2015 wasn’t a great year for stock market investors. The S&P 500 index ended up right about the same level as it started. The emerging market index funds (VWO) did very poorly in 2015 and was down about 20%. Our stock and bond portfolio didn’t do so well either, but at least it’s in the positive territory due to the $54,873 we stuffed into our tax advantaged accounts. So that was 2015, but what about 2016? The bull market is in its sixth year so it’s getting quite worn out. The first week of 2016 doesn’t look good so far. The S&P 500 slid more than 3% due to the China stock market turmoil and oil price weakness. Who knows what’s going to happen the rest of this year.
On one hand, this shouldn’t concern investors who are investing for the long haul. We don’t plan to start withdrawing from our retirement account until around 2030 so we have quite a few years left in the market. Long term investors should ignore short term volatility so they don’t lose any sleep. On the other hand, I would love to pick up some shares at a discount if there is a big drop in the stock market. What would you do if the S&P 500 index fell 10%? Or 20% or 40%? Would you buy more shares or sell to prevent further losses? You need to create a plan so you know what to do when the situation arises.
Here is how I used to react to a 10% correction – Wow, the stock market is down, let’s buy up some shares. I then proceeded to transfer as much money as we could afford to our brokerage account and invest it. This is a good approach, but not great because usually the stock market will continue to drop in a bear market.
From September 2007 to February 2009, the S&P 500 index lost more than 50% of its value. We invested the bulk of our extra money at the early phase of this drop. It turned out well, but I think we could have done even better if we had a methodical buy low strategy. Now that I’m not working full time anymore, we don’t have as much money to throw at the bear market. So it’s more important than ever to invest with discipline. Here is my 5-point buy low strategy.
1 – Review your asset allocation
2015 was a volatile year for stock market investors. If you haven’t checked your asset allocation lately, then you should review it now. Also, if your personal finance situation changed in the past few years, you should evaluate your target asset allocation to make sure it reflects your current risk tolerance. A lot can change in just a few years. In 2008, we were 100% in stock, but now we are much more diversified.
It’s important to find the right asset allocation for yourself and stick with it through thick and thin. Many individual investors lost a lot of money by selling at the wrong time. If you have a personalized asset allocation plan, then you won’t have to worry about trading in and out of the market. You just need to stick with it and rebalance once in a while.
For new stock market investors – You should read my article on how to figure out your asset allocation.
Surprisingly, our asset allocation is pretty close to target. Check it out.
2 – Rebalance
If your asset allocation is off target more than 5%, you probably should rebalance your portfolio. Since our asset allocation rarely deviate over 5%, I usually just add new money in the underweighted areas. This year, I’ll probably sell some REIT (Alternatives) and move it to US stocks. They are in my Vanguard retirement accounts so it is easy and I won’t have to pay any transaction fees or tax.
For new investors – Once you figure out your target asset allocation, stick with it and rebalance about once per year.
3 – Leave the automated investment alone
We contribute to our 401k every month through automatic deduction and we plan to leave this alone. This is where the bulk of our new money is going and we will keep buying through the thick and thin. If the stock market drops, then that’s great news because we will get shares at a discount. If the stock market rises, that’s good too. Our net worth will look good and encourage us to continue to invest.
This has been working well for us for 20 years so I don’t see the need to change it now.
For new investors – Contribute to your 401k and increase your contribution to the maximum as soon as you can. The contribution limit is $18,000 in 2016. Personally, I recommend investing in the lowest fee index funds available in your 401k. This will minimize the fees you pay every year.
4 – Hoard Cash
Fortunately, we still have a little extra left after contributing to our 401k and paying our monthly bills. In the past few years, I used this extra money to invest in our dividend portfolio and Roth IRAs whenever we can. For 2016, I plan to hoard the cash and try to time the market better.
5 – Buy Low Strategy
Hmm.. Timing the market is usually frowned upon by the personal finance community. It’s much easier to just invest new money as soon as you can. Studies have shown that even if you can time the market perfectly, you’ll gain less than 1% extra annually. This is because the stock market goes up over time so investing as soon as you can will get you most of the way there. Also, it’s impossible to time the market perfectly so an average investor shouldn’t even bother about this.
However, I’m going to do an experiment this year and try to time the market. It will be interesting to compare how we do to if we just dollar cost average throughout the year. This will be a small part of our investment so even if I screwed up, it shouldn’t be that painful. This portion of our new investment will probably be $10,000 – $15,000. This will give me something to write about. I’m sure you want to know the result of this experiment, right?
Here is the plan
|S&P 500 drops (off high)||RB40 plan|
|Less than 20%||Hoard cash|
|20%||Invest hoarded cash|
|30%||Move half of bond funds into stock|
|40%||Move all bonds into stock|
Okay, if the S&P 500 drops more than 30%, then this strategy involves messing around with our asset allocation. I know we shouldn’t screw with our asset allocation, but 30-40% off! That’s a huge discount. This is why I allocated 20% to bonds in the first place. In previous bear markets, I felt like I didn’t have enough money to invest when the stock market was way down. Now I have bonds which will enable me to buy when there’s blood in the streets. I’m confident this will work out in the long term, but it could be a rollercoaster ride in the short term.
For new investors – You should ignore #4 and #5. Stick with #1 to #3 until you have gone through a few bear markets.
2016 will be volatile
2016 started off pretty badly and the S&P 500 is about 9% off its high (July 2015) so we still have a long way to go before we hit 30%. We might not get a 30% off sale in 2016, but I’m sure we’ll get there at some point. What do you think about my buy low strategy?
Do you have a strategy for investing in a bear market?
Image Credit: by AZRainman