Everyone loves a bull market. Stocks don’t rise in a straight line, of course, but that’s okay because just about everyone has a plan.
Buy and hold is one way. Another, favored by active traders, is to “buy the dips,” that is, to buy more when stocks fall back.
After all, it’s a bull market. You probably feel relatively certain that buying declines is a good idea — if that good feeling is rewarded soon after by a new market high.
There’s a certain logic to buying dips in a bull market, but not all markets are obviously bull markets and not all bull markets last.
What on earth do you do when a correction kicks in and stock prices fall? You might buy a dip and see the price go down from there. If it’s a real bear market, things could turn ugly for a while.
The “buy the dips” idea does work to a degree, if instead you call it “dollar cost averaging.” With DCA, as it’s known, you don’t try to figure out when a dip is a dip. You simply invest the same amount every paycheck, every month or every quarter, whatever makes the most sense to your cash flow.
If you do dollar cost averaging right, you end up buying the dips without any effort at all. Your dollars buy more shares when the price is lower and fewer when the price is higher. It averages out to a generally lower “get in” price than if you had tried to guess the lowest points in any period of time.
If you like the automated logic of DCA, why not take buying the dips to its logical conclusion — rebalancing.
Like DCA, rebalancing is best done as a periodic, disciplined practice, something you do whether it makes sense in the moment or not.
You don’t brush you teeth because they feel dirty; you brush daily to stay on top of good hygiene. Same idea. Just do it, and don’t worry so much about why.
As you rebalance, you end up buying the dips because that’s what rebalancing is. You sell a portion of your portfolio that has exceeded its target and buy something else in the same portfolio that’s below target.
Bump and dip
For instance, if you had a 60% stock and 40% bond portfolio and the stock portion rose in value, you would first calculate by how much.
Let’s say it’s now 65% of the dollar value of your portfolio. Bonds, then, now represent 35%, even if they haven’t changed in value at all.
Just like brushing and flossing, you sell that extra 5% and use the cash to buy bonds. You’re back to 60/40, just like before.
You just sold a bump to buy a dip. Just like a stressed-out Wall Street trader trying to catch a low point in the market by luck, only you don’t have to deal with the stress and, over time, your return is going to much better than most traders.
It’s brainless investing, but that’s a good thing. Brains are useful, but they also trick us with emotions and misperceptions. Better to have a discipline and let it do the work.
Every long-term investor says the same thing: Make a plan and stick with it. Then a bear market lumbers into view and those ideals get tested.
But it’s your investing process — not the outcomes month-to-month or even year-to-year — that really makes a difference.
If you are a retirement investor, the declines we’ve seen in the stock market since the beginning of the year should not faze you much. It’s been on par with the market drop we saw late summer last year.
More importantly, this drop pales in comparison to the vertiginous, bar-the-door freefalls we’ve seen even in the last decade. Certainly this is nothing compared to 2008, right?
Talk sometime to an experienced investor, someone with a 30- or 40-year track record. Inevitably, they’ll bring up the dot-com crash in 2000 or the bond market massacre of 1994. Black Monday, 1987.
How did they survive such hair-raising times? They had a process and focused on that, not on the movements of the market.
On the contrary, outcome-oriented investors talk about process, but when things go against them it’s all about damage control.
Fine if it’s your money. Imagine the comeuppance for a professional money manager. Bill Ackman, a hedge fund manager known for taking activist positions and talking a lot in the press, recently apologized to his investors for losses.
Ackman runs Pershing Square Capital Management. His fund bet big on certain companies and then watched valuations rise and fall over the summer without taking action.
Stocks can “trade at any price in the short term” Ackman told CNBC. By the end of 2015 his fund was down double-digits while the stock market broke even.
Ackman’s process is complex. His job, one he is paid highly to do, is to take big bets and be right. Arguably, he did stick to his process during 2015 and just managed to get it wrong enough, long enough to hurt.
Are you smarter than Bill Ackman? Paying more attention? Almost certainly not. The trouble is not that Ackman’s process doesn’t work but that it takes a huge amount of resources and even luck to make it work.
Investing process matters
Everyday investors don’t expend even a tiny fraction of Ackman’s brain power and daily focus. The fact is, if you get an investment “right” at some point, buying it low and selling it high on time, the result is virtually always more about luck than skill.
If you buy investments cheaply, diversify and rebalance, now you’ve chosen certainty over chance. You will own assets that appreciate over time. Rebalancing guarantees that you will sell some at higher prices and buy others at lower prices.
And it doesn’t take much focus to do this process right, so long as you stick to it and do not waver when the indexes dip and the headlines cry warnings of impending doom.
Get a process and stay with it. You’ll do better than the vast majority of investors and even best a few hedge fund managers along the way.
Falling stock market got you down? It’s understandable, but let’s turn the question around: Were you thrilled to buy stock in December at those previously higher prices?
It’s a quandary every investor faces. Buying steadily through a bull market can feel great. Every high is followed by a new high. Nothing seems to drop ever.
Yet we know prices fall. Eventually, stock investors take a breather and reassess. It might be that the economy isn’t growing as fast as before. Or some international event takes over the news cycle.
Or, more simply, earnings don’t seem to be justified by continued stock price increases. The way investors look at this is by calculating price to earnings, known as the P/E ratio.
It’s not complicated, really. You take the market value per share and divide it by earnings per share. The resulting number tells you if a stock is expensive or cheap relative to its expected earnings.
Since stock ownership is really owning access to those future streams of income, it’s best to pay less for them than to pay more. Once a stock is overpriced, investor interest declines and a stock’s valuation can stagnate or fall.
If P/E math has your head spinning (and that’s normal) consider this more concrete argument from none other than Warren Buffett, the billionaire icon behind GEICO and dozens of other firms, including Coca-Cola, Dairy Queen and ConocoPhillips.
“I’m going to buy hamburgers the rest of my life. When hamburgers go down in price, we sing the ‘Hallelujah Chorus’ in the Buffett household. When hamburgers go up in price, we weep,” he told investors not long ago.
“For most people, it’s the same with everything in life they will be buying — except stocks. When stocks go down and you can get more for your money, people don’t like them anymore.”
If you own a lot of stocks and prices fall, the only thing you can do wrong is panic and sell them at a loss. Given time, they will return and go to on to new highs.
Meanwhile, if you have cash — from incoming dividends, interest on bonds, from rebalancing or in the form of tax-deductible contributions — a decline in stock prices is a reason to rejoice. Hamburger is on sale! Load up the cart!
Just ask Buffett
Consider this example. You own Fund A, which you have been buying steadily for five years. You purchased it each month without fail in small increments, just saving for retirement like anyone else.
In a normal correction of 10%, then, you are “underwater” only on the last few months of purchases. If you reinvested dividends automatically, you might even be positive on your total investment cost vs. the current price.
What’s more, lower prices now means you get to keep lowering your average total cost in the investment. It’s time to buy, and that means continuing to buy steadily and reinvesting dividends.
The only people who should be concerned about a correction in the stock market are folks who are a few months or a year or so away from retirement. They have some decisions to make. But even they could have avoided the pain by adjusting their portfolios toward fixed income holdings as they neared retirement.
If you’re 10 years out from that date, a stock decline is good news and a reason to buy, not a reason to worry. Just ask Warren Buffett.
If you’re like most retirement investors, you probably spent much of the last several years ignoring the stock market. Good for you. Crazy markets are stressful.
Now you likely feel like the pendulum has swung the other way. Ignoring your investments seems like insanity. What if it goes down a lot? What if something bad happens?
Let’s hope something “bad” does happen. Crazy markets are what you want as a long-term investor. Don’t believe me? Follow along, and you’ll be convinced.
It’s all about volatility, that is, how much an investment goes up and down in price over time. Some investments are very predictable. Bonds, for instance, tend to slowly creep upward.
Stocks are harder to figure out. They can be high, then low, then high again. Over longer periods, that final resting point tends to be higher, but not at any given moment.
Other investments — foreign stocks, real estate, commodities — each have their own rhythm, their own patterns up and down.
Some of that movement is due to economic cycles. Some are due to interest rates. The availability of money, expressed as liquidity or credit, can have a strong effect, albeit one that’s hard to forecast.
Finally, investors often just move their money, sometimes illogically. They tend to chase returns, to their own detriment. Panics can occur, draining investment dollars out of otherwise perfectly good assets.
Or the opposite happens. Too many investors crowd into a small number of companies. The tech boom, for instance, or the real estate bubble, to name just two recent trends.
The bottom line is, volatility is a good thing for long-term investors. If you invest steadily across a variety of asset classes at a low cost, big moves in pricing means you get to buy more of a great investment at a lower price.
It’s impossible, of course, to predict when you will have that opportunity. So it’s important to remain invested and to rebalance periodically.
Rebalancing helps you to make unemotional decisions about what to buy and when, all the while remaining invested. If stocks take off, you sell gains to buy other parts of your portfolio.
If bonds zoom higher and stocks tank, do the reverse. If everything declines, you stay invested (no need to lock in losses by selling) and wait for a reversal. It will come in time.
Loving crazy markets
If you are saving, or if you have incoming cash from dividends and bond interest, that cash is put to work buying assets as they fall.
Programmatically selling high and buying low is the strategy, and rebalancing makes it happen like clockwork. You don’t have to guess what’s coming next, nor do you pay a penalty for being wrong.
Critics might say, “Well, you also don’t get the excess profits for being right!” And that’s true. The problem is, almost nobody can consistently get the markets right and a lot of people have absolutely mastered the art of getting it wrong.
Do that often enough and you’ll end up broke. Get your emotions out of the way and stick to a plan, though, and you can’t help by compound your way to retirement.
A new survey by Bankrate.com shows that many of us couldn’t come up with enough money to pay an emergency room bill or keep a car running, and that we’d likely resort to credit cards or family loans to get by.
The financial website surveyed 1,000 Americans by phone and found that four in 10 do not have the cash on hand to manage an unexpected expense of $1,000. If that sounds like you, then you need an emergency fund!
Easy to say, hard to do. And there’s the problem of retirement. If you put money away for short-term expenses, that means you aren’t saving for retirement, either.
But you should save before you invest. It won’t help to take on high-cost debt from a credit card or home equity line just to pay for broken crown or bent fender. Here are ways to get an emergency fund started — and then get back to retirement saving.
Pay yourself first, and automate it!
It’s a tried-and-true fact of saving. If you get money out of your paycheck automatically, you tend not to spend it. Talk to your HR director at work and ask about ways to split your check into two direct deposits: One to your checking and one to a savings account.
If you find it too easy to move money out of savings, direct it instead to a spousal account or even to a separate bank! Anything to get into auto mode and have money piling up without your taking notice day-to-day.
Find your “latte factor”
Economists have long pointed out that we spend money unconsciously. Daily budget-busters like pricey coffee and lunches out turn into hundreds of dollars a month before you know it.
Take a slip of paper and write down what you spend every day for a week. Write down actual prices, tax included. Then pick something you can live without and multiply that weekly total by 52. Real money, right? Time to cut back, and you know where to start.
Sell something you don’t use anymore
Everyone has a third TV or a disused appliance somewhere in their house. Is anybody listening to that older digital music player? Watching all those DVD movies?
You can have a yard sale for small items and put big-ticket things like sports equipment on eBay or Craigslist. That should give your emergency fund a nice solid start.
Staycation ’til you make it
We love to take trips during the year to break the monotony of work and school. What if you took that money and put it away instead? How much do you spend on a long weekend trip, counting gas, meals and hotels?
If it’s anywhere north of $500 (and it probably is), bank that money instead until you get to a solid goal, like one month’s pay, in your emergency savings account.
Open a Roth IRA
Many of use want to save for retirement and save for emergencies. A Roth IRA helps you do both. Money you put in as contributions can be taken out later.
You can’t take out growth and dividends, but the contributions are fair game. (Check IRS rules carefully here.) If you don’t hit your Roth fund for emergency spending, it grows with the market just like any other retirement investment.
As the year winds down and the ball drops in Times Square, inevitably our thoughts turn to that other big annual deadline — tax filing day.
Sure, it’s more than four months away on April 15, but there are a lot of year-end moves you can and should make to maximize your return while saving for your own retirement.
The biggest of them is to defer more income, but where and how much can be confusing. Here’s a checklist of five tax prep to-dos as we end 2015 and start a new year:
Check your 401(k) contribution levels
If you have a retirement plan at work, be it a 401(k), 403(b) or 457 plan, take a look at how much you are taking out of your paycheck now. Did the total dollar amount reach your personal goals? Did you get a raise at the end of the year and thus can afford to contribute more?
Contribution limit for 2016: $18,000 per year, plus another $6,000 if you are over the age of 50.
Maximize your personal IRAs
If you don’t have a 401(k) or have a non-working spouse, you can put money instead into an individual retirement account (IRA). The limits are lower but savings into these plans is tax-deferred just like your 401(k).
Contribution limit for 2016: $5,500 for each filer, or $6,000 if you are over 50.
Consider a Roth IRA
Subject to income limits, taxpayers who contribute to a Roth IRA are taxed today on that income but enjoy tax-free growth and tax-free withdrawals later, in retirement.
Contribution limit for 2016: Same as a traditional IRA, but you can contribute to both up to the limit.
Add to health savings accounts
If you have a health savings account (HSA), adding money to your account can reduce your taxable income this year. You have until the tax deadline to contribute to this account but if you send money after Jan. 1 be sure to designate to which year you want to apply the contribution. Your HSA provider might have a special form to fill out, so check on that first.
Contribution limit for 2016: $3,350 for single filers plus another $1,000 for those 55 and older and $6,750 for families, plus the added $1,000 if you are 55 or older.
Finally, it’s just good practice to look over all of your retirement and bank accounts each year and to make sure the named beneficiaries on each account is correct. Often, people divorce and remarry and fail to update these forms. In the case of your passing, the named beneficiary will receive your accounts, no matter who you list as an heir in your will.
Taking the time to work on your retirement is a chore, but it’s one worth doing. Even a small effort today to get your plan in good working order pays big dividends later, when it matters.
If the stock market stays steady for the next few weeks, we could easily end the year slightly up, slightly down or in virtually the same spot.
Stocks go flat. It happens. But that doesn’t mean they are a “bad” investment. Rather, it means that the stock market is working normally.
If you go back five years the rise in the S&P 500 index of stocks has been been impressive, an annualized 12.6% with dividends reinvested. Drop back to 10 years ago and it’s still a solid number, up just over 7% per year.
For the long-term investor, that’s good news. An annualized return of 7.2% will double your money every decade. Put in $10,000 and it turns into $20,000. Then, 10 years later, your $20,000 becomes $40,000. You never put in another cent and it doubles, then doubles again.
Compounding — the fact that investments grow dramatically the longer they stay invested — is a cornerstone of the financial world. Every pension fund and college endowment counts on it.
Owning your retirement investments in a tax-deferred account such as an IRA is a smart move. You save on taxes today and all of those extra dollars work harder for you by compounding.
Sure, the stock market might have a flat year now and again. It might even repeat the dramatic declines of 2008 and 2009.
Yet the risk in owning stocks isn’t the flat times or the bad times. Rather, it’s overreacting to these predictable moments and selling it all at a low point.
The answer is to not only to hold on to your stocks through the rough times but to see falling prices as an opportunity. As the billionaire investor Warren Buffett has noted, we love it when hamburger goes on sale. Load up the freezer!
Retirement investors should have exactly the same reaction to a flat year for stocks. It’s a great time to be a buyer. If you buy with discipline, a down year is a chance to lock in more shares at lower prices, lowering your total cost of stock ownership.
You still get dividends, currently just above a 2% return on the S&P 500 Index. If you have no current income needs, that money is plowed right back into the very stocks you are buying, supercharging your portfolio.
Cheer a flat year for stocks. Unless you’re retiring today, it doesn’t matter. The stock market is taking a breather, that’s all, and letting the economy catch up.
Over decades, in fact, you’ll find that stocks are by far the most powerful part of your retirement portfolio, beating bonds, commodities and cash. It’s the engine of your investment plan.
Five years from now you won’t remember or care what happened in 2015. Ten years on the whole year will be a blip and nothing more. In between, compounding and reinvesting will do the heavy lifting you need to retire with more.
It’s hard to believe, but in just a few short weeks 2015 will go into the history books. As the new year begins, it’s worthwhile to take stock of where you are with your retirement plan.
Reviewing financial progress is important, but you can overdo it. Many people confuse constant worry with diligence. Rather, good due diligence lessens the need for worry.
A quarterly checkup is enough, if you set up your retirement accounts right from the start. If so, a year-end review is as much about closing one year as projecting the next.
Here are some year end investing moves that work wonders for your long-term financial picture:
Increase your 401(k)
If you got a raise in 2015, congratulations! Now make sure you don’t just raise your spending to match. Financial planners call that “lifestyle creep” and it can eat your retirement plan alive. If you’re not already hitting the maximum at work, consider bumping up your 401(k) contributions now.
Add to IRAs
If you have a plan at work that’s costly, get whatever you can in terms of the company match and put the difference into an IRA. You still get a tax break, and you can control costs better in a self-managed IRA account. If you have a non-working spouse, consider opening or adding to a spousal IRA.
Put money into health savings
Many people are moving to health savings accounts (HSAs) to pay healthcare costs. Putting money into an HSA will reduce your taxable income in the year you make the contribution. If you make a contribution after Jan. 1 and want to apply the money to the previous year, ask your HSA provider how to designate that choice.
Convert or add to a Roth IRA
You can save a lot of money in taxes in the future by paying the tax bill now. Putting after-tax money into a Roth means it will grow tax-free and withdrawals are tax-free, too. If converting doesn’t make sense (it’s taxable income this year, on top of your regular income), put in a small amount now. Check to see if you qualify first.
Set new savings goals
You know what you earned last year. Did you save 10%? More? Less? Get a solid grip on what actually happened last year and then decide if you can improve your performance next year. If you need to pay off debts or build an emergency fund first, set a schedule and stick to it.
Great retirements don’t happen overnight and they don’t happen by accident. Taking charge of your financial future is the single most important decision you will make this year or any year.
Don’t worry about New Year’s resolutions. Go ahead and make some investing moves now and put a plan into place. You’ll be pleasantly surprised at how stress-free life can be if you have a plan and you know it’s working.
Remember being 20? (If you’re 20 and reading this, take note.) Everything seemed possible, and the sky was the limit.
Sure, college is hard work, at least if you’re doing it right. That first job is a bracing change, an introduction to so-called real life. Often, first jobs are a mix of fun and work, social experiences and other young people learning the ropes.
Money was the last thing on your mind. As long as the bills were paid, all was good. You drove a simple car, lived in a simple apartment or shared a house, ate out on the weekend and tried to enjoy yourself.
Fast forward 20 years and life can be more angst-ridden. Kids need things. The mortgage is due. Bills come out of nowhere. You make more than you have ever made but it never seems to be enough. Taxes, too.
And then there’s retirement. Are you saving enough? Are you saving at all? Around 40 or so we begin to have a very different relationship with money, one marked by worry and and even a dose of fear from time to time.
Here are some ways to break that cycle of retirement worry, whatever you financial status, in order of importance:
Extinguish all “bad” debts
This is an important first step. If you are carrying credit card debt or home equity line debt, pay it off. If necessary, close credit lines. Make a 12-month plan that ends all high-interest debt and stick to it. If that means you sell a vehicle or put off a vacation, make it happen.
Build a cash cushion
It won’t help to be debt-free (other than a mortgage or car loan) if you can’t pay unexpected bills. And those happen. Work hard to get to a basic cash cushion — one month’s expenses — and then build up from there more slowly to three months or even six.
Pay yourself first
Once the cash cushion is in place, immediately up your 401(k) or IRA savings rate. Get money out of your paycheck before you get paid. It’s the easiest way to save and can save you on taxes, too. Aim for 10% of your gross income per pay period.
A balanced, thoughtful portfolio of low-cost index funds is a proven winner over the long term. You won’t be beating the market, and plenty of your friends will brag about the “killing” they made on some stock tip they got from a friend. What they don’t tell is how much they lost chasing tips in the past. Get a simple plan and stick to it.
Ignore the markets
Here’s the biggie. Once you have enough cash to relax about your monthly cost of living and enough to save and invest, you can pretty much tune out the barrage of financial “news” that is designed to foster panic among investors.
Ignore it. Turn it off. If you want, set a date on your calendar to check your balances once a quarter at most. Then relax already, because things will be just fine.
If you follow the science news, you’ve probably run into a number of stories recently about supposed structures on the surface of Mars — buildings, doors, pyramids and the like — even evidence of humanoid people walking around.
Researchers have a word for this: apophenia. Our brains are hardwired to see patterns in the world. It’s why we cotton to lucky numbers, happy coincidences and all manner of reassuring “facts” that cannot be proven or even replicated.
The same thing happens when we go to invest. There’s an entire industry of investment advisors out there who seek to take advantage of your need to see order where objectively there is no order at all.
The most obvious of the money tricks is technical chart trading, the supposed wizardry of divining the short-term direction of a stock based on the recent past. But that same fallacy of seeking patterns shows up nearly everywhere in the investing business.
Financial journalists run polls of economists to try to predict the direction of interest rates or an index. Analysts peer deeply into the books of a company to derive the “fair value” of a firm and, from that, predict whether a stock will go up or down.
Traders use stock almanacs to develop theories as to why stocks go up in some months and down in others. What sports event outcomes predict a good or bad year for the stock market. How hemlines can be used to prognosticate, and so on.
All of it, unfortunately, relies on apophenia to work. Sometimes the chart-readers will be right, and sometimes wrong. Sometimes the analysts will nail an outcome, and sometimes they won’t.
The times when they fail, we tell ourselves, are due to exogenous factors, one-off events that weren’t expected and were not calculated into the prediction.
Average out the winning predictions and the losers and what happens? It starts to look a lot like guessing. In fact, it is guessing, but we want to believe (our brains really, really want to believe) so we plow on looking for reasons.
We really want the lady walking across the Martian sands to be real, and to live in a pyramid. Never mind how improbably such an outcome is in reality. Our brains want random reflections of light to make it real for us.
Fooled by randomness
The solution, from an investing point of view, is to avoid any kind of attempt at guessing what’s next. You can’t be fooled by randomness, to quote the economist Nassim Nicholas Taleb, if you manage to ignore it.
What can you do with your investments that makes sense? Buy a portfolio that matches your own tolerance for volatility. Invest steadily over years. Rebalance periodically, even it hurts your brain to do so.
Keeping your retirement on track is a matter of avoiding the many intellectual traps set for you by your own brain. It won’t be easy at first, but once those first few years of investing sensibly roll by and you see the results, you wouldn’t have it any other way.