Uncommon Cents

One of the things I tell any student of mine is that there are things which are simple, but not easy. It’s simple to tell someone, for instance, what they need to do to lose weight: address your eating (less sometimes but not always) and activity level (more sometimes but not always). Even the details are not that hard to fill in (get a cookbook for a diet you like; choose a form of exercise you can afford, find challenging, and can do conveniently; find a group of people who are helpful in your moving toward your goals). So why do so many folks fail at a goal like this when everything is so simple?

Because simple isn’t easy.

Easy means that no to very little effort needs to go into something. If people could lose weight without doing anything to lose it, they’d be fine. But weight loss is work, which requires discipline, consistency, and planning.

Similarly, improving your financial situation is simple, but not easy. “Spend less than you earn.” Simple? Sure. Easy? Apparently not.

What’s very interesting about this situation is that there are lots and lots of things you can do to make the tasks of personal finance easy, but people don’t take advantage of them. Invest automatically through a tax deferred plan? That’s a 401(k) or equivalent. Pay your bills automatically and on time? That’s called online bill pay. Keep track of your expenses? Try Quicken. Deposit your paycheck into your account automatically? That’s direct deposit. Diversify your stock market holdings? That’s an index fund. These are all easy ways to make your financial life better, but not enough people take advantage of them.

If you’re like me, you’ll want as many ways to make your financial life easy as possible. Take advantage of these ways to make things easy and get your financial life in order. They’re simple–and easy.

As we saw yesterday, the stock market performance in September was horrible; my guess is that October was even worse. Let’s see how the portfolio did in October, reported to be one of the worst stock market months of all time.

The Vanguard Total Stock Market Index (VTSMX) declined a whopping 17.16 percent for the month! But again, that shone compared to the T. Rowe Price International Discovery Fund (PRIDX), which was down a miserable 22.98% for October 2008. Once again (like nearly every time this year), the Vanguard Total Bond Market Index was the star of the portfolio, down 3.23% but still paying a decent dividend. This month the portfolio declined even more than in September, to the tune of a staggering 13.80%! However, the silver lining is that the total performance was, again, better than the total stock market even though most of the portfolio is allocated to the total market and the international market. Bonds again show us their value this month. Now, the question is, these have been bad months…

September was bad, bad, bad in the stock market. How bad was it for my portfolio? Let’s take a look.

The Vanguard Total Stock Market Index (VTSMX) was down a nasty 9.23% for the month. Despite that dismal performance, it was stellar compared to the T. Rowe Price International Discovery Fund (PRIDX), down a horrific 15% for the month! Even the rock steady Vanguard Total Bond Market Index (VBMFX) was down 1.4% but continued to pay its very nice dividend.

The total portfolio returned a negative 8.09% for the month! This would be bad for the year, but is positively horrendous for a month. However, notice that the total performance was better than the total stock market (reflected by the included VTSMX), even though most of the portfolio is split between it and the international fund–again, hooray for bonds and asset allocation! Of course, as you can see, September was bad, but tomorrow we’ll see that it could get worse…

There hasn’t been a ton made out of this (and some that is seems very political), but this past month Teresa Ghilarducci, professor at the New School of Social Research (I’ve never heard of either her or the school) testified before a House of Representatives subcommittee on not just eliminating preferential tax treatment of 401(k), 403(b), and similar plans, but her idea on having workers trade in those accounts for “guaranteed retirement accounts” which would have the government add $600 annually into it and pay about a 3% return with an adjustment for inflation.

This is possibly the worst financial idea since the 401(k) debit card.

I’m sorry, but the 401(k) and equivalent plans are some of the best things to ever happen to individual investors. They offer tax advantages and the ability for the investor to (at least in large part) manage their own money, many times with exceptionally low costs and great diversification. My 403(b) administrator is Vanguard and has a brokerage option, allowing me to invest in close to anything I want with very low costs.

If I wanted an annuity, I’d have gotten one.

If this one becomes law, maybe it’s time to think about moving overseas.

There’s been a considerable amount of discussion here as well as in the personal finance blogosphere on the subject of asset allocation (I particularly like this bit on it by my blogging buddy Mrs. Micah). Asset allocation is, in a nutshell, is how much of your total portfolio (your allocation) you put into, for example, domestic stocks, bonds, or international stocks (various assets). When I discussed the end of year performance of my portfolio, I noted that my goal was to have an asset allocation of 50% domestic stocks, 25% international stocks, and 25% bonds; to explain my model relatively quickly, I took 115 and subtracted my age at the time (40), and came up with the number 75. 75 then became my asset allocation for stocks, 2/3 of which would be in domestic stocks (50% of my total portfolio) and the remaining 1/3 in international stocks (25% of the total). What was left–25%–was to go into domestic bonds.

Looking at the allocation of my portfolio right now, we see this:

Domestic Stocks: 44.54%
International Stocks: 18.94%
Domestic Bonds: 36.52%

What does this tell me? It says that the performance of stocks has not been great this year to date; it also tells me that when it’s time to consider rebalancing my portfolio (which I do once a year), I actually want to put more money into stocks. That’s correct: it’s not telling me to run for the hills from my stock market investments, it’s actually telling me to increase the amount of stocks I’m buying relative to the bonds I’m buying. Why? Because the market is down and I can get more for my money in the stock market (I will look at rebalancing a little later in the year).

This is a large part of the purpose of asset allocation; not only does the bond portion help to prevent the portfolio from having even larger losses when the stock market nosedives, the total allocation gives me an indicator of where to put future investments (and possibly even to move money between the various assets). Asset allocation gives you an idea of where to put your money next. Even when I stick to my 115-age formula, we’re only talking a difference of 1% a year; this year I’d say 74% in stocks and 26% in bonds–not very different than last year.

I’m hoping this example shows the importance of asset allocation to those of you beginning with portfolios!

I’m not surprised to see so many people have a knee jerk reaction to the stock market troubles over the last few months. Just a year after hitting all time highs, the markets have lost close to 40% of their value. Many investors are getting out, or at least stopping new contributions.

Here’s why I don’t, and I wouldn’t suggest anyone else do so–

I’m Following My Plan: I don’t invest haphazardly. I have a plan. My plan includes the common buzz words that people use when talking about their plan: index funds, asset allocation, regular contributions, diversification, low expenses, Roth IRA, 403(b). It doesn’t take a lot of time to come up with the plan, but having one is incredibly important.

More important, of course, is following the plan. Just remember, however, that the whole reason you came up with the plan is for times like these–if your plan was sound, just go ahead and follow it. That’s why you have it!

As an aside, in times like these, asset allocation comes into focus as one of the most important parts of your plan. When you’re in your 20s and early 30s, having the vast majority of your money in stocks is fine, but as you get older, making sure you have a reasonable amount in bonds can provide your portfolio with ballast in difficult times.

My Plan is Based on Time Tested Investing Principles: Regular contributions. Asset allocation depending on age. Diversification. Low cost. Using whatever tax advantages I can. They’ve served me well over time (let me be clear: yes, my portfolio is considerably down for the year, but really, the whole market is down considerably for the year. However, since I’ve started investing seriously, every year before this year has been a positive result.) and I believe they’ll continue to serve me well over time, at least in part because they’ve served many, many other investors well over time, but more importantly, because of my personal history with it.

Selling Into a Huge Loss is a Loser’s Game: If I sold my stocks right now and moved into cash or bonds, that’s it; my chances of being part of a stock market recovery–and it has always recovered–are zero. I’ll have locked in my losses forever.

Even Recent History Backs My Position: Does anyone remember the bear market that happened earlier this decade when the dot com bubble burst? Yes, it was tough, and it was painful–this was in 2000. And yet, a few years later, the stock market was higher than when it burst. Let’s not forget: 2007 marked an all time high for the major indices; the market doesn’t just go up and up and up. Even though in the short term the market decline was painful, I’m way better off even now than I was then, and I was even better off a year ago. I fully believe I’ll be even better far before I’m ready to retire.

Yes, there’s been a lot of stock market chaos the last few weeks, but I’m not planning on doing anything that wasn’t in my plan in the first place. I’m here for the long term!

Volatility in the stock market has been very, very high, and the market has mostly gone in a direction that’s down. But not on Monday, where the indices posted double digit percentage gains. That said, the markets are still down mightily from the start of the month, and while anything is possible, there’s a lot of ground to cover before October 2008 can hit the break even point–never mind a profit.

Still, as the stocks go up, down, and all around–more twists and turns this year than a roller coaster–perhaps the most important thing to do is keep an even keel and maintain your perspective. One day, even as big of a gainer as Monday was, does not a bull market make; in fact, one day is just another day on the road to retirement or whatever other financial goals you have in mind–just like one horrible day, or even one horrible week (like last week was), does not in itself constitute financial doom.

Yes, I’m happier with my portfolio right now than I was over the weekend. That said, I don’t expect that 2008 will end up being another year with positive returns in the market–all I can hope for (and I hope for it with a lot of certainty) is that when I’m really retirement eligible (not from my current job–I’ll retire the second I’m early retirement eligible there and find something else), my portfolio will have grown considerably from what it is now. And in order to get there, I’ll endure lots of ups and downs along the way, and I’ll do so because I believe that long term, history will repeat itself and my portfolio will do just fine and dandy. And that’s the lesson in all of this: when things go great, don’t get too high and when things go poorly, don’t get too low. Eventually, things tend to right themselves–they always have so far!

Just a year after hitting its all time high, the stock market is about 40% off of that high, to levels not seen since 2003. It’s a tough time for many, and if you’re close to retirement and your asset allocation was out of whack, you probably hurt more than others. Looking at current stock market levels definitely hurts.

But just because the hurt happens, don’t make it hurt more.

Pulling out of the market. Selling all your funds and moving 100% into cash. Discontinuing contributions to your retirement savings plan. All of these are ways to ensure that the market isn’t going to just hurt now, it’s going to continue to hurt for a long time to come.

You don’t have to believe me. Warren Buffett is buying stocks. John Bogle is telling investors to get back to the basics of investing. These are two of the most successful finance gurus of our time. Just do the smart thing and follow the plan you made; in the end, you’ll be better off, and you won’t hurt yourself any more than the markets have already hurt you!

Planning isn’t just for emergencies; it’s also for your investing. One of the most important things to remember in investing is not to just have a plan, but to follow it.

Times like these, when the stock markets are in bear market mode, are the times to remember to follow your plan. I’m seeing more and more of my personal finance blogger colleagues worrying that they’re throwing good money after bad and considering switching their asset allocations dramatically. If your plan was sound when you made it, follow it! Also consider this: one year ago, when the markets were right around their all time high, was it a better or worse time to buy stocks than right now?

Food for thought.

Did the market’s leveling off in July after several months of freefall translate into a positive August? Let’s take a look at my sample portfolio in August.

The Vanguard Total Stock Market Index (VTSMX), which makes up the majority of my portfolio, was up 1.58% for the month. The Vanguard Total Bond Market Index (VBMFX) was up a meager .3%, but continued to pay its very nice dividend without issues. Finally, the T. Rowe Price International Discovery Fund (PRIDX) was down 3.60%.

All said, this portfolio was up about a percent for the month, which is much better than it’s done in previous months. Bonds are continuing to be the mainstay, now comprising over 29% of the portfolio (it started at about 25%)–years like this are the reason you keep a healthy part of your portfolio in a high quality bond fund!

We’ll keep reviewing my portfolio to see how it does the rest of the year.