It’s a savings plan!

In the past several weeks, I have been seeing rising levels of angst in social media as the stock market tanked. While anxiety is certainly appropriate for traders, this kind of volatility shouldn’t be a concern for investors as long as they have a plan.

Learning to redefine your objectives

Here is what I mean by having a plan. In a past post (see The ABCs of financial planning), I outlined an idealized cash flow projection for a young couple with a child, with the black bars representing savings and red bars representing withdrawals from their savings.

An idealized savings plan


If this hypothetical couple has their portfolio structured properly and their cash flow objectives are met, why should they care if the stock market corrects by 10% if their long-term objectives are satisfied?

Don’t fight the last war

Ben Carlson at A Wealth of Common Sense wrote a terrific piece about how even endowment funds, which have a perpetual time horizon, can get gripped by short-termism. He went on to outline the problems of over-reacting to short-term market fluctuations with long-term assets:

  • You constantly change your strategy and chase past performance.
  • You ignore any semblance of a long-term plan.
  • You end up being reactive instead of pro-active with your decisions.
  • You incur higher fees from increased trading, due diligence and switching costs.
  • You lose sight of your actual goals and time horizon.
  • You end up with a portfolio that’s built to withstand the last war, not the next one.
  • You lose out on much of the long-term benefits that come from diversification, rebalancing and mean reversion.
The worst sin of over-reacting to market moves is not just the problem of chasing past performance and incurring excessive fees, it’s the syndrome of fighting the last war. In the last war in 2008, the critical failure was diversification. Bond prices did not react as expected and they went down along with stock prices. Consequently, it was not unusual to see well-constructed balanced portfolios down 20% in the crisis.

I have tried to address those issues by working on market timing, otherwise known as dynamic asset allocation techniques (see Building the ultimate market timing model), as a way of mitigating those effects. But make no mistake, my models do not represent the Holy Grail and these kinds of strategies should only be part of a well-balanced portfolio.I have always considered the term “investment plan” to be a misnomer and overly confusing. It`s not an “investment plan”, but a “savings plan”. Learn to re-define your objectives as meeting your cash flows. Learn to trust the power of the market. Then relax.

17 thoughts on “It’s a savings plan!

  1. In a market like this I focus on the yield I am getting from my income portfolio, which remains near constant as prices and yields fluctuate in opposite directions, and not the total value of the portfolio. Helps me sleep!

    1. I once had a client who focused on 1) how much income he was getting; 2) what its growth rate was; and 3) whether the income was sustainable. The value of the portfolio was somewhere down around priority number 18.

      That experience taught me a lot about setting the right objectives and benchmarks in forming an investment policy.

  2. Hi Cam, this comment has nothing to do with the post above.

    In Twitter, I read that you have scaled out SPX due to OB & resistance level. Is that a trade that belongs to your inner trader (i.e. short term)? Also, since you are selling, do you expect the January lows to be retest? And if so, why (fundamental call/ technical call)? Thanks

  3. Whenever the market corrects, you see the same old articles about ‘stay the course’ and ‘don’t panic’. When I read the articles, what they mean is to keep your portfolio structure intact. Some go deeper and say rebalance back to some ideal structure previously decided on in one’s plan. So if one’s plan is 40% this, 30% that, 30% the other thing and it gets out of kilter, one should rebalance because theory says that things will ‘revert to the mean’.

    That used to work because in a tranquil, glacially changing technology, high-duty protected world dominated by America and rational Central Bankers, things actually did revert to a mean.

    I adamantly, decisively, doggedly, persistently, resolutely, staunchly, steadfastly, strictly, tenaciously, unwaveringly, constantly, indefatigably, intently, obdurately, perseveringly, purposefully, stolidly, believe that is no longer true.

    I do believe one has to stick to a game plan but the plan must include what to do when markets correct and when they boom. This is tactical asset allocation.

    Also, I believe rebalancing by topping up losing investments and sell winners is EXACTLY the opposite of what momentum academic theory has proven. It is killing people’s performance, especially veteran investors.

    Rebalancing fixed income versus equities does have merit because it takes advantage of valuation swings in equities. But even here, one must look at the future evolving investment and economic landscape rather than doing it by rote.

    So, yes, ‘stay the course’ of a thinking person with a game plan based on proven concepts, anticipating market swings, taking advantage of them, following proven strategists like Cam and cool logic.

    1. Ken, I completely agree with your premise of balancing portfolios, “stay the course” superficial wisdom and central banks acting in a profligate manner that are creating distortions in asset prices. Reversion to mean as you point out may not be applicable in the context of central banks now controlling asset prices.

  4. Great article as always Cam.
    But I’m around the second from the last black bar.
    How would my savings plan differ?

    1. I can’t really advise you because I don’t know enough about your situation, such as whether you own your house, your tax situation, your health, your family, your spending needs, etc.

    2. At the second to last black bar, you have 25 to 30 years ahead. I find that people shift too much away from equities as they approach retirement. They think of their retirement date as the target rather than their lifespan.

      Risk free interest rates are so low today that the S&P 500 has a dividend yield about the same as the 10 year bond and only about one percent below the 30 year bond. The S&P 500 value will grow over the next 25-30 years and its dividend will grow amazingly. I suggest people look back 25-30 years to get a sense of change. That is 1985-90. In January 1986, the DJII yielded 4.11%. Let’s say you could have had a 6% 30 year government bonds at that time. You would have had a $60,000 income a year on a million dollars worth until today. The dividends today on on the same million dollar investment in 1986 would be $296,000. Compounding is a great thing over a decade. It’s simply amazing over several decades.

      1. I find the comments on this board kind of puzzling. Here is why.
        I take a nominal 30-35 years of working life, where one can save and put money in the stock market (say one has peak/equilibrium earnings from 30 years of age, add another 30 years to get to an age of 60, which is the logic behind this). Assume a person started that time frame of 30 years from year 2000. At that time, the S&P was 1500, give or take. Today, it is close to 1900, so around 400 points higher. The compounded annualized returns on such an investment would be sub par (1.59% over 15 years; dividends excluded).
        Let us now ask the question, if one were to dollar cost average monthly equal sums of money from Y2k to today. It would appear that, the entire capital thus accumulated would grow at 1.59%, or close to that number. The actual math behind this is beyond me, but mathematicians reading this may help answer this situation. Yes, bonds purchased during that time frame, whether corporate or government, would yield much higher. Bonds, circa Y2k were yielding around 5% give or take, depending on credit worthiness, which sovereign was the underwriter and so on. My conclusion here is that predicting the probability of stock market returns is poor. Bonds, are likely to produce an anchor position in a portfolio, and balanced portfolios may be a better way to invest, especially when deflation rules. Ken, circa 1986, the time frame you are referring to, the US long bond was yielding around 12-14%. One of my senior colleagues was reluctant to buy these bonds, then. Hence, the underlying inflation (or deflation), needs to be considered as well, when portfolios are constructed.
        Long term returns on stocks and bonds, in this century (starting Y2k) have not followed the rules before Y2k (prior to Y2k, stock returns on an average were 8-12%). Since Y2k, they are, as I have shown for the S&P 1.59%. In the mean time, time keeps ticking by, and our hypothetical person, has only 15 more years to accumulate a nest egg of significant value.
        Let us examine the question further, as to what happens if a stock portfolio looses 50% capital as a rule every 7 years (it happened between 2000-2003 and 2007-2009). If periodicity were to be a factor, we are now heading into a same period where one can expect 50% capital loss (I am not predicting this). Investment advisers are unlikely to advise clients of 50% loss of capital. If such losses were to be a rule, portfolios would not produce the returns that they are supposed to. The long term returns on S&P, of 8-12% that are touted by investment professionals, are only seen if no dollar cost averaging is done, and only if one “catches” the right time of the market cycle. So, a person who invests 100 $ in Y2k, would today, end up with 127$ (1.59% returns), but if that person invested in March 2003 or March 2009 they would end up with around 100% total return (both were bear market bottoms). Hence, market timing models like what Cam has described, are a good idea, if they can be shown to work. Yes, on a gross metric, maintaining long positions in the market, when the moving average is above 200 day moving average, is a good rule of thumb way to invest capital. It is a just a rule of thumb timing model, for the lazy people like me reading this.
        Let us now examine the question at hand further, of stock market returns and as a corollary asset valuations and portfolio construction. Being a long term student of the market, I do look at the capital availability that powers stock market valuations. So, balance sheets of federal reserve and other central banks, and the net margin interest on the NYSE, are the two gross metrics I look at. If the US federal reserve were to buy US stocks, the markets would go up. The US federal reserve did buy distressed bond obligations from banks, so it is fathomable that they may buy stocks in open market. Bank of Japan has been promoting stock market investments, through pension plans, and the Europeans are likely to keep supporting their banks from going bankrupt (RBS is a good example in the last week). Strange things have happened historically, like what happened in 2008 in the US. My conclusion here is that asset prices are governed more by capital flows, and capital availability than underlying fundamentals.
        So, as negative interest rates are starting to rear their head (BOJ, yesterday), returns on US stock markets appear very healthy by comparison (earnings yield on US stocks around 6%=PE ratio of 16.x; dividend yield 2.x%). I never believed in currency wars, and always looked at the idea with derision, but am now, changing my opinion about it, as I take note of what is going on globally. So, let us ask the question further, Sweden has -1.25% yield, BOJ -0.25%, Eurozone and Denmark in between (see today’s Wall Street Journal). Let us say, hypothetically, these interest rates were to approach -5%, what would happen to global stocks? Is this unfathomable? No. Circa, 2007-08, Eurozone rates were around 4.25%, which now are -0.25%. The difference between the two is 4.5%. This difference is important to note, in the context of -5% hypothetical short term central bank rates. So the more negative these rates go, the more stocks become attractive, if stock market earnings yields is a barometer.
        In this long message, I would finally like to raise an important question of asset valuation. It appears to me that the central banks globally are desperately trying to fight deflation. Put in another manner, asset prices appear to have reached a level beyond which they are likely to fall than rise. Let us examine, how far that premise is true. Let us look at US real estate prices, that reached a peak circa 2005-06. From that peak, they had no where to go, but to fall. Gold met a similar fate, after it peaked in 2011 around US $ 1900$ per oz. Canadian, Australian, Kiwi $s have met a similar fate, they have collapsed against the US$. By certain metrics, I can say the same thing about petroleum prices also. The Saudi experiment of selling their oil at cheap prices is the headline (why do they not sell it at zero dollars a barrel?). However, reality is that there is very likely to be a lot of cheap oil coming on board, creating massive deflation in oil prices. Yes, if the shale drillers did not have access to cheap capital, Saudi Arabia could drive oil to 500$ a barrel. Leaving the extremes of 0 and 500$ barrel aside, by certain metrics, one could make a case of deflation that has now hit the oil prices. These are rolling asset deflation. Values that keep falling, today, tomorrow and as far as the eye can see. So, would Canadian, London, Australian real estate values collapse next? How about 5th avenue prices in New York? Art work is now starting to take a hit (see article in Wall Street journal, yesterday). Let us furthermore examine the question as to what central banks were doing when assets were increasing in value, say around 2005. AS the US stock market and real estate market climbed, with ever increasing valuations, Alan Greenspan noted that there was no bubble in the housing markets. As real estate prices in US collapsed, banks that were a proxy to US real estate approached bankruptcy (example Lehman brothers). The US federal reserve came to the rescue by making the bank capital whole. Why? My conclusion is that the central banks of the world look the other way, when asset prices are going up, but act when there is deflation in asset prices. How does one invest in such an environment? It is difficult. The best way would be to wait patiently and buy assets once they have lost 60-90% capital. Nasdaq, circa Y2k was a very good example. US real estate only lost 50%, on an average, but New York and Palo Alto prices lost no where near that. Oil prices, today, as Cam points out are likely to carve out a generational bottom. S&P 500, was in retrospect a good buy around 2003 and 2007, in retrospect. One needs to structure portfolios that have healthy levels of cash, to take advantage of such ideas. I find portfolio constructions to be one of the more difficult things in life. Why? Because, portfolio components change in values of extraneous factors some of which I have tried to explain in this message.

        1. D.V., Starting at Y2K you had bonds at 6% and stocks at 40 times earnings or an earnings yield of 2.5%. The net resulting poor return was your 1.59% compounding capital gain plus maybe a 2% dividend yield. Using that starting date makes equities look bad. Using any starting date for bonds from the 15% long rates of 1981 to recently, makes bonds look great.

          But we must invest today going forward. Forget history. It’s not relevant to a person’s current decisions. Interest rates are the lowest they’ve been since the pyramids were built. When rates go up, bonds will go down in price offsetting your interest income. An expert recently said bonds offer return-free risk not risk-free returns.

          At today’s starting point, equities are a clear better choice.

  5. Cam,

    Nice article as always and appreciated, but most of those points by Carlson beg the question: when should you change; how do you know it is not short-term? Since you have spelled out your criteria for predicting bears in other articles, seems like the question boils down to: what do you use to decide the market is right and the indicators not up to speed?

    1. Joseph,

      In this article, I am trying to outline what a neutral position should be, in the absence of any knowledge of the markets. We spend a lot of time around here trying to eke out a percentage point or two of extra return, sometimes with success, sometimes not. But it’s important to keep your eye on the big picture and know where you’re going and how far you are from your objectives.

  6. considering I am right in the middle of studying for Level III, this is a very timely post!

    Cheers Cam, always appreciate your insight

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