Letter to My Mother in Law, and All Baby Boomers
Below is an adapted version of an email I wrote to my mother in law at the beginning of this week. I have added links, clarified a couple of things and tried to make myself sound as non-douchey as possible. So there you have it. Investment and retirement advice from a dumb money retail investment hobbyist.
Dear [Mother in Law],
I’m writing this not because I think you don’t know any of it, but to help clarify my thoughts on my own investments. It’s nice to write to somebody who also has an interest in such things.
I’m writing this because you asked me last night which direction I think the market is going to go.
Despite my call on the market last fall, which you made too, and which we were both correct about, I am very skeptical of anyone’s ability to time the market consistently. If I had to bet money (which investing to some extent is), I would say the market is consolidating now, that earnings expectations for 2013 will fall a bit but not drastically, that there is another likely drop/correction coming in May or June as something (who knows what) freaks people out again, but that the market will finish the year marginally higher than it is today. But really I don’t know. It’s certainly not as clear as at least in hindsight it seemed last Fall.
It is certainly amusing to speculate of course. So let’s speculate. I think the picture is complicated this year in particular by the election. I think if it looks like Romney is going to be elected, the market may go higher than I expect. That is not because a Republican is better for the market (statistics show the market performs better during Democratic Presidencies over the last fifty years), but because his election will mean that the Republicans will instantly abandon their recent push for immediate government austerity, and he will not feel as much pressure. If Obama is reelected, the pressure for early 2013 austerity will be much greater, both because the Republicans will still be pushing for it, and because Obama will need to succomb to such pressures for political reasons (as he has to some extent already in the last year). That’s just my cynical, or as I call it, pragmatic, take.
But all kinds of things can always go wrong. Despite what people say, the Eurozone crisis is far from structurally over, and could flare up later this year. Also, profit margins in corporate America are at near all-time highs, and mean-reversion principles suggest they must go down. The best explanation for why American corporate profit margins are so abnormally large is found here. In short, government deficits are leading to higher profit margins. This suggests we should all fear any coming goverment austerity unless actual business investment picks up much more than it has been doing. (Fiscal government deficits matter, but in the face of historically low interest rates, they don’t matter right now, even if the interest rates are low in part because of Fed manipulation of them.) Another risk is the fear many people have that China has a real estate bubble of its own that is about to burst. China is a bit of a black box economically and the macroeconomic figures its government puts out are possibly not truly trustworthy, notwithstanding the fact that many media outlets quote such figures uncritically. Finally, although the market’s 1-year price-to-earnings ratio is below its fifty year average, and although stocks are historically cheap when compared to bonds, the Shiller/Graham analysis of the market’s price versus its ten-year average earnings says the market is not particularly cheap at all. So this all provides strongly conflicting signals for so-called market timers.
Personally, I’m not terribly worried about stock market drops. A few years ago, I made the single assumption that the world is not going to totally fall apart, and that human ingenuity will make things better over time. This is the “Warren Buffett assumption” that all buy-and-hold investors must make. From my point of view, if that assumption is wrong, it does not matter what we invest in anyway. That assumption I have combined with my long investing time horizon. Since my holding period from today is ideally at least thirty-five years before I draw down (assuming I ever draw down my principle — see below), I just keep adding money. I tend rarely to sell anything, I just modulate my buying using new money that I am saving from my income. When people are freaking out, as they were last Fall, and the market is dropping, I add more money to stocks than when, like now, people are extremely happy and complacent, at which point I just save cash.
When I do invest, I tend to invest in individual stocks or sector ETFs, which I research quite a bit and that ideally I hold for a long time — I hold them as long as my thesis does not change and no accounting irregularities are revealed. For example, I have Exxon and Phillip Morris/Altria stock that I have been holding continuously since 1998, before Exxon bought Mobile, and before Phillip Morris spun out Kraft, sold part of its Miller Brewing interest, changed its name to Altria, and spun out Phillip Morris International. Therefore, I was adding stocks like crazy from about August 2011 through November 2011. Now I’m just not buying much, except for my automatic investments in my 401k, which I never mess with much.
Even when I was buying, I was not buying bonds. For me the choice over the last year or two has been between cash and stocks. Yes, bonds have done well in the last two years as rates spiraled ever lower. But I’m a long-term-picture kind of guy. Bonds seem very dangerous to me as a long term holding of ten years or more, given the fact that rates are so low, combined with inflation concerns.
Anyway, when it comes down to it, I think that for an individual “dumb money” retail investor there are only three viable investing strategies:
- My “buy and hold but keep an eye on it” strategy, described above, is the most active;
- Buy and hold the whole index forever; or
- Buy a basket of index funds and sector/geography ETFs at a preset percentage of each, and then rebalance it back to the original percentages on a set schedule (typically once per year) that has nothing to do with “market timing”.
However, these are all strategies for younger, accumulating investors. I am not your financial advisor, but at your age, it is most prudent to assume that your years of greatest capital appreciation and/or accumulation are behind you. Your primary goal should be not to lose money, even over the short term, unless your analysis shows that you will not be able to retire comfortably on the money you presently have, plus any social security/pensions, etc. (This has nothing to do with my perception of your investment acumen, which for all I know is better than my own, and everything to do with risk management and psychological self-management.) Even if that is your conclusion, your primary goal after making that anlaysis should be to minimize the costs you will have in retirement, not to take on extra risk to try to overcome shortfalls. In no event should you have a majority of your money invested in the market once you get to within about a year or two of retirement, or during retirement, though it is best to talk to an actual financial advisor, which I am not, to determine exact allocations.
The eternal conflict is between preserving your purchasing ability in the face inflation during retirement (especially given the fact that you will need to draw down your investment principle over time, theoretically to zero), versus not taking on risk that could potentially derail or delay retirement. The retirements of many thousands of people who intended to retire in 2008 or 2009 but who had tons of money in the stock market, were delayed, and many other existing retirements were derailed at that time, particularly if the original sin of being over-invested in the market was compounded by selling low in late 2008 or at any time during 2009.
An exception to these retirement rules exists if you have enough money (which I understand you do not), such that you can live solely off of dividends or bond interest (as [my wife’s paternal grandmother] did for years, so [my wife] has told me). That is part of my plan. I plan to accumulate dividend stocks over the next thirty-five years, reinvesting dividends, and then just stop reinvesting the dividends upon retirement and live as much as possible off the dividend income, without worrying at that time about selling the stocks (unless flaws arise in their underlying business models) or about their daily or yearly stock price. This of course assumes I accumulate enough by that time. Upon death I can then pass on the stocks to [my wife] or to my kids and/or to a charity.
Anyway, I hope this has been as helpful to you to read as it has been for me to write.
The Dumb Money