moneyFYI
Financial Freedom Is Merely Organized Common Sense
Context Matters More Than The Event
The stock market has cracked recently. The S&P 500 total return index is down more than 23% since the beginning of the year. The number is more than a little unsettling, but we must still ask, “What does it mean?”
The answer is it means nothing until you define the context.
Your investment tactics matter
If you borrowed to buy stocks and you are good at it, you will have lost much of your capital;. If you used $150,000 of your own money and borrowed another $100,000, and then lost 20% of the portfolio, the loan would still be $100,000, and your capital would have fallen $50,000. That’s if you’re good at it. Many leveraged portfolios contain stocks that are more troublesome. If you split your capital 50-50 between Facebook and Netflix on January 1, your capital would be gone and you would still owe $8,000 to the bank or broker.
Your philosophy matters.
If you buy in a lump, you get different answers from when you use a process to invest. If you bought Netflix and Facebook without the leverage, you would have $56,000 of your $150,000 still. Had you deposited 1/6 of your money on the first trading day of January through June, you would have $92,100. Still a significant loss, but not so bad as the single buy approach.
You will notice this example is highly contrived to make a point. Dollar-cost averaging works wonderfully well when prices fall and not so well if they rise sharply. That’s where the philosophy comes in. If you intend to own sound companies for a long time, dollar cost averaging saves you money as prices fall and costs you some as they rise. The thing you must notice is that prices rise more slowly than they fall so on balance you are usually ahead.
When you’re young
If you are 25 and investing to learn and to build wealth for decades in the future, a sharp market drop is not such a bad thing. Your portfolio is not the total of your wealth. You are adding money every month as you save and get stock at bargain prices. Warren Buffett’s advice seems appropriate.
“I’m going to buy hamburgers for the rest of my life. When hamburgers go down in price, we sing the ‘Hallelujah Chorus’ in the Buffett household. When hamburgers go up, we weep. For most people, it’s the same way with everything in life they will be buying–except stocks”
The young have an advantage because they will be buying for a long time
When you’re older.
Let’s take the same $150,000. The owners have been drawing $500 a month, $6,000 a year. Prices are up 8% to $6,480 and the portfolio dropped 20% to $120,000. Their spending need is up from 4% of the portfolio to 5.4% of the portfolio. Further price increases are likely and who knows what will happen to the portfolio. What should they do?
They are not celebrating the lower prices for stocks.
There are many facing that question today, and the answer is not obvious. It is likely different within the group.
The bits to takeaway
The stock market drop means different things to different people. That’s what context is about.
Understand your particular context and it will help you decide better how to invest.
I build strategic, fact-based estate and income plans. The plans identify alternate ways to achieve spending and estate distribution goals. In the past, I have been a planner with a large insurance, employee benefits, and investment agency, a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business. I have appeared on more than 100 television shows on financial planning. I have presented to organizations as varied as the Canadian Bar Association, The Ontario Institute of Chartered Accountants, The Ontario Ministry of Agriculture and Food, and Banks – from CIBC to the Business Development Bank.
Be in touch at 705-927-4770 or by email at don.shaughnessy@gmail.com.
moneyFYI 