 6% drop, biggest one-week fall since 2008

I don’t want to discount the downturn. Yes, the 1,100-point drop in the Dow on Monday was the largest in history. However, on a percentage basis, which is what investors should be looking at, it was the 538th largest decline in history. This of course, doesn’t make a for a good story. If I was a headline writer, here is what I would have written (and subsequently receive zero clicks, leading to a prompt termination):

  • Dow Experiences 25th Worst Loss since 1960
  • S&P 500 Declines to Levels Not Seen Since November 20th – Yes, 2.5 Months Ago
  • The World Fails to End…Again
  • Market Drops 6% in One Week after Increasing 234% over 9 Years

What happened in the markets over the last week can be scary but it’s also normal. The S&P 500 and Dow has officially reached “correction” level which is defined as a 10% downward movement from peak to trough. A drop of this magnitude in such a short period of time should not be discounted. However, it also need to be into perspective. This is the 91st time a 10% correction has occurred since 1928. If stocks fall another 10%, which is entirely possible, it wouldn’t be outside of the norm either. A 20% drop, officially a bear market, would be the 22nd since 1928.

 

No panic here

One lesson I learned over the past week is that I have the best group of clients an advisor can ask for. Although small in terms of quantity, they are robust in composure. A parent at my child’s school said to me yesterday, “Man…your phone must be overheating.”

 

Nope.

 

Quite the opposite actually. I didn’t receive one phone call, text, or e-mail. My clients were not worried. Nor were they surprised. In fact, they frankly didn’t care. Instead of worrying about markets they can’t control, they were busy controlling what they could — yelling at their kids, enjoying the perfectly normal February sunshine, and debating what wine to drink with barbeque (Syrah…or better yet, beer). It was the same attitude I had which tells me that I’m blessed to be in a bunch of perfect marriages.

The biggest investing mistakes usually made are emotional, all-or-nothing decisions when the market is in free-fall. A necessary part of a good advisors where he or she adds the most amount of value is talking their clients off the ledge. While I’m prepared to have this conversation, given the strong bull market, I haven’t had to. This was my first opportunity and it hasn’t been necessary. In fact, a strong stomach from my clients opens up the door to some tremendous opportunity –taking advantage of a downturn.

 

Strategy to feed the bear

“We’re rich because we were smart when others were dumb” – Charlie Munger, Vice Chairman of Berkshire Hathaway

 

The above isn’t an exact quote. I’m paraphrasing something I heard Warren Buffet’s partner say during one of Berkshire Hathaway’s annual meetings. Nonetheless, his point is valid — the best time to buy stocks is during times of panic.

 

However, this is easier said than done. Buying low makes complete sense and every investor can’t wait to do just that. The reality is that when asset prices fall they become sellers rather than buyers.

 

A 10% drop from arguably extended valuation levels is not exactly a buying opportunity of a lifetime. That likely occurred in 2008 and 2009 and it’s a market we likely won’t see again during our lifetime. However, today is a better buying point then last week, and the odds that the market will be higher 5 years from now has increased.

 

According to research from financial columnist Morgan Housel, after a 10% drop from its peak, stocks are higher in five years 86% of the time. The average return during those five years is 51%. After a 20% drop, those numbers increase to 89% and 61% respectively. Logically, the larger the drop, the higher future returns will be. And there’s a higher probability of achieving those higher returns. That’s not a bad deal.

Five years from now, the markets most likely will have made some gains
Source: The Motley Fool

 

While logic states you should deploy your cash now, the fear of regret is going to overpower logic. Here are some perfectly normal thoughts you may be having right now:

 

What if the market drops even further? It’s too early to start buying.

This feels a lot like 2000 and 2008. What if we have another crash? I don’t want to feel that pain again.

This time, I’m going to be aggressive when others panic.

 

The market may continue to fall. It might not. If you invest your reserves now and it falls further, you’ll be kicking yourself. If it doesn’t, and you don’t buy, you’ll be kicking yourself.

 

To be a successful investor, you don’t need to time the markets. You need to control your behavior. Therefore, you need a strategy that’s rule-based, taking the emotion out of your investing decision. Let’s say you have $10,000 in dry powder that you are ready to invest during a downturn. Instead of investing it all in one chunk or waiting too long, a rules-based strategy on deploying a set amount at various drawdowns is a sound strategy. The approach I’m going to show you is adopted from Morgan Housel who articulates it much better than I in this article. Here is a summary:

 

Market falls You invest… Historical Frequency
10% $1,000 About once a year
15% $2,000 Every 2 years
20% $3,000 Every 4 years
30% $2,000 Every decade
40% $1,000 Few times in an investing lifetime
50% $1,000 Once in an investing lifetime

 

With the strategy above, more than half your available funds will be invested after a 20% decline. Larger declines are rarer, so it makes sense to invest sooner rather than later. However, in the event that the market continues its descent, you’ll still be able to take advantage of lower prices.

 

Significant wealth can be created during bear markets which fortunately, yes fortunately, also occur pretty regularly. We haven’t had a 20% decline since 2009, twice as long as the average frequency. While not predictable, it shouldn’t be surprising if such a drawdown occurs again.

 

Whether this strategy is followed with the precision of an olympian archer is not important. What is important is prepared and having a strategy. A simple plan will alleviate mental stress which in turn, leads to less hasty decisions and ultimately, better returns.

Allow me to help you create a portfolio built for a bull or bear market. Get started today by clicking the link below for a FREE portfolio review.

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2 Things Other Advisors Will Disagree With Me On

“What’s your philosophy?”

This question has frequently popped up in my first year as a Financial Advisor. It’s a good and fair question, albeit a loaded one. When I hear that question, I believe most people are referring to investing. If so, the answer is not sexy or surprising – it’s long-term, buy and hold. However, good financial advising is about more than just investing. Real financial advisors look at a client’s entire picture. They take debt, college planning, real estate, insurance, and estate planning into account. However, even here, the answers across planners are pretty standard:

  • Save more than you spend
  • Pay higher interest debt first
  • Invest in a 529 plan
  • Term life insurance is usually better than whole life
  • Have a will and a living trust

Nothing shocking. Execution is often more difficult than the theory but it’s pretty straightforward. Now, you may be asking, “what makes you so special?”

For one — I’m tall, brown, and handsome. Hopefully, that’s enough to gain your confidence but if not, I do have a couple financial philosophies that differ from most advisors.

 

Enjoy your latte and avocado toast

There’s a recent article in Money Magazine titled, Millionaire to Millennials: Stop Buying Avocado Toast If You Want to Buy a Home.

I mean…really? In that article, an Australian property mogul insinuated that folks shouldn’t eat out so much or buy a $4 cup of coffee if they want to afford a house. Well, doing some quick back of the envelope math, sacrificing a latte a day would mean that you would have enough to afford a down payment in San Francisco by May of 2195. That’s 65,000 lattes.

The Money Magazine article reminded me of a story I once heard from Morgan Housel, a Loeb Award finalist for financial journalism. It’s about a guy taking a smoke break with his non-smoking colleague.

“How long have you been smoking for?” the colleague asks.

“Thirty years,” says the smoker.

“Thirty years!” marvels the co-worker. “That costs so much money. At a pack a day, you’re spending $1,900 a year. Had you instead invested that money at an 8% return for the last 30 years, you’d have $250,000 in the bank today. That’s enough to buy a Ferrari.”

The smoker looked puzzled. “Do you smoke?” he asked his co-worker.

“No.”

“So where is your Ferrari?

If you don’t smoke you can substitute coffee for cigarettes and work through similar math. It’s the type of math many advisors use when speaking to colleagues about saving every last buck and letting the magic of compounding interest do its work. However, it doesn’t take into account the simple joys in life. Sure, not buying a pack of cigarettes or a Starbucks a day will save you money. But it may not save you from strangling your boss. Within reason, vices can be good for people; there’s an upside to happiness.

The goal of financial advising should not be to put a stop to happiness but to help you find ways to achieve the life you want. That probably involves a few vices or experiences that just feel good.

 

The market can be beat

Studies have shown that over a 10 year period, more than 85% of fund managers failed to perform better than the S&P 500. These statistics have led many advisors and those in academia to conclude that the market cannot be beaten.

I don’t buy into what academia attempts to preach. Imagine if a medical student was told that no matter how hard they try; they will just be a mediocre doctor. Investing and portfolio management is probably the only subject matter where professors will tell their students that it’s impossible to be better than average.

All the statistics tell me is that mutual fund managers cannot beat the market. I believe individual investors can.

Mutual funds have a tougher battle than individual investors. Fund companies have to hire portfolio managers, research analysts, compliance folks, sales teams, and accountants. These people cost money and they are paid through the contributions from investors, therefore hindering investment returns.

There is also unbelievable pressure for those funds to outperform the market on an annual or even quarterly basis. Therefore, stocks are being bought and sold frequently, not giving a sound investment idea time to perform. Fund managers also face pressure from their bosses to go with the herd. A couple years ago, every manager was all-in on Apple stock. However, when signs of slowing growth started to emerge at Apple, the stock declined nearly 30% from its highs. Many of the funds that were overweight in Apple struggled. However, those managers weren’t going to lose their jobs because, “hey, it’s not my fault — everyone was invested in Apple.” Had the stock gone up 30% and a manager was not invested in the popular company, they may be on the hot seat. Of course, Apple recovered but the point is that it’s tough for fund managers to go against the grain. As an individual investor, you do not face that same pressure.

You as an individual investor can avoid Wall Street’s outrageous fees and short-term pressures. Your edge is that you have the advantage of time. Your investments don’t have to be better than the competition every year or quarter. You can own great companies and give them time to run.

Now, don’t get me wrong. I’m not saying that beating the market is what you should be trying to do. As an individual investor, you should try to do well enough to achieve certain goals such as retirement or paying for your children’s college education. This can often be done by just investing in a diversified mix of low-cost index funds. This alone will likely lead to better returns than 85% of mutual funds. However, investing in high-quality individual stocks alongside those index funds can be a great way to enhance returns.

Is your 401k optimized to help you meet your retirement goals? Are you paying too much in fees for under-performing funds in your retirement plan? A 14-year Vanguard study showed a good financial advisor can add up to a 3% value to its client — a difference of $500,000 for someone maximizing their 401k over 20 years. Click below to schedule an appointment for a FREE 401k evaluation. 

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Enjoy Your Coffee and Cigarettes

Morgan Housel, a Loeb Award finalist for financial journalism once wrote a story that stuck with me. It’s a story about a guy taking a smoke break with his non-smoking colleague.

“How long have you been smoking for?” the colleague asks.

“Thirty years,” says the smoker.

“Thirty years!” marvels the co-worker. “That costs so much money. At a pack a day, you’re spending $1,900 a year. Had you instead invested that money at an 8% return for the last 30 years, you’d have $250,000 in the bank today. That’s enough to buy a Ferrari.”

The smoker looked puzzled. “Do you smoke?” he asked his co-worker.

“No.”

“So where is your Ferrari?

If you don’t smoke you can substitute coffee for cigarettes and work through similar math. It’s the type of math many financial advisors use when speaking to colleagues about saving every last buck and letting the magic of compounding interest do its work. However, it doesn’t take into account the simple joys in life.

Sure, not buying a pack of cigarettes or a Starbucks a day will save you money. But it may not save you from strangling your boss. Within reason, vices can be good for people; there’s an upside to happiness.

If you want to quit smoking, do it to prevent lung cancer and emphysema. However, there are easier ways to save $1,900 a year. My job as an advisor is to help you find them. The goal of financial advising should not be to put a stop to happiness, but to help you find ways to achieve the life you want. That probably involves a few vices that just feel good.

Hate budgeting? You are not alone. I can help you:

  • Create a money management strategy to achieve your goals
  • Explore debt management strategies
  • Design a savings plan that fits your budget

Get started today by clicking the link below for a FREE consultation.

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