Lazy Man and Money

How I’m Managing Stock Market Risk in 2020

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I hope your 2020 is off to a good start. Are you still keeping up with those New Years resolutions? I hope so! If not, it’s never too late. I didn’t make my 2019 resolutions until late February.

So far my 2020 is going well, especially in terms of investment gains in the stock market. The market seems to be continuing making big gains like it did in 2019. I never thought that the S&P 500 would return nearly 30% after an exceptional 9 year bull run.

I’ve been expecting the market to run out of steam for a few years now. Every time I think it might go south, it gets propped up by something. In 2019, I think it was the tax cuts that allowed businesses to buy back their shares. That’s great for investors, but bad for the national debt and United States infrastructure that requires tax money.

I’ve always been a big believer in aggressive stock market investing. I would invest 100% in stocks, which most of it being in technology. That’s because I’ve been young with a timeline of 50 years. So far it’s been a winning forumla. However, I’m nearly 15 years older than when I started my blog. My life expectancy may give me closer to 40 years of time now.

That’s still a lot of time to make up for any reasonable stock market crash. However, I find myself looking to reduce stock market risk. I think it’s just a natural reaction when the stock market feels like a bubble. It’s rare for a bull market to continue for 10 years. It’s also rare for nearly 30% returns. The combination feels like it must be unprecedented.

Of course, I’ve been feeling like there’s a bubble for some time. Back in 2017, I felt that it may be worth trying to the market using historic Shiller price/earnings numbers. Of course, I didn’t pull my money out of the market. I just slowly started to sell stocks and buy bonds. It was around 3% back then. By 2019 I had about 6% in bonds. These were minor changes, but it made me feel better that if the market dropped 10% quickly, I could deploy some of the money in bonds.

Managing Stock Market Risk in 2020

The big gains of 2019 made me fundamentally review how we’re investing. Our net worth has quadrupled over the decade – almost all through stock market and real estate gains. I learned long ago, that when I was up big at the craps table, it’s best to pocket some profits and play with the house’s money. That’s a little of how I’m approaching 2020.

The biggest thing I’m doing is STAYING INVESTED. Some people would sell, but I don’t believe in that. There’s a case to hold cash, but I’m still an aggressive investor with a long timeline. Holding cash doesn’t feel like the right thing for me.

Cue…

Asset Allocations for 2020

Before I get into my new ideas for asset allocation, I think it’s best to review my previous allocation and reasoning behind it:

Old “Rough” Allocation

I have to add “rough” in quotes, because I didn’t adhere to a strong philosophy on it. I know I should have a strict allocation, but I don’t. I defer to the idea that I’m young and being invested in (mostly) diversified stocks is more important than the actual numbers.

I roughly had a 50/50 mix of international stocks (30% emerging, 20% developed) and US stocks – almost all in VTI, a Wilshire 5000 index that aims to cover the “total” US stock market.

Some people believe that investing in US stocks is as diversified as investing in foreign stocks. The theory is that companies like Coca Cola and Google operate internationally. It’s a fine theory, but I don’t believe it… foreign stock indexes often perform very different from the US ones. If someone shows me that they highly correlated, it will get my attention. Until then, I will continue to invest internationally, because I believe investing in dozens of countries over multiple continents is more diversified than invested in one country in one continent.

In that 50/50 mix, I had very few bonds and a small REIT (Real Estate Investment Trust) allocation. It was likely less than 2% of my portofolio combined. In hindsight, their performance, good or bad, might be brushed as a round-off error.

New 2020 Allocation

As I stated before, my goal is to stay invested. I always want to get a return on my money. The difficulty is always how to stay invested while feeling that the market is far, far overpriced?”

I took a few steps:

  1. The first thing I did is sell 40% of my VTI (Vanguard’s total stock market index). I used that money to buy HDV. HDV is an iShares ETF which focuses on high dividend stocks. It returned a 3%+ yield last year. It’s not very diversified, but it focuses on very boring defensive industries that pay high dividends.

    It’s very likely that this fund will pay 3% dividends even in a (reasonable) crash. That’s much better than what saving accounts pay*. Also, it’s very close to the 4% rule that (loosely) states that you can retire if 4% of your nest egg covers your expenses.

    VTI and HDV both focus on the US stock market, so a crash would impact them. However, HDV’s boring defensive industries probably won’t drop too much as people would buy the stocks for income.

  2. Sold some international stocks

    I love international stocks, but I wanted to cut down on some of that risk. I ended up selling about 5% of my VWO (emerging markets) and VEU (companies outside of the US).

  3. Bought some Bonds and Real Estate

    The small amount of bonds I’ve added over the last couple of years wasn’t very significant in my portfolio. I like to think that they were, but it was mostly for my peace of mind.

    I used the sale of the foreign stocks to buy bonds (ticker:BND) and real estate (ticker:VNQ). Bonds and real estate may crash as well, but they produce strong dividend income. In a (reasonable) stock market crash the value they would lose would be minimal. I ended up doubling both my bonds and real estate allocation.

I don’t know how it’s going to go. I might be leaving some money on the table by not being fully invested in the S&P 500. I really don’t mind, because I’m not trying to chase the best performance.

Now I’d like to hear from you. Are you managing risk with the stock market being high? If so, how are you doing it?

* Obligatory mention that banks pay guaranteed rates and dividend ETFs do not. However, I believe they will as they have always done.

Skip the Product, Buy the Investment

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I’m going to start this article with a couple of housekeeping notes. I hope all the father’s had a great day yesterday.

I know I did. My wife and kids took me to Gillette Stadium (home of the New England Patriots) where I could walk on the field and tour the locker room. It was great to walk on the field and think, “This is where the magic happens!” The biggest draw was the locker room tour. On Tom Brady’s locker there was a motivational “poem.” It said (paraphrased):

1. There are people who “+”
2. There are people who “-”
3. There are people who “X”
4. There are people who “÷”

Surround yourself with 1s and 3s. Ignore the 2s and 4s.

Unfortunately, cameras weren’t allowed in the locker room, so I couldn’t get a picture to give you the exact wording. I tried to find the source and closest I came was this Tweet by Jalen Rose:

The connection makes sense as they both went to University of Michigan with Rose leaving the school as Brady was entering it.

(If anyone can sleuth out the whole thing and post it in the comments, I’d love them forever.)

I have one more quick housekeeping note before we get on to the article. I hope to be writing a lot more in the coming weeks. Camp has started which translates to 2.5 hours more of kids’ care in the evening than I get during the school year. That’s a lot of potential productivity.

Buy the Investment, Not the Product

I was reading Joe from Retire By 40s article about thinking before you buy your first home. The main premise was that the house that you live in is a liability. The bigger the house the more the mortgage is going to be. That’s money that you aren’t going to be able invest. You also need to fill it with stuff. Utilities are also going to be higher for bigger houses in general.

That’s why I always say, “Don’t Buy Too Much House.”

However, Joe notes that real estate can be a great investment. After all that’s how Arnold Schwarzenegger made his first million dollars.

I came away thinking, “Buy just enough house to live in and invest the rest of money into an asset that someone else paying you for.”

iPod Nano, A Love Story

Allow me to illustrate the “Skip the Product, Buy the Investment” with the story of an iPod Nano. To borrow from Dickens, it is the best of examples and the worst of examples.

The iPod Nano came out in September of 2005. For $250, you carry a whopping 4GB of music in an extremely compact space. It was amazing!

You could have bought a share of Apple stock for $6.60 on September 2. While the stock went up a bit on the news, that month you could have bought around 38 shares of Apple stock instead of the iPod Nano (I’m rounding up a tiny fraction of a share, but let’s just attribute it to sales tax.) Today, 38 shares of Apple stock is worth $5548.

You could have made over $5000 if you were able to “think different.”

This is an extreme example, so let me balance it with a counter example. I bought the iPod Nano when it came out. A woman I was dating really wanted an iPod, but she grew up in a family without money. She’d been out of school for only a few years, but had a mortgage (with PMI) and some student loans. It didn’t really make sense for her to buy a Nano.

For Christmas, I surprised her with the iPod Nano and she was speechless. I luckily scored a better investment than buying Apple stock.

Today that woman is my wife. We’ll celebrate our 10 year anniversary next month.

College Funding: FAFSA, Financial Independence, and Real Estate

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I recently wrote that college planning is impossible (but that you should do it anyway). The impossibility comes from having a 2 and a (newly) 4 year old boy. It’s so far away, the best we can do is put aside a significant amount of money and adjust our plans over time.

One of the comments on that article said it best: The decision tree is enormous.

The College Funding Decision Tree

College may be free if some politicians have their way. College tuition could continue to climb at unreasonable rates forcing people to make hard-decisions about whether it’s worth it. Our children may get into some schools and not others. They could be public or private. They could be on a 3-year plan with AP credit and credits from our local college. They could be on a 5-year plan if they switch majors or find it too difficult. All this, and I’m not acknowledging community college or trade schools.

Anything and everything is in play, leading the cost to be literally as low as $0 to as high as $250,000. It seems to make sense to budget for somewhere around $125,000 for each child and let the remaining gap be filled with grants, loans, scholarships, work-study, etc. As another commenter mentioned, many feel it is important for the child to fund part of their own college. I firmly believe in them having some skin in the game.

Financial Independence Makes it A Little Complicated

Regular readers know I am a big believer in the FIRE movement. FIRE is an acronym for Financial Independence/Retire Early. That means you have money freedom before typical retirement age. Money freedom simply means that you’ve achieved Hakuna Matata… you have no worries about money.

When I started this blog ten years ago, I didn’t know such terms existed, but I did know I wanted to get to that place. Years of maxing out retirement accounts, my wife’s military pension, and our real estate have fortunately put us in a good position to achieve that.

It’s so close that the biggest obstacle is the uncertainty of college costs.

Among all the uncertainty, there’s one beacon that represents some stability: The Free Application for Federal Student Aid (FAFSA).

FAFSA and Real Estate

The Free Application for Federal Student Aid (FAFSA) is exactly what it sounds like. It has clear formulas and rules around a family’s income and assets. While those rules may change over time, I would expect the changes to be minor ones.

In other words, it’s something that can be planned around.

For example, retirement assets don’t count. So this person with a hundred million IRA may be in decent shape if he were to fill out the FAFSA. (He’s really not.) To an obviously lesser extent, we would be in better shape as well from years of nearly maxing out all our retirement accounts.

Many people who are financially independent get there by discovering that they can live a fulfilling life and be very happy on a smaller income. It’s easier than trying to save $10 million dollars. We live that frugal lifestyle as well. Having a small income is a big part of the FAFSA application.

It’s like all the pieces are falling into place… except for one… real estate.

One of the legs that supports our financial independence push is real estate. We didn’t plan it that way, but my wife separately bought condos in 2002 and 2005 near the top of the market. When we moved so that my wife could serve in San Francisco in 2006 the properties were well under water. Even today, they are valued at between 25-33% less than what we paid for them.

Fortunately, we were able to rent them and over time the mortgages have started to get paid off. We got a double HARP to refinance them both to 15-year fixed mortgages. Despite all that, we lose a little money each month on them (and a lot when repairs are necessary) while we build equity. In about 10 years, before our children are ready for college, we’ll have significant real estate assets.

[If you are curious you can read a little more about our real estate “empire” here. (There’s a reason why empire is quotes.)]

Overall, I love real estate. I’m not second guessing the decision to keep the properties. The forced savings have really contributed to our net worth.

However, as you may have guessed by now, the FAFSA formula doesn’t work well for those with significant real estate assets. If had taken the money we lost each month and truly maxed out our retirement options (there’s a lot of small business stuff I can do with SEP-IRAs, solo 401Ks) we’d have “protected” assets from the FAFSA. If we created another business, it’s value would also be “protected” from the FAFSA. (And it seems you can’t throw the properties in an LLC and call it a business.)

At the most recent FinCon convention, I talked with a number of bloggers. Some were financial independent bloggers. Others were real estate bloggers. I don’t think I found one person who fit in all the categories of financial independence, real estate owners, and having children… but I’m sure there are many people out there who fit this profile.

I tried to explain my situation to a few people, but it was difficult. It’s taken nearly a thousand words just to paint the picture for you.

I think the correct answer is just to forget about the FAFSA. I have difficulty with that as I like to optimize things in the future. This is the best way for me to look to optimize things.

The other part of me thinks that it might be worthwhile to refinance the 15-year fixed mortgages to 30-year fixed mortgages. Then we’d actually be making money on the properties and we could use it to fund our living expenses which would free me to max out the small business retirement account options. We’d be earning less principle which would make the assets worth less.

Then I stop myself and ask “Is all that worth it for a better FAFSA formula?”

I don’t have any answers here. Maybe you do? If so, please let me know in the comments. Thanks!

Tips on Investing in Non-traditional Options

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In today’s tough economic times, people are seeking to make investments that ensure the most return on their money. This calls for smart and sensible decisions pertaining to where and how to make the investment. Occasionally, it might also require that you look past the traditional investment options i.e. stocks, bonds, and mutual funds.

Non-traditional investment options are increasingly gaining traction among individual investors.

In addition to the group of investors seeking to diversify their traditional investment portfolios, a new crop of investors is increasingly putting money in investments well out of the mainstream as their primary investments.

Non-traditional investments are particularly attractive as they provide the investor with:

  1. Greater investment portfolio diversification beyond the traditional options
  2. Greater risk management options
  3. Access to investments and markets ordinarily inaccessible to regular individual investors

Devoid of the “head spinning” complexity of regular investments today, non-traditional investments are proving a worthwhile venture.

Some of the popular non-traditional investment options include:

1. Collectibles – Collecting things, albeit not a new activity, is fast gaining popularity as an investment option. People are increasingly buying collectibles with an eye on their potential returns.

While this form of investment could give substantial returns, working knowledge of the niche is required. Collectible prices have been known to fluctuate over short periods of time so it is important that one invests in them with “money they could afford to lose.”

2. Jewelry – People are increasingly looking at jewelry as a form of investment rather than focusing on its ornamental value. Businesses like www.frontjewelers.net are helping individuals generate more investment options by offering them franchise opportunities.

It is safe to say that jewelry as a money minting investment can only get better with time.

3. Real estate – Property is arguably the ultimate tangible asset. In contrast to other tangible assets, the price of property performs more consistently and there are numerous ways to invest in the industry. Some of the real estate investment options include:

  1. Investment in rental property – In this option, you acquire a real estate investment at a value substantially lower than the market value. The property is then rented out to tenants. To make the investment pay off, the you look at the price of the property appreciating and mortgage amortization.
  2. Owning your own home – This is a much simpler way to invest in real estate. You live in the investments. For payoff, you look at a combination of mortgage amortization and price appreciation.
  3. Real estate investment trusts – REITs let you invest in massive income-generating properties. Unlike the other real estate options, REITs do not buy real estate properties with a view of reselling them but to increase their real estate portfolio.

    REITs could be alternatively referred to as trust funds with high yields that invest in very big properties and sell on big markets.

4. Peer to peer lending – In the recent past, there has been a considerable growth in the number of lending clubs on the internet. These lending clubs help bypass all the bureaucracy involved in banks as loan intermediaries. The lenders also make good returns on their investments.

[Editor’s Note: I think I’d stick with the later two. After the Beanie Baby crazy of 1996 and its collapse, I’m not big on collectibles. I don’t know the first thing about valuing jewelry. I can look up the price of gold, but I judge the qualify of craftsmanship or style to make it worthwhile.]

Money’s 7 New Rules of Financial Security (Part 2)

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I’m reviewing Money Magazine’s 7 New Rules of Financial Security. You can read Part 1 here.

Rule No. 4: Borrowing

Old thinking: Borrowing sensibly is a good way to build wealth.
New rule: Borrow cautiously. You have to worry about the other guy’s debt too.

Money Summary: Credit was cheap and plentiful like food at Sizzler. Americans acted as expected and ate as much as they could. Now there’s lots of vomiting going on. Next time don’t eat so much. (Sorry, that might not have been Money’s exact point, but I couldn’t avoid the analogy.) Side point, you may be exposed to more leverage than you think. People paying you money may have been leveraged… their leverage becomes your problem when they can’t pay you.

Lazy Man’s Take: Sounds like money is saying that moderation is the key. Hmmm, I remain unconvinced that’s a new rule. I do like the side point though. It’s something that I hadn’t thought about. I had done a lot of investing with Prosper and have found the returns not very good (though my Lending Club returns have been great). Perhaps everyone else’s leverage became my leverage.

Rule No. 5: Housing

Old thinking: You can expect your house to appreciate handsomely over the long run.
New rule: Your home won’t make you rich. But it is an important savings tool.

Money Summary: Except for two decades where real estate had skyrocketed real estate has been in line with inflation. Real estate also has other issues when it comes to investing in it: maintenance costs, insurance, taxes, remodeling costs that rarely pay for themselves, and steep buying and selling costs. Still owning a home is a great “‘commitment device,’ or a tool that forces you to save.”

Lazy Man’s Take: There’s a great chart with the article. It’s well worth clicking over to. I’ll be here when you back. Done? Good. Back in May of 2007, I suggested the housing run up may be due to more people having dual incomes. Maybe I was wrong and it was government subsidies in the 1940s and easy credit and low interest in the 2000s. If that’s true, there’s going to be a lot of disappointed real estate investors.

As far a commitment device goes, it’s pretty easy to set up an account and automatically funnel money into it. You can invest your money in things with returns that not just in line with inflation, but actually exceed inflation.

Rule No. 6: Diversification

Old thinking: A diversified portfolio lowers your risk.
New rule: Diversification won’t always save you – and you need more of it than you think.

Money Summary: Diversify even more. Get an international bond fund. Use Morningstar’s Internet X-Ray tool.

Lazy Man’s Take: I feel like I already wrote this rule. I love diversification, but I don’t think this is really new. The old thinking and new rule basically say the same thing to me. A lowered risk implies that it won’t always save you. Otherwise the old thinking would have been “diversification eliminates all risk.” I have been using Morningstar’s X-Ray Tool for years now.

Rule No. 7: Retirement

Old thinking: Retiring early is a prize.
New rule: Retiring early is a problem.

Money Summary: With 401k accounts shrinking the odds of retiring early is much more unlikely than it was in the past… and it wasn’t very likely then. Staying at your job for another year could make a big difference in if your money lasts. Lastly, you have to consider that you might not be able to work if you want to – your health and the job market could push you out as you get older.

Lazy Man’s Take: Once again, all solid information, but I’m not sure it’s a new rule. We’ve known for a long time that working an extra year makes a huge difference in retirement income. It’s a year you aren’t withdrawing and are adding to the next egg.

I’m going to stick to the old thinking… The new rule isn’t very motivational.

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