It looks like February 2020 is going to deliver the price of admission for everyone owning the equity markets: We’ve experienced a nice slow climb up over the last six months, completely reversed by taking a broken elevator shaft down. In the span of six days, the market has given up eight months of gains and is down by 12.25% as of closing on February 27th.
This is the fastest weekly fall in the market since October of 2008! Another headline reads that yields on the 10-year treasury bonds have fallen to all time lows!
Market’s volatility index, otherwise known as the “Fear Index”, measured by the spread in options is at its highest levels since 2011.
CNN Money’s Fear/Greed Index is sitting at 13. This gauge’s all time low was a 12 on September 17th, 2008!
It’s as if we had a bunch of reluctant participants in the market all use this as their reason to fly to the exits! I’ve fielded a lot of messages over the last week from friends asking:
What are you doing?
Are you selling anything?
Are you buying anything?
Will you be okay?
I am not in the business of giving investment advice, but this financially independent early retiree is going to be okay. Below I’ll disclose what I’ve been doing over the past couple weeks, what I plan to do if this market selloff intensifies, and some thoughts about the recent drop.
What is Working:
- The Investment Policy Statement: Prior to leaving my career, I wrote an Investment Policy Statement which outlined where our assets should be allocated and what justified opportunistic buying opportunities. The Investment Policy Statement is open of those documents that you don’t need to look at…until you *really need to look at it*. Some of the adjustments I’m making to the portfolio were predetermined more than twelve months ago.
- Equity Glidepath: I’ve written repeatedly about using the equity glidepath outlined by Karsten @ Early Retirement Now. Based on the history of market returns, the biggest risk to a 4%ish safe withdraw rate working is a steep drop in equities with a prolonged recovery. The equity glidepath is our safety net. Shortly after retiring, we moved our asset allocation to 60% stocks and 40% and held some of our bonds in long term treasuries. Our plan was to slowly move this to 100% over five years. Fortunately our portfolio returned just over 20% in 2019 putting us well above our financial independence number and as of mid February the portfolio sat at 70% stocks and 30% bonds.
- Purchasing during the decline. As of this writing, our allocation is 80% Stocks and 20% Bonds. I wrote an investment policy statement before retiring that spelled out that the VIX index higher than 25 was the time to buy more stocks. It went above 25 and I executed the investment policy statement. The VIX is an excellent measure of fear, but using this means there’s the possibility I’m “buying early” – sometimes volatility stops at 25 and other times it has gone as high as 40-50.
- Working One More Year & Additional Income: We are fatFIRE thanks to the additional time worked and side income still being generated. 95% of the time the additional year or so I spent at work seems like a bad decision. A market drop like this hits and it is a firm reminder that I’m glad we took the conservative path and built a six figure cushion above our original financial independence target.
What Is Our Plan Going Forward?
- The Buy and Hold Forever List: I have a predetermined list of fifteen companies I would like to own and “hold forever”. Businesses can change and I review this list a couple times a year, but this market selloff provided an opportunity to add some of these businesses that I was frankly struggling with their current valuation. I like playing in the “lower risk, lower return” side of equities. I buy larger companies with what I think is low to reasonable debt levels and stable cash flow. I plan on being an owner of these companies for fifty years.
- Loss Harvesting: I might harvest some losses on some of the other individual stocks I own and would rather not own forever and exchange those for either the “buy and hold forever” list or index funds.
- Adding more REIT exposure. The income on many REITs is looking more attractive than it has at any time in my early retirement. The Vanguard International REIT Index (VNQI) is specifically attractive, along with a few individual names I’ve tracked for a while. Low rates help REITs borrow money cheaper and increase the gap between their yields and a bond. This should make them outperform fixed income over the next decade.
- Stay calm: This is the most excitement we’ve had in the market in a while. It creates multiple emotions: Will this bounce back quickly? Am I going to miss out? It also creates the thoughts of “just how far could this go?” This isn’t a time (at least not yet) to go 100% into equities or even go into margin. I still don’t want to risk my freedom chasing returns since things can fall further.
Does this mean everything worked out well?
No. A few things I were doing created some painful losses, including:
- Writing Options for Income: I commented a couple weeks ago about writing some options to generate extra income. With writing options, I’m acting as the insurer against volatility and this sharp move was the *worse case* scenario as the insurance writer! I sold call options on stocks we own that I eventually want to sell at the right price while selling some put options on stocks I want to buy. Thanks to this sharp drop, all of our call options immediately maxed out in value while the put options may result in some small losses in future months if the market doesn’t recover. Howard Marks quoted this drop as something with a ~0.1% probability and listed less than ten instances over the past twenty five years. I’ll be monitoring this and evaluating the strategy. As of today, I think I made the correct decision but had a poor outcome. Judge the decision, not necessarily the results! (courtesy of Annie Duke’s Thinking In Bets)
- Cruise Line Stocks: There’s a saying that investing is a lot like surfing, being right but early is just as bad as being wrong, because the wave still crushes you. I’ve always liked the cruise line stocks, you get a nice on board credit for being a shareholder and own a (normally) boring company that pays a nice dividend. I thought the companies were a nice discount at 10-15% off their highs. Never did I expect news of quarantines, trapped American passengers, and denied port entries causing these companies to fall by 40%. That’s been a painful few weeks. If the coronavirus concerns continue, the travel stocks could look like the banks did in 2008. High fixed costs compared with a sharp then prolonged drop in revenue is catastrophic to their business model. Some may not survive, others might require a bailout, and the investors with the courage to purchase the survivors at the right price will be rewarded for taking that risk.
I don’t know what is going to happen next in the market and that’s okay. Will the coronavirus and its potential other impacts really impact long term value in the world’s markets by 12% or more? I just don’t know. Will the market fall more? I don’t know. These are the times where patience and risk tolerance matters. This isn’t the first drop I’ve experienced and it won’t be the last. Each time seems to be a bit easier to tolerate because I’ve seen it before, but markets never act exactly the same. By avoiding any drastic moves and staying calm, this too will pass.
Michael Milken interviews Howard Marks, specifically listen to the commentary on cycles and psychology in the markets.
Important book referenced in this conversation, Short History of Financial Euphoria
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