Based on some of the recent questions/comments here on the blog, it seems folks are getting ready to.
I routinely get questions like “I have a lump sum to invest, but this market looks to me like it is about to crash. Should I wait?”
Typically, I trot out my standard lecture about how market timing is a fool’s errand, point them to Investing in a Raging Bull and go about my business.
But recently, these concerns have taken a spike up as has the flow of new subscribers here. So, maybe it is time to explore this subject again. If you are already a jlcollinsnhinista, you already know the drill. There’ll be nothing new to see here. Move along.
But if you are new to all this, together we’ll explore this market and what to do about it.
Let’s get started.
Back in October 2007, the market peaked at ~1549 and then began it’s long, ugly slide to its ~735 bottom in February 2009, losing over half its value in what was the worst financial meltdown since the great depression. Of course, no one really knew that was the peak, or the bottom at the time.
Warren Buffett “lost” 25 billion dollars. “Lost” is in quotes because he didn’t panic and sell. So, when the market recovered and marched on up to new heights, as it always does, so did his fortune. So did the fortunes of all who stayed the course.
Since that low in February ’09, the market has had one of the great Bull runs in history. Its rise has been relentless, interrupted only on occasion with modest ~10% “corrections” as Wall Street calls them. These, of course, sent the media into full panic mode:
Courtesy of jflaxman
Nightmare on Wall Street: will the blood bath continue?
Since November 2016 the market has accelerated from ~ 2086 to the current peak reached early this March of ~2396, for a remarkable 4 month gain of ~15%. In the media, this has come to be known as “The Trump Rally.”
Now, the market is a huge and complex creature, and I am always very skeptical of pundits who so glibly claim…
“today the market rose (or fell) because investors worried about (or celebrated) X (or Y or Z)”
But, to the extent this has been “The Trump Rally” I suspect the prospect of these campaign promises becoming reality are the key reasons:
- Healthcare reform promising lower cost and better coverage
- Tax reform lowering corporate tax rates and reducing regulations (more profitability and competitiveness)
- Tax reform lowering personal tax rates (more spending power)
- Massive new infrastructure spending
- Better trade deals, favoring US businesses and US employment
In the past few weeks, however, the effort to rewrite healthcare failed and, to paraphrase the President:
“Who knew how complex this stuff is and how difficult to get done”
Since the March 1st high, the market has drifted down about 3% closing April 13th at ~2329. It kinda feels like it is holding its breath.
Add to this the fact that in various fancy versions of P/E (price/earnings) ratios, the “P” is getting larger and larger while the “E” seems stuck. Given they are again reaching historic heights and, after an incredible 8-year Bull run, the market is “due” for a Bear, it is not surprising that some investors, in some quarters, are getting very nervous. The market seems “priced for perfection” and if these good things it is anticipating fail to materialize, things could get ugly.
Surely, we are poised for a plunge and you should sell, sell, sell! Or at least wait to deploy new cash.
But, things are never this simple and the future never that clear. If it were, everyone would already be heading for the exits. Instead, it could be, we are set for another powerful move up.
The Trump administration could regroup and start notching up victories on each of those bullet points above. Or the market, fickle as it always is, could decide those things are not all that necessary after all and some new thing(s) have its heart all aflutter anew.
Could be, rather than the “P” falling, the “E” will start catching up and those P/E ratios will start to drop to more comfortable levels.
Plus, as the saying goes, “the market climbs a wall of worry” and there is certainly a lot of worry out there just now. Markets are far more prone to crashing when everyone is euphoric than when they are nervously looking over their shoulders.
So, what is really going to happen next? Beats the bloody hell out of me. I have no idea. Neither do all those media gurus who claim they do. I’m just willing to admit it and/or am not delusional.
So, what to do?
Well, first, let me reiterate as I have throughout this blog: market corrections (~10%), bears (20%+) and crashes (30% on up) are a normal part of the process. They can’t be predicted or avoided. They are best simply ignored. Warren Buffett:
“The Dow started the last century at 68 and ended at 11,497. How could you lose money during a period like that? A lot of people did because they tried to dance in and out.”
(confession: that quote is drawn from my memory and is likely not exact. I gave up trying to find the exact quote in order to finish this post. I’m sure one – maybe even you – of my astute readers will point us to it in the comments below. Thanks!)
From reader Ryan in the comments below:
http://jlcollinsnh.com/2013/06/14/stocks-part-ixx-how-to-think-about-money/
The original quote is in the YouTube link interview.
Thanks Ryan!
Market timing is a losers game. Even if you guess right and this market does plunge shortly, you still have to predict how far that drop will go and when to get back in. Most often, those that get it right sit on the sidelines while the market drops and then recovers leaving them to buy back in at higher prices.
Don’t believe me? No worries, at least for me. Go ahead. Give it a try, and learn the hard, expensive way.
But this doesn’t mean we are without tools around here to mitigate the risk.
Those of you who have read thru the Stock Series know we think in terms of two life stages:
- The Wealth Accumulation Stage, where we use cash flow to mitigate the risk
- The Wealth Preservation Stage, where we use bonds or courage to mitigate the risk
Briefly, here’s how this works…
During the Wealth Accumulation Stage I recommend holding 100% stocks, ideally in VTSAX. During this stage you are working and have earned income. Since you are aspiring to financial independence, your savings rate is very high. Each week or month you are adding this new cash flow to your VTSAX fund.
Anytime the market drops, your cash buys more shares. On sale, if you will. Market plunges are a gift, even as this new cash flow serves to smooth the ride.
During the Wealth Preservation Stage we have two options.
1. We could add bonds to smooth the ride. That works like this…
Whenever the market moves enough, in either direction, to alter your chosen asset allocation you rebalance. This means selling what has gone up and buying what has gone down or stayed the same.
For instance, my allocation preference is 75% stocks/25% bonds. The run up in stocks shifted this allocation and once it reached 80/20 I rebalanced to bring it back. This means I sold some of the stock fund and bought more of the bond fund. If stocks continue to rise, I’ll do that again. Should they plunge, I’ll sell some of the bond fund and buy more of the now cheaper stock fund.
2. Or, instead of smoothing the ride, we could just use raw courage and endure it.
This means holding 100% stocks and just ignoring the wild and crazy ride. This is something my pal Jeremy is thinking about and he makes the case here:
However, this is not something to consider if you are using the 4% rule and you need every penny to make ends meet, and unless you are absolutely, positively certain you won’t panic and cut and run during the next market crash, whenever this might be. Jeremy meets both these tests.
In fact, unless you lived thru the Crash of 2007-8 and stayed the course, I’d advise against even thinking about this. It is easy to say you’re tough enough sitting on top of this great Bull. But it is an entirely different feeling when the world appears to be collapsing around your ears and all the “smart money” is lining up on the window ledges.
Trust me. I failed in this myself in ’87, and never could have stayed the course in 2007-8 with out that costly lesson under my belt. A hard eyed assessment and a little humility regarding yourself can save you a lot of grief and a ton of money.
Bottom line
So, if you are aggressively adding cash each month to your VTSAX account you can smile if and when the market drops. As you can when you reallocate if you hold bonds.
If you are 100% stocks and living off your portfolio, like Jeremy plans to, you’ll just grin and bear it knowing this day would come and this, too, shall pass.
As for me, I’ve been thinking about following Jeremy’s idea. A nice, sharp market plunge would be just the thing to move me off the dime. Maybe if the market drops 10%, I’ll move a third of my bonds into stocks. If it goes on down 20%, I’ll move another third. If it drops 30%, I’ll move the rest.
Maybe. Or maybe I’ll just keep my nice 25% allocation of bonds and rest easy.
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Still skeptical about holding on thru all these plunges?
Word is, Fidelity reportedly conducted an internal performance review of accounts held between 2003 and 2013 to find which did the best. The results:
- First: Dead people
- Second: People who forgot they had the account
That’s right, the dead performed best, followed by those who just forgot about their accounts altogether.
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Addendum 1:
My pal Alan, who along with his wife Katie is organizing our UK Chautauqua coming this August, sent me the chart above which comes from the British blog monevator.com
It is worth taking a look at the next time someone assures you this market simply must collapse shortly. Understand, of course, this is not to say this market must go higher, only that it can.
Addendum 2:
Sir Isaac Newton and the South Sea Company: How the man some regard as the smartest who ever lived dealt with the famous bubble.
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Before you comment:
I realize I have touched on politics in this post and hopefully I’ve done it in such a way that my own political views remain obscure.
I saw no other way to discuss the market’s recent moves. But this is NOT a political post and I don’t want the comments on it to become a political cesspool. There are enough of those out there already.
Any partisan political comment will be deleted and any partisan political points embedded in an otherwise useful comment will be edited out.
Thanks!
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Some books for your consideration:
Non-fiction
Yuval Noah Harari has become my favorite non-fiction author and this…
…might just be my all time favorite non-fiction book. A close second, which I’ve just finished, is his…
Mr. Money Mustache brought this one to my attention with his review. He calls it “This tiny and simplistic and charmingly outdated book from the 1950s completely changed my life.” We’ll have to take his word for it having changed his life, but the rest I can vouch for.
Great concepts and principles, wrapped in a 1950s sensibility that’s like climbing into a time machine. Interestingly, Schwartz routinely refers to female executives in his various examples and stories. Such creatures were not all that common in the ’50s, but then neither were a lot of his cutting edge views.
I wish, like Mr. MM, I’d come across it as a teenager.
Fiction
A friend of mine originally from Minnesota recently introduced me to two book series, each set in that state. These are entertaining reads in the crime/detective/adventure genre. Both have a central character, along with supporting characters that reoccur in each book.
As he suggested, I am reading them in order, and here are the first book from each series:
Sandford is probably the better writer, although I find both engaging. But Krueger’s characters are more interestingly drawn. Either is a fine way to pass a quiet evening after a long day.
For more book ideas check out:
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New Podcast:
Recently the guys over at ChooseFI had me on their show. We had a blast! If you want to give it a listen it goes live Monday April 17th: jlcollinsnh interview
They’ve already interviewed Mrs. Frugalwoods, Go Curry Cracker and The Mad Fientist, so if you just can’t wait till mine is up check ’em out!
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Other random cool stuff:
For my daughter, and all the other wild and free spirits out there…
Here’s to all the girls who’d rather catch flights than feelings
More on how it used to be in the 1950s: