Showing posts with label Investing. Show all posts
Showing posts with label Investing. Show all posts

Friday, June 30, 2017

Have no fear, market crashes will always be here!



While I don't believe that a bear market is coming, one big lesson from the last two recessions is that it can't hurt to be prepared.

Crashes will always come and go. Whether it's 6 months or 6 years from now, nobody really knows. The prospect of me becoming a thousandaire again is not beyond the bounds of possibility.

As a Generation X-er, I've been at ground zero of 2 big market crashes: the Dotcom Bust of 2002 and the Housing Bust of 2008. Both were followed by deep recessions. The great recession of 2008 was way deeper, but the recession of 2002 could be just as deep-- if you happen to work in the tech industry just like I do.

In the summer of 2000, I left my job in Philly to work for a software company that sells analytical tools to fund managers. The company was headquartered in Research Triangle Park, NC --the tech hub of the south. They collect data from investment companies that manage funds pooled by individual investors (i.e. mutual funds) and translates that into useful information.

Times were pretty darn rosy in that the company even paid for my relocation plus some generous sign-in bonus. There was "irrational exuberance" as massive euphoria was everywhere, investors were buying internet companies left and right that have ridiculous valuations. The NASDAQ index rose from 1,000 to almost 4,000 at its very peak.

But sometime around March that year, it came to a crashing halt. The bubble, which had been building up since I moved to the states, slowly started to pop. People lost faith. Stocks sunk. With less and less money to manage, fund managers who have been buying software licenses from us suddenly had to cut back on their spending causing our sales revenue to plummet. I had a strong inkling of a sinking ship  and boy I was right!

Except for the fact that...

I resigned a few hours before I was supposed to get laid off!


In a bizarre case of bad timing,  I submitted my resignation letter just a few hours before my company announced the massive employee layoff. My immediate boss happened to be on vacation that terrible day (maybe on purpose), so I had to give my two weeks' notice to his boss who happens to have a stake in the company's bottom line-- there's no chance he's going to give me a hall pass on severance pay.

The 'firing' process went something like this. A memo appeared on our inboxes telling us which room to go: room A or room B. I was asked to go to room B. Once there, an HR personnel told us that we're in room B because the people in room A will be given their pink slips.

There was complete silence in the room. We know this will happen but not so soon. There was a sense of relief at first. And then people were in tears, especially the ones that were friends with the people in the other room. I couldn't help but think about the friend of mine who just bought a house. But in retrospect, I felt bad for everyone.

As for me, I literally didn't know whether to laugh or cry...

- The good news was that I already accepted a contract position elsewhere that pays $50 an hour.
- The bad news was that I didn't get my severance pay-- I officially resigned, not laid off.
- The worse news was that  I had to work for 2 more weeks to fulfill my obligations. Ugh!!!

Later that day, the whole office was talking about my good but somewhat bad timing.

How not to fear the next market crash

When crazy things happen, always expect the worst. Companies can layoff people at any time, but it can become the norm during a recession-- hardworking people can lose their jobs. When people lose their jobs, they spend less-- much less. And when they do, companies make less money causing them to layoff more people. It's a vicious cycle.

As an investor, however, you should learn to embrace bear markets-- these are the greatest windows of opportunity in your life to leap frog from where you are to where you want to be. When the market drops 20%, 30% or 50%, then you'd be buying shares at a discount. Think of it this way, if bear markets were IPhones you'd be rushing to the nearest Apple store!

Here are some facts:
  • Bear markets generally occur every 4 to 5 years
  • Every single bear markets are followed by bull markets
  • The worst thing that you can do is stay in cash (read this Charles Schwab study).

Keep your portfolio well-diversified

Diversification essentially means investing in a mix of asset classes to ensure you are not in serious trouble even if you lost a significant amount of money on one of your investments. This is because any losses, incurred on any of your investments, may be offset by gains earned by other assets.

Being diversified can help cushion against losses, and that's a precaution that you can take now. Increasing your allocation in bonds, for example, helps soften the effect of a market crash on your portfolio because they are usually inversely correlated to stocks.

You should rebalance your portfolio like a dentist every 6 months to match your goals.

Stay the course, don't miss out on market rebounds

Many investors sold at the bottom of the bear market in March of 2009, turning temporary paper losses into real, wealth-shattering losses.

According to another Schwab study, if you had invested $100,000 on January 1, 2009, but missed the top 10 trading days, you would have had $43,000 less by the end of the year than if you’d stayed invested the whole time. Your timing might end up much worse than mine!

Make cash an integral part of your portfolio

Cash reserves will come in handy in down markets. With cash, you can buy when prices are relatively low, without having to sell any of your existing positions at a loss. Cash can provide your portfolio with a sense of stability and offers protection against volatility. It helps mitigate downward risk.

In my case, I'm setting aside at least 10% of my portfolio in money market accounts. But that's just me, run your own numbers.

Beef up your emergency fund

In a recession, 3 months won't do. You need at least 6 months worth of expenses. Beefing up your emergency fund helps keep your stress level down. Being prepared gives you the confidence that you need to tackle any of life's unexpected events like a job loss during a recession.

I eventually lost that contract job that paid $50 per hour. The original 6 months was shortened to a few months due to spending cuts. But guess what I did?

Instead of rushing to find another job, I toured the whole continental United States for the next couple of months! All because I had my emergency fund in place.

Have no fear.


Learn how to protect your portfolio in a downturn.
Here's a great book that I recommend.


Tuesday, January 31, 2017

The real cost of buying that 65" TV

My wife posing at the Jersey shore.

Earlier this morning, I've sold a mutual fund that I held for 15 long years-- Laudus International MarketMasters Fund™ (ticker symbol SWOIX). As the name suggests, the fund invests in shares of companies outside the United States. It falls under Morningstar's "Foreign Large Growth" category because the fund manager's focus is on the stocks' long-term growth prospects as opposed to their valuation.

I bought the shares in 2002 for $1,699. I no longer have a copy of the trade confirmation because 15 years is obviously a very long time, but I do remember the exact amount. This is because it was one of my first mutual fund purchases outside a company-sponsored 401K retirement plan. I had to roll-over a measly balance of about $5,000 to a traditional IRA account. I then split the amount evenly to buy shares of 3 mutual funds for $1,699 each.

I finally decided to sell the fund in favor of another because of the following reasons:
  • 15 year average annual return of 7.75% is boring
  • gross expense ratio of 1.59% is relatively high even for an international fund, and
  • I decided to switch to a more value-focused ETF fund.

What's interesting is that the shares are now worth a cool $8,580. This is in spite of the fact that I never actively bought additional shares of the fund-- I stopped contributing to my traditional IRA in favor of a ROTH IRA.

The number of shares that I own grew over the years from about 150 to 396 shares when I sold it. Thanks to automatic dividend reinvestment!


That said, you're probably wondering what on earth does the selling of my mutual fund have anything to do with buying a 65" TV ??

Nothing really... so go ahead, buy that $1,699.99 TV on Best Buy.

But I hope this post gave you an idea how much the purchase will really cost you in the long run.



Tuesday, December 27, 2016

Rebalancing your portfolio is like going to the dentist

There's probably nothing more uncomfortable than your visits to the dentist. I don't know about yours, but my dentist certainly doesn't have the gentlest hands that I can brag about. Once you're seated on that dreaded chair, you'll be as helpless as a toddler as she works on scraping the tartar buildup from every corner of your teeth with her very rough hands. It's never a pleasant experience.

The same can be said when rebalancing your portfolio. Except that now, you're in charge. You are the dentist and your patient's set of teeth is your investment portfolio.

Your portfolio needs regular checkup

Every six months you need to get your teeth checked or else you might get cavities no matter how skillful your brushing skills are. Same is true with your portfolio- it needs regular checkup no matter how good your mutual fund or stock picks are.



Just like your visit to the dentist, it's never a pleasant experience. But you know it needs to be done regularly to maintain your financial health. Unlike your experience at the dental chair, the pain is purely psychological.

Rebalancing your portfolio involves selling your winners-- the ones that went up substantially in value, and buying some 'losers' with the aim of adjusting the allocation to match your original goals.

The problem is that this process goes counter to natural human emotions. Because of greed, we tend to buy more of those that went up. Out of fear, we sell those that went down without regard to the long-term outlook. As a result, we end up buying high and selling low.

Perform an X-ray of your investments

The dental X-ray machine provides pictures of the teeth, bones, and soft tissues around them. Not only do these images help find issues with the teeth, but they can also provide some insights on possible problems with the mouth and jaw. A similar tool should be used for your portfolio, and it's probably already being offered by your online brokerage.

I've been a Charles Schwab customer since 2002. I have benefited immensely by the investor tools available on the website. One of them is the "Schwab Portfolio Checkup" tool, which I've been using to 'x-ray' my portfolio on a regular basis.

The following aspects of your portfolio should be thoroughly examined.

Asset allocation

You need to stick to your long-term plan. The majority of your assets should be invested in equities when you're in for the long haul (10 years or longer). Historically, stock investments offer the best upward potential compared to other investments. In my opinion, someone with a high tolerance for risk and longer investing time horizon should allocate 90% of  his portfolio to stock funds.

Equities are often categorized based on market capitalization: large, mid, and small caps. Large-caps are companies that have market capitalizations of $10 billion or more.  As a consequence, they provide stability and liquidity to a portfolio. Small and mid-capitalization companies have more up-side potential for growth given their smaller size.

As you approach retirement, it's wise to gradually increase your allocation to fixed-income instruments such as bonds, which are less riskier. This is especially true when you find yourself unable to sleep at night, constantly worrying about an incoming market crash.

Not only will fixed-income instruments 'soften' the effect of a market crash having no direct correlation with stock market price movements, but they also generate regular income flow that you can potentially reinvest.

My asset allocation as of August of 2016

Sector diversification

The equities portion of your portfolio may be diversified in other aspects, say, market capitalization. But if those companies all belong to single sector then you may be in trouble.</

For example, everyone knows what happened to the airline sector in 2011 as profits were trimmed substantially when the travel industry was hit hard by rising fuel prices.
The chart below displays the percentage of my equity holdings by sector compared to the overall market (S&P Global BMI). Any deviation of at least 20% will be a red flag.



Equity concentration

Billionaire investor Warren Buffett famously stated that "diversification is protection against ignorance" and many investors took this to heart and lost a lot of money.

The problem is not because they got cocky or too confident about their picks that they end up investing in just a couple of individual stocks. Rather, it's because their portfolio is highly concentrated in a few stocks (not to mention that they're not Warren Buffett).

In my case, the two largest individual stocks in my portfolio are Microsoft (MSFT) and Bank of America (BAC), both of which I've owned for a very long time. But they represent less than 5% of my portfolio.


The thing is even if you run the company yourself or are involved in its day-to-day operations, there will always be some risks that need to be managed. The saying that you should never put your eggs in one basket still holds true.

Fixed-income

Like equities, your typical fixed-income mutual fund may be comprised of different types. For example, US treasuries provide stability while municipal bonds provide tax-exempt income. Treasury Inflation-Protected Securities (TIPS) provide protection when inflation is high.

You should examine the allocation of your fixed income holdings to make sure they still reflect your original goals.


Bonds can be also classified based on the credit ratings of the companies or institutions that issued them. For example, US issued treasuries are rated AA+ by Moody's. On the other end of the spectrum are junk bonds, which generally offer higher yields and therefore riskier.

Lastly, it is important to understand how your fixed-income investments react to higher rates. For the past decade, the Federal Reserve kept interest rates very low to promote economic recovery. This is where the time-to-maturity matters. The longer the bond matures, the more sensitive its price reaction will be against interest rate hikes.

Quality

There are many techniques that you can do to check the quality of an investment. In my opinion, it doesn't make much sense to perform fundamental analysis on a baskets of stocks like mutual funds or ETFs (or you'd be more inclined to pick individual stocks instead), so we normally rely on some reliable benchmark to compare to.

One red flag is the consistent underperformance relative to its benchmark. Given a choice, I'd personally invest only in mutual funds that have a long positive track-record. Sadly, they seem to be hard, if not impossible to find, in employer-sponsored retirement plans.

I'd pick a fund with higher Morningstar ratings (3 stars or more). The company provides data on thousands of investment offerings, including mutual funds. It has emerged as the trusted source of investment research.


Expense ratios

You need to pay attention to your fund's expense ratio as it can easily eat up your return. Actively managed funds have substantially higher expense ratios than index funds for obvious reasons-- they need to pay a fund manager and other expenses related to actively managing the fund. Sadly, most actively managed funds don't beat their respective benchmark indices.


I'd personally avoid any actively managed fund that charge more than 1.2% unless the fund has an exceptional track record. Note that international funds generally do have higher expense ratios so it doesn't make sense to compare their expense ratios to domestic funds.


What's next

Your portfolio's 'X-ray' report is an important tool. Using the numbers and information that you gathered, you can adjust your portfolio to better reflect your risk tolerance and time horizons for various goals.
As for me, here's how I've rebalanced my portfolio for 2017. With rising interest rates and record-high equity prices, I decided to increase my cash position while making sure that it is still completely aligned with my current goals.


Just as X-rays can be harmful to you when done too frequently, rebalancing your portfolio too frequently can do more harm than good.

You don't need to follow the day-to-day changes in your portfolio either--- for most of us, that would be stressful and could potentially just lead to reactive, bad investment decisions driven solely by emotions.

In my case, I rebalance my portfolio once in every six months. About the same frequency, as my visits to the dentist.



Sunday, September 11, 2016

9-11 Portfolio

The week ending 9-11 is somewhat catastrophic as global equities and emerging-markets tumbled by at least 2%. Dow Jones index is down by 394 points, while the S&P 500 fell by 53 points. It was the biggest rout since Britain voted to secede from the European Union. The previous two months have been very tranquil in comparison.

That said, my brokerage portfolio lost $2,399.44 in just one day:


Roughly 70% of our assets are invested in mutual funds, and a few individual stocks. 85% of this portfolio is invested in highly diversified stock mutual funds. Only 9.6% of this is invested in bonds, and the rest are parked in cash.


It's probably worth mentioning that a small percentage of the International Equity portion is invested in the Philippines, my country of origin. EPHE is an emerging market ETF (exchange traded fund) that tracks the country's market. It is composed of great companies that I've known since I was a kid (Ayala, SM, PLDT etc.).

The Philippine stock market took a hit when President Obama cancelled a meeting with the country's new president, Rodrigo Duterte, after the latter called him a "son of a w**re":


Note that I'm refraining from making political comments about the new president in an effort not to make this a political blog.

I'd be lying not to admit that I'm somewhat disappointed that our overall portfolio took a hit by around $12,000 or half a million pesos in just one day. But it was only because it was on the brink of reaching the one million dollars mark (the first million is indeed the hardest).

In the past, I've always anticipated buying opportunities. Everyone knows what happened in 2008 when the markets tumbled, tumbled, and tumbled even more due to the housing crisis and credit default swap fiasco. While everyone that I asked, sold, sold and sold more; I bought, bought, and bought more.

Our net worth had quadrupled since then. So trust me, I'm always on a lookout for buying opportunities :)