A rollicking week in the markets is really a chance to clean up your act
Washington Post, August 28 2015
Don’t say you weren’t warned.
A few months ago, with markets on a hot streak, you were given the Solomonic heads-up that “this, too, shall pass.” Your portfolio was basking in the sun at that moment, but as always, winter is coming.
U.S. markets had climbed to all-time highs. Those in Japan, Europe and China hit multi-year records. The contrarian inside thought, “Now is the time to start planning for when markets are less accommodating, more volatile — and for when something eventually goes wrong.”
Well, folks, “less accommodating, more volatile” arrived last week. The Standard & Poor’s 500-stock index fell more than 10 percent in four days, something that has happened only nine times in 80 years (since 1934), said Jim Bianco of Bianco Research. That makes it a rare event of some potential historical significance.
What was true two months ago is even truer today: The sooner you clean up your financial act, the better.
Consider yourself lucky. The big snapback off that almost 12 percent drop this past month in the S&P 500 and more than 17 percent drop in the Nasdaq gives you another opportunity to act before the next crisis hits — and there is always a disaster somewhere over the horizon.
Let’s look at what you can do right now to stay on track. If you want to reach your long-term goals, you need to (a) be proactive and (b) avoid making the usual silly mistakes.
In June, you were advised to clean up your finances and restructure your debt. That is a good starting point. Here’s more to consider:
1 Have a fully developed financial plan. Start with a household budget, in detail and on a spreadsheet, showing your known monthly expenditures and income (along with potential unknowns). That will give you some idea of your needs.
Ignore the chumps telling you how much money you save by not buying lattes; that’s penny-ante nonsense. Get the big things right — your housing costs, your health care, your kids’ college savings, and then we can begin to think about your retirement. If you are a $5 latte away from insolvency, then sorry, folks, but you are already out of luck.
2 What do you need to retire on? Figure out how much you will spend each month once you stop working. What will you do? And what will that cost? Will you travel, garden, do philanthropy work, write the great American novel?
Why is this important? If you don’t know what your end goal is, you have no idea how much risk to assume and what you need to add each month while you are working to reach your goals.
From there, start with your existing assets and assume a real rate of return (net of inflation) for the next 20 years for a balanced portfolio. Next, determine how much you need to contribute each month from now until you retire to hit your targets. We use very fancy-shmancy software in my office that generates all sorts of great looking charts, but really, you can do the basics of this sort of planning with a simple spreadsheet.
3 Reconsider all of your individual stocks. Although the indices swung to and fro, the real action last week was in some of the higher profile names: Facebook traded from $95 down to $72, then back to $86. Netflix did the bungee jump from $125 to $85 then back to $110. It wasn’t just the tech names — Ford fell as much as 24.7 percent from its previous close. Banking giant JPMorgan dropped 21.3 percent in one day! Starbucks sank 20.4 percent from the previous close. Most of these heart-stopping falls were recovered in the subsequent rally.
I have reviewed portfolios holding hundreds of company names. Unless your job is running a mutual fund, you cannot do this.
Do you really need this sort of stress? You are not on a trading desk, not watching these things in real time, not likely to ride out temporary pullbacks, not likely to outperform the indices. You are taking a whole lot of risk for no discernible reason.
Last week’s bounce back is a blessing. Take this opportunity to sell the stocks you have accumulated over the years and rotate into an index fund. I bet many of the stocks you hold are no longer consistent with your risk tolerance or long-term goals.
Any company can file for bankruptcy, any stock can go to zero. But an asset class — i.e. US Small Caps, International Large Cap, Domestic Mega Caps — cannot.
4 Be ready to take advantage of volatility. Last time out, we said that “the problem with market corrections is that they always seem to come along when you are least prepared for them. That is a shame, because they offer wonderful opportunities to create lasting wealth — but only if you have a plan.”
Question: Did you put it into effect?
My colleague Josh Brown has a nice little trick to do during the sorts of market mayhem we saw last week. When you see market futures down 1,000 points, the way they were early Monday, pick a favored ETF or asset class. Put in a “good-til-cancelled order” (for what you can afford) at 10 to 15 percent below recent prices. Courtesy of the market panic, you get to increase exposure at absurd prices. You can do this with any ETF representing broader indice.
5 Finally, envision your emotions. If you can imagine the emotional roller coaster the markets may put you through, you can better handle the stress. You cannot control what happens out there in the big old crazy world, but you can manage your response to whatever the market creates. You have been given another golden opportunity to get yourself together.
Don’t blow it.