Q1 Portfolio Review: Well that was a wild ride!
As of March 31st, 2020, our portfolio was sitting at 95% Equities and 5% Cash & Bonds. This was a big shift from the 67% Equity and 33% Cash & Bonds as of December 31st. So this means I put all the bond/cash allocation into the market at the bottom on March 23rd and am now rolling in money, right? Not hardly…
Total performance for the quarter was down 28.1% compared to 21.3% for the Total Stock Market Index. This under performance was a combination of buying the dip early with my bond allocation and having assets that are more sensitive to the market. First, I didn’t get the run up in January through mid February for our ⅓ bond allocation. Then when I bought significantly at the end of February and early March, suffering the downside from there until March 23rd. I was fortunate to see the recovery in the last week of the month – the portfolio was down just over 37% at the bottom on March 23rd.
So What Went Wrong?
I spent a lot of time attempting to design a portfolio against a drop from being near market highs with high valuations. This meant buying both individual stocks that were reasonably valued and historically held up well in recessions and owning both small cap and international index funds where overall price to earnings ratios seemed far more reasonable than the S&P 500. Unfortunately both of these things made our portfolio more sensitive to a pandemic!
Individual Stocks: We currently have 56% of our holdings in individual stocks. Three of our top four holdings all relied on some form of public gatherings. Entertainment Properties Trust owns movie theaters and other experiential properties like ski resorts and water parks. Their tenants were ordered closed and the share price fell by more than 65%. Two of my other top holdings were Disney and Cracker Barrel, each experiencing a 30%+ and 50%+ decline from their peaks. Financial stocks also under performed with my holdings in Bank of America and JP Morgan declining more than 30%. The only large stock holding that outperformed was Costco, which barely moved thanks to lines forming out their stores every morning.
Small Cap & International Funds: The Russell 2000 Index and the Emerging Markets Index both trailed the S&P 500, being down 30.4% and 26.3% for the quarter. The large US companies have more access to capital and traded at a premium compared to the smaller and foriegn companies.
Lack of Technology Exposure: The glaring weakness with my theory / concern over high valuations meant less exposure to technology companies. As the CEO of Microsoft recently said, we just experienced two or more years of digital transformation in two months, and I missed being invested in it. We own a few shares of Apple, Microsoft, Google, and Amazon, but are underweight in this sector as a whole compared to an investor in an S&P 500 Index Fund.
Is This a Temporary or Permanent Loss? It is too early to tell. One of the toughest parts about being invested in the public markets is having to stomach a daily report about the auction value of my holdings. When there are limited buyers in a time of panic, those prices are painful to look at. I have a few holdings that have experienced losses that might be permanent/semi permanent: Carnival Cruise Lines and Norwegian Cruise Lines. These companies have needed to issue equity along with debt at junk bond pricing and did significant damage to their balance sheet. Every other company we own are experiencing pain in 2020’s earnings and potentially some hangover into 2021, but aren’t issuing equity into the teeth of a market decline that will do permanent damage to me as a shareholder in their company. There is temporary damage due to lack of earnings in 2020 and subsequent dividend reductions and suspensions that came along with it.
What About Buying The Dip? We had a 2/3rds stock and 1/3rd bond portfolio at the beginning of the year with the expectation of following an equity glidepath and slowly transitioning this to 100%. Between some outside income I had coming in and the market drops, I shifted too much into equities too early in this decline. Not only did I buy too early, but I bought some of the same assets that declined too quickly. The bond allocation that should have cushioned the downturn instead was put into risk sensitive assets on or before March 9th. The total market index has recovered to the March 9th level as of April 30th, but the Russell 2000 small cap index is still 15% below its March 9th levels as of April 30th and has even further to go to get back to late February pricing.
The positive news is that after April 15th, the more sensitive assets have been recovering a bit quicker and closing their performance gap against the S&P 500 Index..
So Am I Worried?
Not really. Fortunately we still have 20+ years of living expenses, a flexible budget, and some side income coming in. Seeing hundreds of thousands of dollars in net worth evaporates hurts, but it’s important to remember this is why the 4% rule (or thereabouts) works, along with knowing the power of budget flexibility and that we went into this with more than our financial independence goal saved. There are two podcasts that were released in the last month that speak to why this isn’t the end:
Michal Kitces on Bigger Pockets Money
Have We Seen The Bottom – With Big Ern
So What Happens Next?
I’ll eventually post all the lessons learned out of this decline, but we are still in the midst of a steep economic recession and uncertain recovery time due to this pandemic. I am being careful not to make any major changes to the portfolio and plan on enjoying the upside of these sensitive assets since I suffered the downside. Long term I already know I’ll segregate out a portion of the portfolio and revert it into an S&P 500 index fund and a lower risk bond fund. This will serve as the “meat and potatoes” while having a smaller chunk of money for individual stock investing. I know I will always tinker with some level of stock investing, but the size of these investments will be better managed since the consequence of a significant and permanent market loss is me going back to work. That consequence isn’t worth the benefit of a slightly better lifestyle that comes with taking incremental risk and beating the market.