Source: Yahoo Finance, 2020
Ah crap, our portfolio is down around 20% from its peak. That’s a lot of money. A few months ago, we were cheering on the ASX200 at 7000 points and now we’re wondering if it will go below 5000 points and it feels like a major kick in the guts. This should be a reminder to everyone about how unpredictable markets can be and if you haven’t got a plan to calm your emotions then you’re likely to do something that isn’t in your best interest.
Disclaimer, before we continue, I must remind you that the information on this website is general in nature and not to be considered financial advice.
What not to do
If you haven’t sold out already then selling now will crystalize your losses. You better hold on for the ride!
History reminds us
Something to remember is that crashes are part of the natural cycle of markets. The market has been through countless crashes and corrections in the past and it always manages to surpass its previous peak. Just think, in the last 35 years we had the crash of 1987, the dot com bubble, 9/11 terrorist attacks, the SARS outbreak and the GFC just to name a few. Each time billions have been wiped from stock market valuations yet the market has still managed to recover and surpass its previous highs.
Why is this so? Put simply, the desire for companies to provide shareholder returns, just like the resilience of the human spirit, must never be underestimated. As we speak, companies all around the world are developing plans to quarantine, recover and ensure continuance of their operations. Some companies are even ramping up production to meet demand for their products, I’m looking at you, toilet paper manufacturers! So yes, while it is doom and gloom right now, I’m betting that the world has what it takes to get over this pandemic.
What should we be doing?
Overcoming psychology
Firstly, you need to overcome your own psychology by acknowledging what you do and don’t know as well as what you can and can’t control. Here are some points to consider.
- Acknowledge that this pandemic does have real economic effects and that businesses will be disrupted. However, there’s little way for you and I to know extent of it as well as the exact ramifications that it will have on markets.
- The S and P 500 has fallen over 25% from peak to trough so far and the ASX200 is not too far behind (Yahoo Finance 2020). How low major indices will go is completely unknown.
- Acknowledge that the market will recover in time, but how long will take to do so? Your guess is as good as mine. Accept that the act of trying to time the market bottom is pretty much impossible.
- Accept that your portfolio value is down so selling now will crystallize your losses. It is actually the time to be out looking for bargains. As Warren Buffett once said “Be greedy when others are fearful and fearful when others are greedy”
- If the company that you work for is not performing well, you may lose your job, you have no control over this. What you do have control over is ensuring that you have a sufficiently sized emergency fund as well as good control over your household cash flow.
Time to go shopping
And no… …it’s not time to buy toilet paper and face masks. It’s time to look at buying into the market. To do this you’re going to need cash. While I can’t tell you what you should do, I can share with you how we are approaching this. At the FFE house we have several levers that we can pull in order to access cash beyond what is coming in from our pay checks, these include:
- Savings (including the emergency Fund)
- My epic stash of annual leave
- Investment loan offset account
- Redrawing from the home loan offset account
- Selling stockpiles of toilet paper (ok just kidding, I really can’t help myself with the toilet paper jokes right now)
Depending on what levers you have available, what I will be discussing may/may not affect your individual situation.
Since our asset allocation has already been planned out, and yours should be too, the part that will attract the most thought is how much money should be invested and over what time period. The overall objective being to invest as much money as possible while still maintaining a cash flow situation that allows us to maintain our standard of living. How much money this equates to will depend on cash flow and risk tolerance.
Currently we invest between 50% and 60% of our household take home income into the markets each month, but because the market is so low this amount should increase. Assuming that our cost of living will remain the same, the additional cash will come from pulling 1, or more of the levers mentioned above. The result of this being that our savings will fall; and/or debt levels will rise. This will mean that we need to be comfortable with increased financial risk to the household. Our considerations for using each of the levers are as follows:
Reduced savings levels for emergencies
Reducing the size of our savings account will result in a reduced capacity to deal with an emergency situation. In our situation if a real emergency did arise while our purchased asset values are down, our contingency plan would be to redraw money from our home loan offset account. The cost of this will be interest payments at the current interest rate.
Cashing in annual leave
This will be subject to a double hit of heavy taxation as well as a reduced overall payout due to my recent move back to the city (which results in a loss of all site allowances). We’ve agreed to leave this alone for now as there are other, more economical, alternatives to financing additional share purchases.
Increased investment loan debt
This is exactly what it’s been created for, investing. The item to give careful consideration is the overall portfolio gearing ratio because while debt multiplies gains, it also multiplies losses. So if we’re geared too heavily and can’t service the debt we may be forced to sell assets at a loss, which is an unacceptable situation for building wealth long term. This method is preferred over re-drawing money from the home loan because of the favourable tax treatment of investment loan debt vs household debt; I’ve discussed this previously in my debt recycling article.
Drawing from home loan offset account
As discussed earlier there is no need to touch this unless we encounter a real emergency, and trying to invest extra money in stock market while it’s down is not one of them.
Going forward
So overall our plan is to invest extra into the markets over the next 3 months. The amount will likely be close to double what we are currently investing and will be funded by savings first, followed by the investment loan offset account as and when required. We will re-assess our household situation at the end of May to determine how we are wish to proceed.
Concluding thoughts
So, if you’re still uncertain as to what to do in the current market, I hope this article has given you pause to consider the tremendous investment opportunity that the market has presented. If you are afraid of getting into the market now please have a look at my article about Bad Luck Bill who starts his investment journey just before past market crashes like this one. If you are looking to increase the amount of money that you are putting into the market please consider your household cash flow as well as be considerate towards the increased risk level that your household will face. Creating an action plan will help you reduce emotionally driven decision making which will hugely improve your chances of creating a positive outcome.
Engineer your freedom
References
Yahoo finance, 2020, S&P 500 (^GSPC), last accessed 18/3/2020,
< https://finance.yahoo.com/quote/%5EGSPC?p=%5EGSPC>
Yahoo finance, 2020, S&P/ASX200(^AXJO), last accessed 18/3/2020, <https://au.finance.yahoo.com/quote/%5EAXJO?p=%5EAXJO>