Are We Headed for a Crash?


There was an article in Money magazine  this month where five market prognosticators are talking about a coming crash.  One expects a drop of 50%.  Another says that it will be the biggest crash in his lifetime.

 Let me first say that while it is fun to try to predict where the markets will go next, most of the time it is really anyone’s guess.  If you say that the markets will drop and you keep saying it long enough, eventually you’ll be right.  If the market is dropping and you say that there will be a recovery for long enough, eventually you will be right.  The issue is getting the timing right, which is something no one can do consistently.  If people knew that shares were going to drop next week, they would sell this week, so the market would drop this week instead.  When you know, you’re too late.  Remember that everything is already priced into the market, including the likelihood of a crash or a rally on the horizon.

              

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That said, because it is fun to prognosticate, let me say that perhaps the doom and gloom chorus in the Money article are wrong.  They are correct that share prices are high compared to historic levels.  Price earning ratios are normally around 15 to 17, but today they’re in the low to mid 20’s.  This means stocks are 150% as expensive today as they normally are based on earnings.

But when PE ratios are high, there is two ways for them to correct back to normal:  Prices can fall, as the Money magazine interviewees suggest, or earnings can rise.  I think there is a good possibility that the latter may happen.  If they do, then the higher prices we’re seeing today will be justified.

 


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The reason I make this assertion is that we’re seeing some factors that would tend to drive earnings higher.  If President Trump and the Republicans are able to cut taxes, that would lead to more investment and more spending as more people get back to work and see their paychecks rise.  More importantly, if Obamacare is actually repealed, the restrictions that are keeping employers from hiring people full time will disappear,  leading to more productivity through full employment, more cash in people’s pockets, and thereby higher earnings.  The markets rallied immediately after Trump’s election because of expectations of these outcomes.

Then again, if tax cuts are not passed, or if repeal of Obamacare does not occur, or an event that shakes the economy such as an impeachment of the President occurs, stock prices could reverse.  That is why it is so difficult to make predictions.


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So what should you do?  The same thing you should always do.  If you are young and building wealth, you should be investing regularly.  If the markets drop, you’ll be able to pick up shares at lower prices and you have plenty of time to wait for a recovery.  Recoveries also tend to be very fast, returning shares to their previous levels within a year or two, unless the government interferes like it did in the 1930’s.

If you’re nearing retirement, you should be pulling the money you’ll need during the first few years out of the market.  You should also be shifting money to income investments like bonds to provide a hedge against a stock market collapse.  If you’re going to be living on your portfolio, you don’t have the time needed to wait for a recovery.  If you have a lot more than you’ll need for living expenses, like you have $10 M but only need $2 M to generate enough income for living expenses, you can afford to keep a lot of the excess invested in equities since you would still be fine financially if the markets did drop 50%.

It is fun to try to predict where the markets will go, but your investing strategies should be consistent and be based on the idea that you really don’t know where markets will go.  You need to determine your tolerance for risk, and look at the likely and fairly possible moves that could happen in the markets, and allocate your investments accordingly.

Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Accounts You Need to Have for Financial Security


Today I wanted to talk about how one in general should be allocating funds.  As stated previously, this blog is primarily concerned with strategies to grow funds quickly, assuming that an investor is starting out with little money but working a steady job with a reasonable income.  It also assumes that an individual has scaled her “lifestyle” so that she is making more than she is spending.  This is the most basic requirement for becoming wealthy.  Virtually everyone can scale back to have extra income left over, but it takes a degree of sacrifice and patience since one will need to wait a bit longer to buy things but they will be quite a bit less expensive when one does (because one will be paying cash rather than buying them on credit).

The first place a person should put extra income is in a cash account that is readily accessible.  This should be built up until it contains enough to cover several months worth of expenses.  These funds are used to take care of the various unexpected expenses that occur (such as the car breaking down, heater going out, roof leaking, unexpected surgeries, etc…).  These funds should be guarded judiciously and not spent for things such as vacations, shopping, etc… since these are the funds that prevent you from needing to take out loans or run up the credit cards if something happens.  This account will also be used to live on if one loses one’s job, allowing time to find a good job, not just one taken out of desperation.

                                   

The second account is a retirement account.  This is the money you will live on when you’re ready to retire and also should be guarded carefully.  The only reason to access this kind of account is if you’re about to be out on the street if you don’t.  Absolutely don’t use this money for any other purpose, including taking out a loan against it.  The reason is that if you start saving in your 20’s each dollar will be worth over $128 when you retire, so if you take out $10,000, for example, you just robbed yourself of $128,000 in retirement worth, which translates into $12,000 per year in income.  This account should be filled with index funds when you’re young and gradually be filled with more dividend paying stocks, bonds REIT’s, and cash as you get closer to retirement.

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The third account is your investment account.  This is the account that will use the strategies in this newsletter to grow large, allowing you the financial freedom at some point to work or not work, as you choose.  This account will be invested in stocks starting with 1-3, and eventually growing to 10-20 as your wealth builds to the $500,000 – $1 million range.   Because the money in this account is not critical – you still have enough money to pay for emergencies and fund your retirement with the other two accounts – you can afford to take the risk of one or two of your positions taking a substantial loss.  Also, if you find you are not a good stock picker, such that your investment account does not do as well as the markets, the other accounts will make sure you end up in a good position as well.

Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

What to Invest in with your 401k


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When investing your 401k money, it is critical to diversify, where you allocate your investments into different asset classes.  In a good 401k you’ll have choices of asset classes among:

  1.  Large US Stocks Index Funds
  2. Mid-sized US Stocks Index Funds
  3. Small US Stocks Index Funds
  4. US Bonds
  5. Real Estate Investment Trusts (REITs)
  6. International Stocks
  7. International Bonds
  8. Managed Large-Cap Stocks
  9. Managed Small Cap Stocks
  10. Emerging Growth Stocks
  11. Target-Date Funds
  12. Money-Market Funds

In a bad 401k fund, you may only have a few of these choices, and those that you do have will all be managed funds with big fees (of more than 1%).  A great plan may have even more of these choices, although the list above is more than adequate for good diversification.

       

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Given the choices above, here is how I would typically set up my 401k:

  1.  Large US Stocks Index Funds  (15%)
  2. Mid-sized US Stocks Index Funds  (20%)
  3. Small US Stocks Index Funds (20%)
  4. Real Estate Investment Trusts (REITs)  (20%)
  5. International Stocks  (15%)
  6. Managed Large-Cap Stocks  (10%)

Notice that I have about 25% in large US stocks, 40% in medium and small US stocks, 15% in international stocks, and 20% in real estate.  Factors that go into these decisions:

  • Sometimes large stocks do better than small and medium stocks.  Other times small and medium do better than large.  I want to be in both places so that I’m invested in those areas regardless of which is doing best at the time.
  • Over long periods of time, small and medium stocks will outperform large stocks.  I therefore have slightly more invested in medium and small US stocks (40%) than I do in large (30%).
  • I want to have things that may do well when the stock market is undergoing a correction.  Real-estate is normally fairly uncorrelated to stock movements (except for 2008, when a real estate bubble cratered the stock market).  I therefore have 20% in real estate, which will provide returns almost as good as the stock market over long periods of time since REITs have both rental income and appreciation of property values.
  • I have some money in a managed, large US stock fund, simply because the particular funds I have in my 401k have a track record of great investment returns when compared to the S&P500.  Normally I would forego these and just invest in index funds since the fees are higher for managed funds and performance is normally about the same as index funds, but so far the managers have shown themselves worth the fees charged in my case.
  • I have some international exposure as well.  Most of the time, the action is in the US, but during some periods international stocks do better.  I always want to be invested in whatever is doing well at a given moment.

       

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An important aspect if you want to do well is discipline.  You need to decide upon your allocations and stick with them through think and thin.  At times, it is difficult to stay invested the way I should.  For example, in late 2016 with the Brexit and other events, the international stock fund in my 401k has been doing poorly over the last year, while US stocks have been doing well.  I was very tempted to drop the international stock fund and just be in US stocks, given the performance.

This would have been exactly the wrong thing to do, however.  Since international stocks have been doing poorly, while US stocks have been on a roll, the price of US stocks has been bid-up and international stock prices have dropped and some stocks may be under-priced.  We may very well see a shift from US to international stocks as investors look for bargains outside of the US.  When that happens, I certainly want to be there.

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Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.