I’m Scared Of A Crash….Where Should I Put My Money?

The first draft of this post was written on Feb 1, 2018,  1 day before the 666 point drop in the DJIA.  (I write my posts 1-2 weeks ahead) . The post was written in response to reader’s comment, a concern along the lines of “I’m Scared Of A Crash…Where Should I Put My Money?”.  Appropriately, his concern became the title of the post you’re currently reading, and then the market started to wobble.  Causation, or coincidence?

I continued to edit the post through the Yo-Yo market of the past week. The timing is a bit ironic, methinks.

Today, I answer a readers question: I'm Scared Of A Crash....Where Should I Put My Money? Click To Tweet

This post is intended to provide some longer-term thoughts about how you may want to decide where to put your money:

Markets Of All Sorts Are At Record Highs

By almost any measure, Stocks/Equities are highly valued and Bonds are at risk from a shift toward higher interest rates.  Both are at the end of decade-long Bull Runs.  Creeping inflation could force The Fed into raising interest rates a bit faster than markets would prefer.  Reversion-To-The-Mean is starting to get discussed in the press.  Seems there’s always a headline that can justify a market correction.

In reality, it could get ugly.

Or not.

Make no mistake, Risk Is Changing.  We’ll talk about it today, and I’ll share a bit about what we’ve done recently in our portfolio in response to this increased risk.

Risk Is Changing. It's time to be cautious, but it's not time to panic. Click To Tweet

“It’s Not Time To Panic”

Ironically, I wrote the above “Panic” sentence just 24 hours before the market first jolted in the wrong direction.  Today, as I write this section of the post at 3:24 pm on Feb 2nd, the DJIA is down 551 points.

I don’t know where this market will go, and neither does anybody else.  It could collapse next week, or it could bounce back with even more vigor.  On percentage terms, a 500 point move isn’t even a blip.  Don’t forget, a “Correction” is a 10% move (-2,500 points from a 25,000 DJIA), and a Bear Market is defined by Investopedia as a 20% drop (or -5,000 points from today’s DJIA!)

This insignificance of a 666 point move was best highlighted by the following Tweet sent out by Jim over at White Coat Investor one of the brighter minds in the world of blogging, at the close of today’s market:



Where Should I Put My Money?

Today, I intend to answer the question of “Where Should I Put My Money”.  This post was triggered by a reader’s comment in my post “We Just Became 100% Debt Free”.  I’ve copied the comment from Scott below, and I’ll address his concerns below (thanks, Scott, for granting permission to use your comment today!).

I love his comment and suspect many of you feel just like Scott. Today, we’ll talk about it.  I’ll share my response to Scott’s comment later in today’s post, as well as the specific actions we’ve taken in our portfolio during the month of January.



What Should I Do?

My takeaway from Scott’s comment is that many of us don’t know what to do with our money right now.  Markets are volatile, and the future direction is unclear.  The uncertainty is particularly unnerving for those of us approaching the sacred “Red Zone” of retirement.  I can relate to Scott, I’ve had some of the same concerns myself.

Below, I’ll take you through a few steps that I’d recommend you consider if you’re trying to decide what to do with your money.  The steps apply regardless of your age, and regardless of your income.  As you read through the sections, think long term, and consider your tolerance for risk.

For the record, I’ve used these same steps to self-manage our portfolio for 30+ years, and it’s worked well for us.

1. Determine Your Asset Allocation

The first thing everyone should do is determine your optimal asset allocation for your risk tolerance and your current situation in life.  The decision you make on how you’ll allocate your assets will have a huge impact on your returns, as well as the volatility of your portfolio.  If you want to read more details on the topic of Asset Allocation, check out my article “Why Is Asset Allocation Important”.  A few examples:

  • If you’re 60 and dependent on your portfolio for income, you have a lower tolerance for risk, and your portfolio should reflect that conservative tilt.
  • If you’re 30, spend less than you make, and have 10+ years before you need the money, you can tolerate higher risk, and your portfolio should tilt heavily toward equities.

Your ability to tolerate risk will help determine your optimal asset allocation.  Below is a great example of the risk/return tradeoff from White Coat Investor’s recent article What Should The Mix Of Stocks & Bonds Be In My Retirement Portfolio:

2.  Rebalance Your Portfolio

Yeah, yeah, yeah, I know.  Everyone says “Rebalance Your Portfolio”.  BUT….how many of you actually do it?  When is the last time you looked at your Asset Allocation and made a conscious decision to move something between asset classes as a rebalancing move?

Yeah, yeah, yeah. We all know to rebalance our portfolio. But How Many Of Us Actually Do It? Click To Tweet

I did some rebalancing last week, and it was intentional.  I’ll be the first to admit that I don’t do a good job of “formally” rebalancing our portfolio, but I do make “tweaks” from time to time, and it works for me.  I’ll talk about the moves I’ve made in the “What I’m Doing With My Money” section below.  For now, the action item for you is to review your current asset allocation.  I’d suggest you try Personal Capital it’s what I use to track my Asset Allocation, and it’s free (full disclosure, you can also sign up for a paid service with Personal Capital and they’ll manage your assets for you.  If you end up clicking that link above and signing up for the paid service, I’ll get a small affiliate payment to help keep these electrons humming.)

Another way to look at your asset allocation is to ask yourself how much loss you’re willing to tolerate in pursuit of gains.  Below is an excellent chart to help you determine your risk tolerance (Source:  William Bernstein, as shared by The Retirement Cafe):

Action:  Take time now to check your asset allocation and ensure it’s aligned with your risk profile.

3. Don’t Panic

Once you’ve determined your asset allocation, and reviewed your portfolio to ensure that your current allocation is lined up with your target, Don’t Panic.

Markets Go Up, And Markets Go Down. Don't Panic. Click To Tweet

The whole point of having a targeted asset allocation is to be able to relax when the market moves against you since you knew (or should have known) that you’re targeted allocation would have a resulting amount of volatility.

This is what volatility feels like, folks.

It’s pretty uncomfortable when the markets are tanking, but it’s how the markets work. I’ve been investing since 1985, and have lived through many corrections in the past 33 years. The dreadful correction that was 2008 was the most painful and I can remember the entire experience as if it were yesterday.  I had close to $1M invested in the market, and saw my net worth drop by over $220,000 from Dec ’07 to Dec ’08, in spite of my high savings rate and constant Dollar Cost Averaging into the market during 2008.

It hurt.

I never panicked in 2008, but rather kept to the plan, never sold a single share, and consistently invested a fixed amount every paycheck into various investments as determined by our targeted asset allocation.  Several times “near the bottom”, I made some small rebalancing moves and threw some additional money into stocks.

Over time, that patience has been rewarded.

it hurts when your net worth declines, and you realize you do have less wealth than you had a year ago.  That volatility is your price to get the higher long-term returns that equities have historically offered.  Nothing comes for free.  Make sure you consider the cost of volatility when you determine your targeted asset allocation, then don’t be surprised when you see the volatility you’ve signed up for.  It’s the way the market works.  Deal with it, or choose a more conservative allocation strategy.

The following Tweet from fellow blogger Bob @Tawcan is a good reminder of the recent market volatility from a longer-term perspective:


4. Keep Some Dry Powder

When the market really tanked in ’08, I was fortunate to have a bit of cash sitting on the sidelines, which I moved into stocks throughout the correction.  Now that I’m 129 days from retirement, I have a lot of dry powder.  I’ve written previously about the Bucket Strategy we’re using to fund our retirement.  If you’d like more details, click “How To Build A Retirement Paycheck”. (Note:  If you’re within 5 years of retirement, I consider that post “mandatory reading”)

Action: Regardless of your age, net worth, or income…if the current market volatility is making you nervous, consider shifting a bit of your portfolio into cash.  You’ll sleep better at night, and have a bit of dry powder to redeploy in the event of a market correction.  If you’re within 5 years of retirement, start filling Bucket 1 with safe, liquid assets.


My Response To Scott

I thought a lot about what I should say before I typed the following response to Scott’s comment. He was asking “Where Should I Put My Money”, and I knew the answer deserved more than a quick response on a blog post. As I wrote the response below,  I decided I would write the post which you’re reading today.  The topic deserved more attention than I was able to give in the high-level response, but nonetheless, I typed out the following initial thoughts as a response to Scott:


Given that Scott’s risk tolerance profile closely matches mine, my response focused on ensuring that he build up a solid Bucket 1 to ride out any market corrections. The whole point of Bucket 1 is to ensure you have sufficient liquidity, tucked away in low-risk “cash equivalent” investments, to survive through any but the very worst of market corrections.  This is critical as you’re approaching retirement.

ALERT: Markets WILL Correct. It's how they work. Make sure you have sufficient liquidity to ride out any market downturns, especially in your early retirement years. Click To Tweet

Note that I mentioned to Scott that I was re-evaluating my belief that bond funds were appropriate for Bucket 1.  With the increased interest rate risk, bonds aren’t as “risk-free” as many believe them to be, and I’m getting concerned about having Bonds in my Bucket 1 allocation.  See the “What I’m Doing With My Money” section below to see what I decided to do about it (Plot Buster:  I just Sold $170k Of Muni Bonds To Become 100% Debt Free.)


Just Tell Me What To Do!

Some of you don’t want to mess with Asset Allocation.  You Don’t Want To Mess With Re-Balancing.  You just want to be told what to do.

Some of you just want to be told what to do. If that's you, then the following section is for you. Click To Tweet

If you don’t want to do any of the steps above, the following post I put on on ChooseFI may be exactly what you need.  It was targeted to a very large group (11,000 members on the FB group), as some high-level things you may want to consider in light of the 1,800 point drop in the DJIA over the past two trading days:



The response to the post above was incredible.  We’ve had a great exchange in the Facebook group about a lot of the topics which are addressed in this post.  One thing I’d change about that post if I could….rather than say “If you’re under Age 35”, I would revise it to say:

If you're more than 10 years from retirement, a massive correction is EXACTLY what you want to happen. Click To Tweet

The best thing that can happen during your “Contribution” years is a major market correction.  It affords you the opportunity to buy stocks on sale.  Conversely, the worse thing that can happen as you work through your Retirement Red Zone is to have a major market correction cause the sequence of return risk to become a very real threat to your income through retirement.  Take a few minutes, now, to ensure that your “Bucket 1” in your retirement drawdown strategy is adequately funded.


What I’m Doing With My Money

The chart below speaks to me, loudly, and it’s influenced a few moves I made in our portfolio in January 2018.  It’s the projected real returns (after inflation) for the next 10 years by asset class, and it’s really, really ugly:

Source: Research Affiliates

The reality is that we’ve seen a very unusual 10+ year bull market in stocks and a 30+ year bull in bonds.  Based on Research Affiliates projections, we’re going to experience a “Reversion To The Mean”, with much lower real returns over the next decade.  No one can tell the future, but my gut says these folks are directionally correct.  Nothing goes up forever, and the potential for lower returns following this phenomenal run is logical.  Best to prepare for it.

So…what are we doing about it?

I’ve made some “tweaks” in our portfolio over the past month, based on my belief that risk is increasing and a correction is likely over the next 1-2 years.  I don’t believe in market timing, and I intentionally make small but ongoing revisions to our asset allocations when my instinct tells me it’s time to revisit things.  Over the past 30+ years, my instinct has been right more often than not, so I’ve learned to listen to her.  I view this as an informal rebalancing strategy, not market timing.

Below are the actions we took last month, which give you a good sense of how I’m viewing the increase in risk, and how I manage our portfolio with small incremental moves.  Slow and steady wins the race, said the turtle to the hare.

The Steps We Took In January 2018

  • Reviewed our Asset Allocation (I do this every year, as I update our Net Worth Statement following 12/31 year-end reports from our various investment funds.
  • Decided our Asset Allocation was appropriate, and we weren’t too far off target (though a bit heavier than target on S&P500, given it’s recent and incredible Bull Market Run).
  • Quantified how much $ we’ve got placed in Bucket 1 of our Retirement Bucket Strategy, and ran a projection for what our starting balance would be when we retire on June 8, 2018!.  Finalized plans to ensure Bucket 1 would be at targeted levels prior to our retirement (3+ years of spending).
  • Sold $170k of Muni Bonds, paid off our house, and became 100% Debt Free.  The 3.5% risk-free “return” from paying off our mortgage looks to be a good bet in today’s market environment, so I took it.
  • Sold ~$50k of S&P500 and moved it to International (VTIAX), Small-Cap Value (VISVX) and Value funds (VIVAX).    All 3 of these segments have underperformed of late and should be positioned to outperform large-cap US stocks over the next decade. Word Of The Day:  Diversify.
  • Executed a Mega-Back Door Rollover from my 401(k), which resulted in selling ~$20k of large-cap US stocks in my 401(k)  and moving the funds to the Money Market Fund in my Roth for future investment (“Dry Powder”).

None of these moves were particularly large, as I intentionally avoid any single action impacting more than 5% of our total net worth.  I move in small tranches, and only when I feel we need to rebalance to better align with our targeted asset allocation.

If you’re curious, you can also see the moves I made in January 2016 when market volatility jumped for a moment.  As you’ll see, my response to market volatility is consistent, and summarized below:

  • Check your asset allocation
  • Make small rebalancing moves, as required.
  • Keep some “Dry Powder” on hand.
  • Don’t Panic.

Conclusion

Markets are, by there very nature, volatile.  We’ve perhaps become a bit immune to this fact during the incredible bull run of the past 10 years.  Regardless, markets have their personalities, and the undeniable fact remains that to earn “high” returns requires an appetite (and ability) to absorb high volatility.  We’ve been isolated from this reality for a decade, but the facts remain the facts.

Take some time to think about your tolerance for risk, and determine the asset allocation that’s appropriate for your situation.  If you find that your current investment portfolio doesn’t align with your targeted asset allocation, take the initiative to make some smallish, incremental moves, to get you back on track.

Don’t panic.

Markets are, by their nature, volatile.  If you’ve decided that a high exposure to stocks is appropriate for your situation, don’t be surprised when a Bear shows up to join you one night at dinner.  Determine in advance that you have the stomach for the volatility, or determine that you don’t.

It’s called Personal Finance for a reason.

Choose what works for you, build a solid strategy based on your long-term goals, and respond accordingly to the inevitable market volatility.

Put it all together, and hopefully, we can all Achieve A Great Retirement.


P.S.  Some Relevant Articles On The Topic:

For those would like to read more on the topic, below is a short resource list from authors I respect:

As US Stock Prices Rise, The Risk-Return Tradeoff Gets Tricky:  This article from Vanguard presents a balanced view, highlighting the fact that the S&P 500 has risen 250% since the low back in 2008.  Vanguard presents their “Fair Value CAPE” measurement, which indicates that stocks, while highly valued, are not at the extremes reached in the dot-com era.  Their outlook for 5-year returns in the US stock market is subdued, and encourage folks to consider international investing, where returns are projected to be higher.

Source: Vanguard (see hyperlink above)

What To Do When Your Stocks Are Soaring: Ben Carlson writes an excellent blog called A Wealth Of Common Sense and wrote this article for Bloomberg.  Ben shares some ideas on options for investors who are sitting on large gains in their portfolio, with a focus on position sizing (rebalance when something gets larger than your targeted asset allocation), avoiding concentration in a single stock (specifically employer granted stocks), the benefits of diversification, and “reverse dollar cost averaging”, whereby you gradually reduce your stake in highly valued equity by regular sales over a course of several months.

Bubbles, Bubbles Everywhere – How To Protect Yourself from Financial Mentor. I’ve long been a fan of Todd Tressidor, and in this expansive post, he argues that current over-valued asset classes should cause concern, that “something is wrong” and it’s time to be fearful.  Worth a few minutes of your time to read through the thoughts of this mature thinker, who’s lived through numerous corrections.

Breathe, Relax, World Is Not Ending:  Tawcan puts corrections in perspective and speaks to controlling risk through diversification and the importance of time IN the market (vs. timing the market).

5 Moves I’ve Made In Today’s Market Volatility:  A post I wrote during the market volatility of Jan 2016.  You’ll see my action was consistent with the recommendations I’ve made in today’s post.

28 comments

  1. In short, if you were planning on putting it in stocks before the “faux crash” and you have more than 10 years till retirement or when you’ll need it, then put it in the market. You’ll never be able to time it.

    I find these big-move days fascinating, if nothing more than to examine how the media uses click-bait and sensationalism to drive ratings.

  2. We’re sitting tight. We went into retirement with a mound of dry powder for living expenses, and also for building our home. The first few years of retirement are crucial but we’re still thinking long term, and keeping the same mentality we had when we were still adding to our investments each month. That is, we’re keeping an air of nonchalance.

    1. “We went into retirement with a mound of dry powder for living expenses.” Exactly how we’re approaching our retirement, Mrs. G. Hope I can have the same air of nonchalance that you demonstrate! Good luck with your building project at the new Groovy Ranch!

  3. Great article.

    I feel lucky to be 10 plus years away from the red zone. It means I have to worry less on my allocation… All new investments go into the world equity index. We do have our target amount of cash in the Life happens/emergency funds.

    And I am lucky to read blogs from people that are about to retire and define sequence of return scenarios for me.

    All the best

    1. I thought of this article when I read your recent options post about not having any more “dry powder”, ATL. Hope things have turned a bit in your option position with the volatility (one thing for sure, increased vols sure give us a nice bump in the option premiums on those put sales!).

  4. Pretty much in line with what I said a week ago, and the rebalancing post I put up – but you went into much more detail and gave much better explanations. Great job!

    I agree with many of your comment-providers; its a correction. As I understand it, we’re back to around Jan 1, 2018. After a 19% uptick last year, this year may be just cruising along.

    Since, like you, I put in a certain amount each month, I figure I’m getting some of these on sale now, so yay! Since I”m now putting in close to 60% of my gross pay, it wouldn’t hurt if it dropped another 20% for the next 1-2 years, so I could get some stuff at really good sale prices.

  5. Great article. I am in the same boat as you, 54 and retiring(hopefully) at the end of the year. The issue I have is that I only have about half a year in cash. I was about 90% in stocks, which looking back paid off, but foolish. The issue now is to get at least 2 years in cash for a cushion, I would take a huge cap gains hit. Is it worth it for safety if you are going to pay 15% tax on the gains?

    1. 6 months in bucket 1 is concerning, especially with 90% allocated to stocks. As for the capital gains tax, if you need the money in the next two years, aren’t you going to have to pay it anyway? I’d start selling some winners and getting bucket 1 up to 2 years, but that’s just me! “Personal” finance, right! Glad my writing is making you think, congrats on your pending early retirement!

  6. Excellent, excellent blog posting Fritz! I’m within 5 years of retiring myself and your advice presented here makes a great deal of prudent sense. I’ve very recently written a few posts on asset allocation that coincides with your thoughts and insight presented here.
    The bottom line and believe you’ll agree; “if last week’s volatility was nerve-wracking then one’s allocation to equities is too high.”

    MrFIREby2023
    Blogger: https://firechecklist.net/

  7. White Coat Investor: “Wake me when it’s back to like 2013….”

    Tawcan: “Yawn.”

    Fritz: “It hurts when your net worth declines, and you realize you do have less wealth than you had a year ago. That volatility is your price to get the higher long-term returns that equities have historically offered. Nothing comes for free.”

    The three quotes above are perfect examples of why I come to this blog: WISDOM!

  8. So glad I read this post, Fritz! As a new investor, I read Todd’s article and now yours and I’m finding the level of risk I am able to accept. I love when you said, “Make sure you consider the cost of volatility when you determine your targeted asset allocation, then don’t be surprised when you see the volatility you’ve signed up for. It’s the way the market works. Deal with it, or choose a more conservative allocation strategy.”

    A lot of good stuff in here. I really appreciate you sharing the steps you took early in 2018. Even though I’ve got a while to think about that, it is nice to learn from others who go before me.

  9. Thanks for the thorough post Fritz! I feel like I’ve had my 15 minutes of fame now!

    Although there are some differences in some details and in terminology, I find a lot of similarity between this approach and that described in Big ERN’s Safe Withdrawl Rate Series parts 19 & 20 (glide paths). His research showed that some sequence of return risk could be mitigated by starting with a lower equity ratio at the beginning of retirement (if the CAPE >20). This seems similar to the use of buckets and rebalancing over time. I believe his research assumed a negative correlation between equities and bonds, but I’m not sure this is reality today, so the use of cash/money market fund in the 401(k) makes sense.

    In any case, starting retirement with a full Bucket #1 seems to keep your options open to deal with the potential/probable bumps along the path. Thanks again!

    1. It’s the star of the show!! Thanks for leaving the comment, Scott. Your fame will last for decades (you’re on the internet now, and you’ll be here forever!). Big ERN and I are friends, and there’s no one I’ve seen who has done a more comprehensive analysis on the topic of Safe Withdrawal Rates. I agree with his conclusions, and agree with your summary here. My bucket strategy is built with his analysis in mind.

  10. Great article Fritz! I took the opportunity to capital loss harvest some bonds and ultimately replaced with some VBIRX, short-term maturity bonds, hoping to mitigate some of the interest rate risk. I still have more opportunity here (harvesting bonds), but started debating just taking the capital loss and moving this part of my asset allocation into online savings. No interest rate risk and a negligible difference in yield…

    1. Good move, Jason. I took a similar approach with my ~6+ year maturity MUNI fund when I paid off our fixed 3.5% mortgage (reducing interest rate risk on longer maturity bond holdings). As much as I hate the low yield in online savings, the reality is there is no risk of capital loss, and if interest rates continue to climb you’ll slowly see the yields on savings increase. Good strategy for a conservative investor.

  11. I’m moving some bond into MM. Just a few percents now, but maybe more later. We don’t have much cash at all because we’re still in our 40s. Our bond+MM allocation is about 22% at this time. That’s okay for me.

    If I was in my 20s or 30s, I’d go 100% equity and forget about it.

    Also, I wouldn’t get excited until we see 20% drops. The market will probably be okay this year.

  12. We are nearing FI (and maybe RE) so this bucket strategy you speak of is very intriguing. We’re also considering a rising glide path in FI/RE, to at least guard against selling equities early on.

    It seems we didn’t pick the right time in the market cycle to be considering FIRE but that’s life! Just have to plan differently now.

  13. Very good article, Investing can be scary but I think you just have to take your emotion out of the equation and hope for the market to be high when you take your money out, I would personally never do so unless I wanna retire and enjoy my life, so I think it’s very important to just invest but also save some cash at home in case of something bad happen. I do recommend also reading Tony Robbins book “unshakeable” http://amzn.to/2Cps2MN it’s really an awesome book that shows you how to take advantage of the volatility of the market and avoid making some deadly and common mistakes. Thank for the post guys…
    Keep up the good work.
    .

  14. Excellent advice. I have a question for you when did you start building your first bucket. Because it seems liek that would be last. In other words, build your assets in bucket #3 (e.g. 401ks, etc). Then fill up bucket 2 with some assets from 401ks (e.g. lock in gains) and then maybe put your retirement investing into bucket #1, plus other savings for the next 2 years.

    Thoughts?

    1. Great question, Jason. I first started filling Bucket 1 when I was 3 years away from my Retirement Date. I converted ~1/3 of targeted “full” amount in each of the 3 years, resulting in 3 years worth of spending on the day I retire.

      I can understand your argument about it being “your last bucket to fill”, and I would agree with that if your 4+ years from retirement. Regardless of how you do it, the important thing is to have 3-5 years of spending in Bucket 1 by the day you retire to avoid Sequence Of Return risk in the first 3-5 years of your retirement.

      Important stuff, thanks for paying attention and thinking about it!

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.