Playing with Buckets – The Current Market in Context

“So Keith, should I buy stocks now or is the market going lower?”

“What should I invest in if the stock market is going to go down further?  I heard it could drop another 20%.”

“My brother-in-law said that gold is going to skyrocket this year.  He sold out of stocks back in November.  He said we are going into recession.”

If you are a financial advisor or a portfolio manager (as I am), these are very common questions and comments received from clients, friends, and family.

Here is another one I hear on occasion when the market drops: “How do you sleep at night?  I would not be able to sleep being responsible for other people’s money in this market.”

So this quick post is going to put everything in context and hopefully put a few people at ease as the market bounces around as it tends to do more often than not.

As for my sleep, that is determined more by the sleeping whims of my capricious 18-month old daughter than by the fits and starts of the market.  The issue of being responsible for client’s money is hugely important but I do not lose sleep over it because we work hard from the outset to prepare for the inevitable downturns the market will produce.  As long as you plan for downturns and know they are possible, you do not have to stress too hard over them.

Which then leads to the second point; know what your investment is for.  I usually take what is known as a bucket strategy, both with clients, and with my own finances.  That means for each financial goal that I have, I have a mental “bucket” of cash that goes to achieve that goal.  Retirement, if ever, is a very long-term goal.  Going to Disney World is next year’s goal.  I will not be putting my Disney money into the stock market, nor will I let my retirement money sit in a shoebox under the bed.  Each bucket should be invested according to timeframe and importance.

So the most important thing to know is the purpose of the dollars you are investing.  If you tell me that it is essentially gambling money and you’re hoping for some good trading profits, then go for it!  Just make sure you treat the gambling bucket for what it is, and that you do not steal from the other buckets to fund it.  If you want to throw a few dollars trying to time the market, or into that bio-tech company your brother-in-law told you about, fine, but it should be treated the same as money you take to the casino; mostly entertainment where you are hoping to get lucky.

So if you are below the age of 50, you should be max contributing to your IRA, 401k, 403b, or deferred compensation plans, and therefore, you should be thrilled when the market goes down.  That’s because you are a buyer of stocks and the price just got lower.  Go back and read Warren Buffett’s New York Times Op Ed he wrote in October 2008, the deepest throes of the financial crisis.  The link is here (Buffett Op Ed), but here’s what I found to be the most important bit:

“Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.”

If you have a large pot of money which you are now drawing on to provide living expenses, as in retirement, things get a little trickier.  You should start by making sure you are working with a competent advisor who does not pretend to be smarter than the market.  No offense to the brothers-in-law out there, but even a monkey throwing a dart can beat the market on occasion.  If you depend upon your bucket of money to live on, it should not be gambled with.  Depending on the total amount of money in the bucket and the annual spending amount required, it should be a simple manner to put forth an investment plan which will give you the highest likelihood of success.  Think about it this way – you can divide it into two separate buckets – the money you need to live on for the next 3 – 5 years, and the money you need to live on for the next 5 years and beyond.

So when the markets begin to get shaky just remember this – stocks are risky assets.  They will pay you a higher rate of return over a long period of time, but the cost for holding them is a lot of moving around, both up and down.  Therefore, they should only be held to achieve long-term goals.  In other words, stocks go in your long-term bucket.  Funds needed within the next 3-5 years should be counted in the short-term bucket and therefore only hold your safe money.  Safe money doesn’t pay much of anything these days, and that’s just a reality we have to live with.  Don’t buy anything from anyone saying they have a risk-free way to make 5%, or 8% or whatever it is.  They are either lying or incompetent, and that’s not the type of person you want handling your financial affairs.

So to answer the rest of the above questions:

Should you buy stocks now?  You should buy stocks if you are currently under invested in risky assets sufficient to fund your long-term goals (make sure to consult with your financial advisor).  Are we going lower from here?  I don’t really know.  Maybe.  And if we do, and you are a buyer of stocks, you should be happy about it.

What should you invest in if you think the market is going down?  There are securities out there that perform well when the market goes down, but speculating on directional moves should be limited to your gambling bucket, and I surely will not be recommending any.  If you heard the market could go down another 20%, there is someone else on some TV station or newspaper who says it can go up 20%.  No one has a corner on the market, so take all market forecasts as just some smart guy or gal’s educated opinion.  The more certain of themselves they sound, the less serious you should take them.

Follow up Question – “Yeah but this particular guy/gal called the financial crisis!  Doesn’t that mean they are in fact smart and can call markets?”

Investors and analysts who are famous for making big market calls tend to have much lower batting averages on the next big call, so be extra wary of the guy or gal who made headlines for being right on some big market move.  Here are just a couple of examples….

John Paulson – bet against sub-prime and won; bet on gold and lost

Meredith Whitney – bet against banks and won; bet on a municipal debt bomb and lost

Elaine Garzarelli – famously called the 1987 shock; never got back in the market.

Jim Rogers – bet on commodities and won; continued to bet on commodities and lost

This list could go on and on.  I hope you get the point.

Should you buy gold?  No, gold is a terrible investment.  I explain in a post from a few years ago, linked here.  And while I hate to keep picking on the brothers-in-law, it just seems that everyone has one who can pick the best stocks or call the market trends.  These are the same people that can blow up your portfolio if you are not careful.  Use extreme caution, and depending on your brother-in-law’s current experience, credit score, and/or professional designations you may want to keep his advice in the gambling bucket.

Are we going into recession?  It is certainly possible but there are a few things that keep me optimistic.  First, 70% of the U.S. economy is consumer driven.  More people continue to get jobs, prices at gas pumps have gone down, household balance sheets are in good shape, and for the first time in a long time we are starting to see wages increase as well.  That means consumers are getting paid more, spending less on gas, and do not have crushing amounts of debt holding them back.  Either way, you should have an overall portfolio that will not make you lose sleep even if we do go into a recession.

The market is down 7% year-to-date.  That is a blip.  And, if the market moving over the course of a few months causes you to have concerns or want to radically adjust your investments as a result, then maybe you have not done enough work on the outset to 1) Identify your financial goals and divide them into buckets, and 2) Invest each bucket in a way that gives you the highest confidence of reaching that specific goal.

That’s it.  That is the magic sauce.  Everything else in investing is tertiary to these basic concepts.  If you can keep these thoughts in mind, then market swings like this become an opportunity and not a source of stress.  So sleep easy (unless you have small kids, in which case, I sympathize) and make sure to mind your buckets.

Until next time….

“It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent. There must be some wisdom in the folk saying: ‘It’s the strong swimmers who drown.'” –Charlie Munger


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