Q. During all this CoronaBear financial upheaval, an article on what you are doing financially and personally would go really far.
A lot of your principles — like tithing, personal and mental wellness go a long way and should resonate with your readers. Likewise, talking about what financial steps with dollar-cost averaging you're doing to maintain a balanced portfolio would be helpful.
What Am I Doing in this Bear Market?
A. I'm doing exactly what I've been telling you to do for the last nine years!
I've come to discover that it really doesn't matter what I write in advance. I've been writing about bear markets, about behavioral finances, about why you need a financial plan and how to write one, about the importance of staying the course, about why it is smart not to try to time the market, pick individual stocks, or use actively managed mutual funds, about how to keep finances in their proper place in your life, and how to earn, save, invest, spend, and give well.
But one big market downturn and it's like it's a brand new blog that nobody has ever read before. The WCI Forum is somehow now full of market timers. The WCI Facebook Group is somehow now full of stock pickers. The Bogleheads forum is convinced that this time it's different. At least the WCI Subreddit seems to be hanging in there. Guess what guys? I'm still here. The message is still the same:
- Earn as much as you can while maintaining balance in your life
- Save at least 20% of your gross earnings for retirement
- Invest it into a fixed asset allocation, diversified between stocks, bonds, +/- real estate
- Keep your costs low
- Don't try to time the market
- Use low-cost, broadly-diversified index funds
- Use tax-protected, asset-protected investing accounts as much as possible
- Develop and follow a written investing plan
- Keep a long-term perspective
- Get good advice at a fair price
- Rebalance, tax-loss harvest, and donate appreciated shares to charity in lieu of cash
Nothing changed except we all lost a little bit of money, many of us lost part or all of our income, and many of us are now terrified to leave our homes and go to work lest we become infected ourselves or worse, bring the coronavirus home to our loved ones. Lenin said, “There are decades where nothing happens; and there are weeks where decades happen.” The last few weeks might feel like decades to some investors. It feels to many like the world has changed permanently and it will never be anything like January was.
In a lot of ways, the last decade or so was like all of those long two-a-day practices before the season opens, and March 2020 is the big game, the season opener or even the championship game against your rival. Yes, all that preparation matters, but this was the moment you put in all that work for. Now it is time to perform. Now is the time to be a real white coat investor. Now is the time to find out what you are made of. The investor matters more than the investment. What kind of an investor are you going to be? Are you going to be a weak-kneed wimp with a short-term perspective who drops his shipment at the first sign of an Imperial cruiser? Or are you going to stick with your reasonable plan until you hit your financial goals?
A bear market should not be a surprise. On average, they happen once every three years. An investor with a 30-year career and 30 years in retirement should expect to go through 20 of them. Every one of them is unique, but they all end the same way (with a recovery that goes on to new highs), and most importantly, they all end. This too shall pass.
If you don't need this money for thirty years, why are you acting like yesterday's performance matters? Religious leader Spencer Kimball said the most important word in the dictionary is REMEMBER. REMEMBER your financial plan. REMEMBER why you're investing. REMEMBER financial history is composed of booms AND busts. REMEMBER that while pessimism sounds smart, sexy, and seductive, the history of mankind should be subtitled “The Triumph of the Optimists.”
With all that in mind, let's talk a bit about some behavioral finance lessons that we can learn from the last few weeks.
Hindsight is 20/20
A lot of investors are beating themselves up for having a cloudy crystal ball. “Why didn't I sell all of my stocks for cash, I knew this pandemic was going to be a big deal,” they think. There are a lot of problems with that mindset. The first problem is that hindsight is 20/20. The right thing to do is obvious retrospectively. It is so obvious that we can't imagine we could be so stupid as to not be able to do it prospectively. It doesn't help that we keep running into braggarts out there saying “I knew it, that's why I did X, Y, or Z.”
This is just classic cocktail party talk though. Just like the guy who says “I bought Google when it wasn't worth anything” but never mentions that he also had 20% of his portfolio in Enron when it went bankrupt. These folks aren't mentioning all of the times they got out of the market and it didn't pay off.
“But this is once in a lifetime stuff,” you might think. No, this happens about once every three years on average. Did you see 2008 coming? Did you see 2011 coming? Did you see 2018 coming? Nope. You didn't see those either. Yes, you knew there was going to be a pandemic. You might have even known it was going to be bad. But you didn't know exactly what the economic and health effects were going to be. Don't kid yourself. If you knew it for sure, you would not have just sold 20% of your stocks for cash. You would not just have sold all of your stocks. You would not just have sold VTI (total stock market ETF) short. You would have borrowed every dollar you could have and bought puts way out of the money on massive leverage.
Do you know anyone who did that? Me neither. You know why? Because nobody knew for sure what was going to happen. Nobody has a working crystal ball. Even among some of the most informed people on Earth (US senators) only a handful of them even sold their stocks. Quit beating yourself up.
Now, imagine you did something like selling some or all of your stock index funds for cash back in February. I know several people personally who did so. I say to them, “Congratulations on your prescience.” I truly am happy for them. Now what? They are faced with a difficult decision–how to get back into the market.
There are many different options, but they all have their risks:
- Never go back into the market, stick with cash, bonds, CDs, etc. The risk here is that your money won't grow fast enough to reach your financial goals.
- Never invest in stocks again and reinvest the money in real estate. The risk here is that stocks recover while a real estate crash is delayed. The stock market is very much a leading economic indicator, but rents and property prices tend to lag significantly.
- Dollar-Cost Average (DCA) back into stocks over a long time period, such as a year or two. This works great in a long recovery, such as 2000-2002. But if you did this in 2008-2009 (or worse, Dec 2018-Jan 2019) you would have ended up buying at prices higher than you sold at!
- DCA back into stocks over a short time period, such as a few weeks. This works great in a quick recovery, but the risk is that the market keeps dropping for another year, or two, or three. Yes, better to sell at the top and buy back in 20% down, but then you'll be kicking yourself for not being able to prophesy a further drop. Maybe you'll even sell again at a lower amount and miss the recovery.
- Lump sum back in now, count your blessings, get a written investment plan you can actually follow (with a less aggressive asset allocation) and swear never to do it again. I actually think this is the best option, but just like with a short dollar cost average period, there is risk of further loss.
The great thing about a buy and hold investment strategy such as the one I advocate is that you only have to make a decision once. You only have to decide you're not going to sell in advance of or in reaction to a market downturn one time. The decision is made. Now every time you are faced with the opportunity, there is no dilemma because the decision is already made.
It's a bit like the way I grew up with a fairly strict religious upbringing. In my religion, culture, and family, we don't drink, smoke, or use recreational drugs. So as a teenager, I made a decision I wasn't going to do any of that. How many hundreds of times over the ensuing decades do you think I was offered a cigarette, a beer, or a joint? It's pretty much a weekly event. But I didn't have to sit and stew each time about what I was going to do. I had already made that decision decades ago. Easy peasy.
Following a written investing plan that says “Buy and hold” is similar. It takes less time. It takes less effort. It takes less mental anguish. And guess what? If you fund it adequately, it will provide returns sufficient to meet your reasonable financial goals, which is the whole point of this investing thing.
Market Timing and Stock Picking
There is no evidence that market timing or stock picking works any better in a bear market than in a bull market or at any other time. In fact, there is plenty of evidence that shows it hurts portfolio returns, especially after expenses and taxes, and especially in the haphazard way that most investors go about the process. So what is it about a bear market that causes people to want to do this more? I think it's two things:
First, the market is more visible to us. Tanking markets make for interesting news. It is simply on our minds more.
Second, and more importantly, if we could do it successfully, the rewards would be much higher. When the market goes up or down by 5-10% a day, the reward for buying at the end of a down day and selling at the end of an up day is that much higher. But it isn't any easier to actually do. Likewise with stock picking. We see that the capitalization of the stock market is rapidly changing. Teleconference stocks like Zoom are going straight up, while airlines and cruise companies seem destined for bankruptcy. Somehow we think that we're can outsmart the millions of other people who are analyzing, buying, and selling these stocks. We think we know their true value better than anyone else. We think our crystal ball is clearer. Guess what? You don't and it's not. Don't fool yourself.
Short Term Thinking
I am amazed at the short term thinking exhibited by otherwise very smart people. I see “capitulation” (i.e. selling low) left and right these days. When I ask these people “when will you actually spend this money?” the answer is always years and usually decades in the future. If I ask, “Do you really think the return on this investment between now and then will be negative?” The answer is no. There's a massive disconnect there and short-term thinking causes people not to see it.
Pain of Loss VS Pleasure of Gain
We are wired to feel a lot more pain from losing money than we feel pleasure from gaining it. If you recognize this, you will realize that it explains a lot of your behavior (and especially the behavior of those around you.) It's not logical though. If you can force yourself to be Spock instead of Kirk at times like these, Future You will thank you for it.
Selling Low is Stupid
While many people beat themselves up for not selling at market peaks, it is important to realize that selling AFTER a market decline is downright stupid. Seriously. It's so dumb it's all I can do to not berate the people who are doing it. I understand if you are FORCED to do it. That is you've lost your job, you've cut your expenses to the bone, you've blown through all of your cash, and you've spent all of your bonds. Better to sell low than starve. But few are in that situation just a few weeks into a bear market.
Why is selling low so dumb? Well, when you buy shares, you are buying a portion of a company's future earnings. When you hold on to those shares, you are holding on to a portion of a company's future earnings. It is a real company, with real assets, and real profits. In fact, you own part of the most profitable enterprises the world has ever seen. Ever. You're not putting your money on red on the roulette table. The expected return is positive. And the lower the price gets for that share of future earnings, the higher that expected return gets. What other product do we buy less of as the price goes down? Nothing except status symbols. So unless you bought your index funds as a status symbol, now is the time to buy more, not sell what you have.
Perhaps you believe that it is different this time. The world has never seen such a terrible pandemic. There has never been so much quantitative easing. There has never been so much borrowing by governments, industry, and individuals. Whatever the reason, consider the fact that if this time really is different, and stock markets are not coming back as they always have in the past, then it really doesn't matter what you do with your investments. If all of the world's most historically successful enterprises have zero future earnings, there is not going to be a refuge in bonds, real estate, precious metals, cryptocurrencies, or commodities. And you'll only be able to transport and protect so much in canned goods and ammunition.
So, since shares are now cheaper than before, since if it is different it doesn't matter what you do, and since you can't successfully time the market drops and rises, selling low is stupid. So don't do it.
It helps to think long-term and to be a bit philosophical. Accept that you will take what the market gives and be happy with it. Accept that everybody else's wealth has dropped just as much as yours and that relative wealth matters more than absolute wealth. Accept that this too shall pass. You were never as rich as you thought you were at market highs and you were never as poor as you thought you were at market lows.
Playing Behavioral Games
Some people love to play behavioral games with their money. If that works for you, then, by all means, do it. But cold, hard logic can be your friend too. Here are some of my favorite games that people play, and why they are just that.
“You don't lose anything until you sell.”
This is one of my favorite dumb sayings. I accept that it helps some people stay the course. But it's a total lie. Yes, you own the same number of shares and the same percentage of future profits of the business, but you really did lose money. When the market drops 10% and you had $1M in stocks, you really did lose $100K. When the market rises 10% on that $1M stock portfolio, you really did make $100K. In fact, any long-term stock investor (who has more in stocks each decade of life), has had days when they made more than any other day of their entire life recently. Likewise, they have lost more money in a single day recently than they may have saved or even earned in a given year. That's just the way it works with an increasing portfolio and high market volatility. Just don't tweet about it or you'll be eaten alive and eventually start receiving threats toward your family. (Ask me how I know.)
“Don't look at your portfolio.”
This one is dumb too, although if it helps you stay the course, feel free to use it. Folks advocating this tell you not to log in to your accounts and shred your statements without opening them. But who are we trying to kid? We can all do simple math. If we have a $500K portfolio and it is 60% stocks, we know we have $300K in stocks. If the market went down 10%, we know we lost about $30K. I don't have to log in to know that. I don't have to read a statement to know that. It's just basic math. And you can't ignore market movements when they are reported as widely as they are in a bear market.
“Forget your password. “
Here's another strategy for the desperate. When the market starts dropping, go to your Vanguard (of Fidelity or 401(k)) account and try to log in with the wrong password three times until it locks you out. Now you can't sell low! Brilliant! Except if you actually know how to reset your password. Which takes just a few minutes on the phone or using your email. Hey, if it helps, it helps. Knock yourself out. But if something like that is what keeps you from selling low, you're probably in too aggressive of an asset allocation.
Want to know how to know your asset allocation is right? It's when your fear of opportunity cost precisely balances out your fear of loss. Unfortunately, that is not a static thing. Risk tolerance drops in a bear market. So you really need to consider where that balance is AFTER losing 1/3 or more of your wealth. Thus I think it is impossible for anyone to know their risk tolerance until their first big bear market. Err on the conservative side until then. If you realize it's no big deal for you to lose real money you used to have, then you'll be able to ramp up your risk level at just the right time and nothing will be lost. But if you overestimate risk tolerance and it causes you to sell low, then watch out! Hopefully, you can hang on through the sleepless nights until the bear is over and then reduce your risk level, but if not, try to just sell down to the sleeping point rather than going to all cash.
The Value of an Advisor
In my view, there are three ways a financial advisor can add value:
- Help you get a reasonable financial plan into place
- Do your financial chores for you
- Help you stay the course in a bear market
Financial advice and service isn't cheap, so many of us choose to do this stuff ourselves to save money. But if you are not capable of drafting your own financial plan, you hate doing financial chores so much you find you are not doing them, or you need someone to talk you down off the ledge in a bear market, good advice is well worth paying a fair price for. You can find good advisors that I have vetted here. There is no shame in using one temporarily or even permanently.
So what am I doing in this bear market? I am earning, savings, investing, spending and giving money. I am exercising and spending time with my family. I am trying to keep my patients and co-workers safe. I am trying to balance my clinical work with my WCI work. I am trying to make sure I am taking care of my employees, extended family, and favorite charitable causes (although I am using cash for that now since I no longer have any appreciated shares in my taxable account). I am rebalancing and tax loss harvesting and staying fully invested. I am investing money into the market whenever it becomes available to (about once a month.) I am staying the course. Come with me if you want to live.
What do you think? What behavioral traps do you see people falling into? What behavioral crutches have you found useful? Are you staying the course? Comment below!