Lazy Man and Money

Introducing the Lazy Man Rule of 20

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At the start of 2020, I took a fresh look at the stock market and realized that it was up about four times from 2010. Many people who had $250,000 in the markets in 2010 are now millionaires. My wife and I started working before 2000, so we had already saved up a lot in our 401ks and Roth IRAs before 2010.

I was excited by all this progress. The plan was working to perfection. I had a fear… I didn’t want to lose all these gains. However, we weren’t 45 years old, so we still had a decade or two before we started to access these retirement accounts. I wanted to stay invested, but I didn’t want to take the big risks that I did when I was 25. At that time, not only was I young, but the market had collapsed with the Dot Com bust of 2000. It was the perfect time to buy growth stocks.

In 2020, it looked like technology dominated the stock market. The world’s biggest companies were not GE, Walmart, Citibank, and Exxon like they were back in 2000. Instead, we have GAMAF: Google, Apple, Microsoft, Amazon, and Facebook. (I’m substituting Microsoft for Netflix in the popular FAANG acronym.) To reduce tech risk I replaced much of the major total market index ETF I had (VTI) with a high-dividend index ETF (HDV).

I may have lost out on some gains as the pandemic was great for tech stocks. Alternatively, many companies cut their dividends. However, vaccines came out and the boring companies that are in the high-dividend index are thriving. Those boring consumer staples and energy companies are in-demand as they are generally inflation-proof.

There was one other way that I tried to protect our money in 2020. I added more bonds. I haven’t been a big fan of bonds because historically, the best returns come from stocks. I’d rather have 60 years of 10-12% returns than 60 years of 4-6% returns. However, with stocks in a 10-year bull market, I felt it was best to move some money to bonds to diversify with a lower-risk asset. I slowly started to buy Vanguard’s major bond ETF (NASDAQ: BND).

Fast-forward to today and I was either smart or very lucky. I think maybe it was a little of both. HDV is only down about 5% from its highs. VTI is down around 20%. The tech-heavy NASDAQ index has been off of its highs by about 30%. Bonds haven’t been great as they’ve been down about 11% – but they are at least better than VTI.

One of my good friends has an Investment Policy Statement (IPS) that she loves. An IPS puts down in writing how you are going to invest in advance of any market conditions. The beauty is that once you have your philosophy in black and white you simply have to just execute it. I’ve been thinking about creating one for some time, but I’ve been living up to my Lazy Man moniker on that one.

With the market going down and possibly heading further down, I’ve started to think more seriously about what might be in my IPS. One thing I know for sure would be a valuation-based asset allocation. I know a lot of people stick to one asset allocation and change it to be more conservative as they grow older. One old rule of thumb is that you should subtract your age from 100 and have that percentage in stocks. Thus, at age 45 now, I would have 55% in stocks (100-45). I’m an aggressive investor so that rule of thumb doesn’t sound great to me. (It may work beautifully for you though.)

While I do believe that age should be important in asset allocation, I also believe that the market’s valuation should be considered. Here’s a chart of the Shiller P/E:

The Shiller P/E is an indicator of how expensive the market is. The higher the number, the higher the price you are paying for the earnings. One thing that you’ll notice is that for 125 years until the last decade, when the P/E is above 25 there’s been a crash. It can stay up there for a little while. It almost always crashes at 30 until the last ten years or so. It’s crashed down a bit from 37, but could still have some way to go.

That’s why I came up with…

Lazy Man Rule of 20

The Lazy Man Rule of 20 says that my bonds should be around the Shiller P/E minus 20. When the Shiller P/E was 37, I should have had 17% in bonds. In reality, I had around 15% of my money in bonds. (This is a new rule that I’m implementing now, but it would have been nice to have been at 17% bonds.) Now that the Shiller P/E is at 30, I should have around 10% in bonds. I have been selling off bonds and buying stocks (including the NASDAQ at 30% off), but I still have about 11.25% of my money in bonds. The next day that stocks go down, I may sell 1% of my bonds and buy stocks.

Let’s look at how this may have worked in big market bubbles and crashes in the past. I’ll start with my first year out of college in 1998:

  • Bubble of 1998

    At the top of the market in 1999, the Shiller PE hit about 45. Using my rule of 20, I should have 25% of my money in bonds (45-20=25). In hindsight, it should be 100%, but 25% bonds for an aggressive investor at age 25 is a lot. I may have missed the run-up in 1997 and 1998 as I sold stocks to buy that 25% in bonds.

  • Crash of 2000

    As the market starts to crash in 2000, I allow myself to sell the bonds to buy stocks. Bonds performed well from 2000 to 2003, but the stock market was down 9% in 2000, 12% in 2001, and 23% in 2002. By the time it recovers in 2003 the Shiller PE was 23, which means that I only 3% bonds and 97% stocks. That goes to about 7% bonds (Shiller P/E of 27) until we get to 2008.

  • Crash of 2008

    When the crash of 2008 hits, the Shiller P/E goes to 15%. Suddenly, I was allowed to have -5% bonds. Realistically, I can’t do that, so I get to 100% stocks while the market recovers.

  • Bull Run from 2010 to 2020

    During this time, I’m gradually selling stocks and buying bonds. In 2013, I only have 2% bonds. By 2014, I’m up to 5% bonds. In 2015, I’m up to 6.50% bonds. This continues… in 2017 I had 8%, in 2018, I had 13%, in 2019, I have 8%. Finally, in 2000, I’d be back up to 11%.

One of the keys to my Lazy Man Rule of 20 is that I stay invested. I’m not pulling money in and out of the market. Some people claim that you can’t time the market. Is valuation-based asset allocation timing the market? I think it depends on who you ask. I think it is, but I’m using the market itself to tell me what to do.

Make Your Own Rule

I picked my Rule of 20 out of thin air. It was based on my gut feel and I’ve acted when the stock market is up and down. It was only recently that I made the connection that I tend to have bonds that are Shiller P/E minus 20.

If you are a more conservative investor you might want to choose to keep bonds that are equal to Shiller P/E. Or maybe if you are in retirement, you want to have twice the Shiller P/E in bonds. As I get older, I may move from my Rule of 20 to go through all these valuations.

What do you think? Are you going to explore valuation-based asset allocation? If so, let me know what your rules might be in the comments.

Flight to Safety

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Many of you may not follow the markets day-to-day. That’s a good thing. However, if you are like me, you watched Monday as most major indexes were down 3%. It doesn’t seem like a lot, but usually the market moves in tiny 0.4%-ish increments back and forth. It’s very boring. Yesterday’s drop felt very different. By the end of the day, the markets recovered. Unless you followed the drop, you wouldn’t have even known it happened. Yesterday, the drop stayed most of the day, but at least got a little better towards the end.

Nonetheless, these drops feel like a warning to me. Outside of the quick drop and recovery due to the COVID news in March of 2020, the markets have mostly had a great 11 year run. I’ve written quite a few times during that run how stocks have starting to look expensive. My last article on stock getting too expensive was just last November. I make Chicken Little seem confident about the sky. I still feel justified with the Shiller P/E is through the roof – an indicator of just about every preceding crash.

Well, maybe I’m not that bad. I’ve simply reached the point where my priority is shifting from “growing money” to “protecting money.” It’s a gradual shift as I get older and have more money. I also started from a place where I was investing in powdered water that could sent over the internet. Well, once again, I wasn’t that bad, but I was an aggressive investor. So the shift that I’m doing just probably brings me closer to a normal investor.

If you feel the same, here are some things to consider:

How to Invest with Safety in Mind

  1. Do Nothing

    2. I’ve got years before I use my retirement income. You may too. If so, maybe just be lazy and do nothing. Even when the markets have dropped over the last 20 years, they’ve come back in a year or two. However, if you need that money to live on right away, you may want to make some changes, so you’ll have enough cash to get you through a potential downturn. Unfortunately, no one know can tell you how long that may be.

  2. Get Boring

    3. I love investing in Google, Snapchat, and even a little Lyft. I even bought a few hundred dollars of a penny stock, Super League Gaming (icker: SLGG) on a whim. Only Google would be considered a mostly safe bet of any of these.

    A lot of people have boring index funds. I do too. They are great and perfect for a time like this. During yesterday’s drop, my Snapchat stock lost more than 10%, while my index funds were mostly down 2%. Index funds are great, but some are weighted by company market-capitalization. That means that big tech companies like Apple, Google, Amazon, and Microsoft can control a lot of one of the biggest indexes, Vanguard’s Total Market Index (VTI). If something bad happens to tech, the whole index could considerably.

    Because of this focus on potentially volatile tech, I looked for a different way to hold a lot of great U.S. companies. I found that high-dividend ETF tend to focus on very boring companies that make good profits year-after-year. I went with HDV, though I don’t feel strongly about it over other high-dividend ETFs. The top ten holdings have sectors like energy (Exxon/Chevron), healthcare (J&J, Pfizer), and consumer staples (Proctor & Gamble, Coca Cola). While VTI is down 10+% from its highs, HDV is just down ~2%. Vanguard’s small business index (VB) is down ~15%.

    Of course, a high-dividend ETF (HDV), pays about a 3.5% dividend – money that I can use to buy the other cheap indexes. I should mention that HDV, like any stock ETF, isn’t completely safe – it simply seems safer than an all VTI holding. I’m always going to own a lot of stocks, so at this time I want them to be boring ones of companies that make money and give me their profits.

  3. Shift some Stocks to Bonds

    4. It’s better to do this before the stock market starts going down. I usually like to be 100% invested in stocks – especially since most of my money is in a retirement that I won’t use for years. However, when the market just kept going up and up, I got nervous and started to shift money into bonds. I did it gradually – moving a 0.5% at a time as the market kept going up. Once I got to about 15% of my portfolio in bonds, I stopped.

    As the markets started to sell off the last couple of days, I sold very small amounts of those bonds and bought dips. Realistically, it’s probably not going to move the needle too much. I’m not making big enough moves. Nonetheless, psychologically, it feels good to be able to buy in at lower levels. It also helps me feel that I have some control.

    If you are 100% into stocks now, it may feel tough to sell them now that they are down to buy bonds. Despite that, I feel it is best to get your portfolio in a place where you feel comfortable. Perhaps holding more bonds will do that for you.

I hope you are able to the #1. That’s probably the best. I’m not built that way. I am enjoying how my #2 and #3 plan is working for me now.

Do you have any strategies you use when the market gets jitters?

P.S.

Several personal finance bloggers were asked about how to adopt a frugal lifestyle. Each was given their own question. Fortunately my question was about passive income and frugality. I inherited my frugal lifestyle from my mother, so it would have been tough for me to explain how to acquire a frugal lifestyle.

Is Now the Time to Start Selling Stocks?

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That’s a title, I’ve been typing for at least the last 6 years. It’s usually only once a year and my answer has always been that it’s probably time to diversify with international stocks and bonds, REITs (Real Estate Investment Trusts), and other investments.

Let’s look at a chart to understand why my annual Chicken Little impression:

Shiller PE Ratio

For those who don’t know, the Shiller P/E is a measure of how expensive the S&P 500 is. The S&P 500 is a good proxy for how the overall US markets are doing. It is calculated by doing the following:

Add up the annual earnings of the S&P 500 companies over the past 10 years. Adjust those past earnings for inflation using the Consumer Price Index (CPI). Average the adjusted values for earnings over 10 years. The Shiller PE is the current price of the S&P 500 index divided by those earnings over 10 years.

In short, the Shiller P/E gives you a great idea of where the market is valued in a historic context.

When I looked at the chart over the last six years, I noticed that any time the Shiller P/E got above 25, things didn’t go well. I’ve also noticed that 25 seems to have been at least the “new normal” since around the 2000 market crash. That crash was the only time that the P/E went consistently above 30. In fact, COVID brought the number back down to 25, which for some reason is only available on the table information.

In any case, you can see where the valuation is now in the chart above. It’s higher than before any crash. Could it get up to 50 and stay there? Perhaps. Could earnings catch up and bring it down that way. Of course. If the “new normal” is a baseline of 25, is >39 still too high? I think it is and it leads me once again to warn that a crash may be coming soon.

I got lucky last January and moved more money than usual to bonds before COVID hit. When it did and the stock market got hit, I sold those bonds, which hadn’t dropped much, to buy back into the stock market. It worked out well.

As the market continues to go up and up, I’m starting to get more and more nervous. I’m usually a very aggressive investor, but now I hold more bonds and cash than I ever had. I noticed that emerging markets didn’t have this same kind of run, so I’m investing there as long as valuations make sense. It’s harder to find Shiller P/Es of other countries, but here’s a source (Shiller P/E and CAPE are the same thing).

How To Diversify Now?

In the beginning, I mentioned that it could be time to diversify into international stocks, bonds, and REITs. I think those are core places to diversify. You may also consider the following: gold, cash, cryptocurrencies, and buying other businesses.

I haven’t invested in gold yet. I did invest in another business a few years ago, which has gone very well. I have some REITs, but I may buy more. I have also bought crypto, but I’m unsure about buying more at historically high levels. That leaves me holding more cash and bonds than I would ordinarily hold. In the grand scheme of things, it’s not a lot of cash and it is probably healthy to be more diversified in bonds.

What do you think? Am I being Chicken Little saying that the sky is falling once again? Or is it perhaps wise to acknowledge that it’s been a tremendous 11-year run and all good things will have to end at some point? Let me know in the comments.

Give Your Stocks a Shave

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This will be a quick article today. My wife got back on Friday after 35 days of getting shots in people’s arms. Now she’s in the full-spring cleaning mode that she missed and I need to join in rather than typing on a computer. I’m expecting to have April’s monthly review ready tomorrow and then get back to a more normal schedule of posting on M-W, or T-Th.

The markets have been going up, up, up for weeks now. When I did my monthly net worth we hit another record – about the 6th month in a row. They’ve been big numbers too. You’d think I’d be very happy about this, but I’m not. I get nervous when the markets seem to get too high. The Shiller P/E (CAPE) ratio is higher than it has been since the crash of 2000. A historically high number for the Shiller PE is usually 25… it’s almost 38. Here’s a chart from Multpl.com.

As you can see these kinds of peaks haven’t ended well in over the last 150 years or so. Of course, the stock market in 1904 isn’t close to being similar to 2021 – it’s very different. There’s a chance that things are different nowadays. However, even if you look at the last ten years, the market looks very expensive.

I have an internal conflict when this happens. Since I’m only 45, I want to stay invested for the next few (hopefully several?) decades. The other side of me says to sell high and buy low. It’s hard to be fully invested with a long-term outlook and still believe that the sky is going to fall at some point soon.

So what can you do?

Shave Your Stocks

When the market reaching new records, I like to shave off some stocks and put it into bonds, almost like dollar cost averaging. It may be as much a mental thing than a math thing – I feel that I’m better prepared for the next crash. In reality, the move is small, but I can do it a lot and it adds up if the markets keep going up and up.

I don’t shave off too much at any given time. It can be a half or a full percent of my holdings. I also look at stocks (usually ETFs) that are near their highs. For example, VTI (Vanguard Total Stock Market Index), VEU (Vanguard FTSE All World ex US ETF), and HDV (iShares Core High Dividend ETF) are three ETFs that I invest in that are currently bumping up against their all-time highs. They are all candidates for me sell a bit and buy a little BND (Vanguard Total Bond Market Index).

This is basically little more than rebalancing your asset allocation – a common thing that most financial experts would endorse. However, I look at my investments more than most people (probably a couple of times a day), so the psychological effect is helpful for me. Most people shouldn’t be as crazy as I am in checking stocks.

For that awesomely large part of the population, I humbly suggest that this is a good time to check in on your asset allocation if you haven’t in awhile. They may not be where they were a few months ago. They may not be where you want them with the current market valuation.

What If The Stock Market Drops 50% Tomorrow?

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I’m not a fan of clickbait titles. This may look like a clickbait title, but it isn’t.

It’s an honest thought I had yesterday based on real analysis of more than 100 years of data. Seriously.

Here’s a current (3/6/2018) chart of the S&P 500:

Go ahead and click Image for larger version in a new tab. We might be using that later (Or click for the latest chart on Yahoo and make sure you select the Max number of years.)

It looks pretty good except for the dot-com collapse around 2000 and the sub-prime mortgage collapse around 2009. If those two events didn’t happen, it might look like a Bitcoin chart, right?

I’ve got another chart to show you. Regular readers might know what’s coming up. It’s:

Yep, the good-old Shiller P/E Ratio chart. (Sometimes it’s better known as the CAPE ratio.)

I’ve argued before that there is a crash any time it gets over 25. It may take a few years, but it seems to happen.

That’s all stuff that I have written about in the past. Here’s another piece of data to consider:

This means that currently the market’s price is nearly 33 times its earnings. Throughout more than a hundred years of history it’s been closer to 16.5 earnings (averaging the very close “mean” and “median” numbers).

If the market drops 50% tomorrow it would be at the historically normal valuation.

See, the title wasn’t clickbait, right?

Where Do We Go From Here?*

You may think from the above that I’m suggesting that you shouldn’t invest. I don’t think that and I still own about 90% of my portfolio in stocks. That portfolio is in retirement accounts, so I won’t be touching them for years and years anyway.

I think there a few things that may make you feel better from the dire math scenario I proposed above:

  1. Since around 1988, a solid sample size of 30 years, the Shiller P/E is 24.95 (using yearly chart data). Maybe advances in globalization, internet, better access to investing markets, etc. means that there is a “new normal” of Shiller P/E being 25? This time includes at least 3 crashes too.

    So while 33 is still higher than 25 (my 5-year confirmed this math), maybe the downside isn’t 50%. Maybe it’s 33%. That’s still a big drop, but it’s got to be somewhat comforting, right?

  2. This is the S&P 500, which means they are American companies. You can invest in so many other places. I’ve increased my asset allocation in Europe and emerging markets. Their valuations aren’t as high and they seem to be performing well.
  3. This is the stock market. You can invest in bonds, real estate, commodities, and a bunch more stuff. I’m normally a very, very aggressive investor. I believe a smart plan is to be more conservative in your investing when valuations look high. I’m just going to be a regularly aggressive investor at these valuations.

    4. I’d like to add one more personal note on the last point. I have been buying Twitter stock for quite a few years now. (I’ve written about it many times.) It was a terrible investment for quite awhile. It was really terrible. Overall, I’m up around 60% from what I paid for it. While that may sound great, the general stock market has probably done the same or better over that time.

    Today, I pulled the trigger and sold some Twitter shares. I’m moving the money to my favorite bond ETF (Vanguard’s BND fund). It’s a very basic asset allocation shift towards being more conservative in my investing.

    What are your thoughts on the market? Let me know in the comments below.

    * If you know me at all, this a subtle nod to perhaps one of the best hours in television history: