Yesterday I heard a “financial expert” on the radio talking about the recent drop in equity prices. She said, “If you have any big expenses coming up in the next year or two–a tuition payment or something–that money does not belong in the stock market.”
What a shining light of financial wisdom in the darkess. Lady, why didn’t you say this last month? Thank you, Captain Obvious.
Here’s why I got smarter about finance after I quit paying attention to people like her. They always tell you stuff that’s obvious and not actionable. So, let me tell you something actionable to do when the stock market drops a few hundred points.
Relax. A 4% or 5% drop is not a meltdown, a 10% drop is a correction. We aren’t in panic territory, but even if it were…
Financial Planners earn their keep by helping you formulate a plan and then helping you stay the course. The financial planner who told you to move money into the market should be telling you not to sell in a panic. The financial planner should be asking you if little Johnny or Buffy will be heading off for college next fall. Keeping you calm is where they will earn their commission. If your advisor can’t convince you that your plan has already taken the certainty of a drop into account, s/he isn’t worthy.
Stock markets go up and go down. Some individual equities like Enron go from high-flying to bankrupt. This is real risk. This is why I never invest in individual stocks. (I will gamble on individual companies, however.) At the worst of the Great Recession, Index funds went down, but they never went under. The risks of stock market investing are these:
- the companies you own go bankrupt
- you’ll sell at a bad price
An index of thousands of companies mitigates the first risk: a hundred companies may fold, but not all of them will. And given the way capitalism works, the losses from the failures fertilize higher profiits in the survivors. You win because the index fund adjusts how much of each company it owns as they grow or shink.
Another consideration is your dividends rate. It goes up as a percentage when prices go down. If you can live on the lower dividend rate that your index fund pays, you need never sell any equities. And the underlaying equities hedge against inflation better than bonds.
For the index investor, the only risk is being forced to sell when you don’t want to. If we’re looking at a short-term correction, this risk is pretty low.
History has shown us that a recession generally lasts one or two lean years before the economy fully recovers. Sometimes, like 1987 they come back very quickly and we forget they happened. Other times, like 1929 they presage a decade of famine. A paranoid might hold more, but that’s crazy.
The biblical patriarch Joseph prepared for the feast/famine cycle by keeping a strong cash position. Thus he was selling when everyone was buying and vice-versa. In my case, I won’t be forced to sell my VTSAX to buy catfood this year or next–ask me again in 2020.
In fact, if the market goes seriously bad, I’ll take some money from cash to buy more VTSAX at a discount. That’ll shorten my 2020 glide slope, but I think I’ve got some margin. On the up side, that’ll buy a lot of catfood in my declining years.