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Focus on Your Saving Rate When the Market Fluctuates

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Focus on Your Saving Rate When the Market FluctuatesIt’s only natural to feel anxious when the stock market drops or spikes too fast. The stock market has been stable for so long that many of us aren’t used to the volatility anymore. I wrote this post the last time (2016) the stock market had a correction (10% decline from the peak) and it still applies. Today, I’ll rewrite the post with updated data. When the market is volatile, it’s best to focus on increasing your saving rate. This is especially true when you have 5 or more years left before retirement.

New investors tend to fixate on finding the “best” investments, but what they really should focus on is increasing their saving rate. Most people can increase their saving rate by 10 to 20% without a drastic change in lifestyle. On the other hand, it’s very difficult to beat the market consistently and increase your rate of return. When you’re starting out, your portfolio value will be relatively small and increasing your saving rate will have a much bigger impact than increasing your ROI (return on investment).

Let’s say your portfolio is worth $100,000. If you increase your ROI by 2%, that’s only $2,000 extra. It is probably much easier to cut back a bit and focus on investing $2,000 extra instead. Your saving rate is directly under your control, but the stock market is out of your hands, as the recent volatility illustrated.

New investors

When I was new to investing, I tried to pick the “best” investments. I did it all wrong, though. In my 401k, I picked the funds with the highest returns from the previous year. I didn’t know that over 90% of actively manage funds underperform low cost index funds over the long term. I also didn’t know that the stock market is cyclic. The best funds from one year probably won’t be able to repeat their performance the following year.

In my brokerage accounts, I purchased speculative tech stocks because the price kept increasing. This didn’t turn out well because a few years later, the dot com bubble popped and my portfolio crashed along with Pets.com. While experience is the best teacher, I still wish I had taken the time to learn about investing earlier to avoid those pitfalls. It sure wasn’t fun to go through those stressful periods.

That’s why I encourage everyone to start investing as early as possible. It can take many years to form an investing strategy that you’re comfortable with. You need to go through a few market cycles to see how you will react to the gut wrenching drops. Here is the investing strategy that I can live with through the ups and downs. It works for me, but it might not be the right fit for you. Everyone needs to find their own investing strategy.

  • All of our retirement funds are invested in low cost index funds. This is the core of our investment portfolio.
  • Our taxable account is mostly invested in high quality dividend stocks. Most of these companies should be able to maintain their dividend payout during a downturn. The price may drop, but quality stocks should come back when the market recovers.
  • I have a few speculative investments to keep life interesting. This is a very small part of my portfolio.
  • 20% of our investment portfolio is in bond funds. If the market drops further, I will have the option to trade some of these in for stocks.
  • We have alternative investments in rental properties, REITs, and real estate crowdfunding. These investments provide some stability when the stock market is volatile.

With this strategy, we don’t have to worry about how the stock market is doing and we can just focus on saving as much as we could. In the short term, our portfolio will gyrate wildly along with the stock market, but it should be fine over the long term. Our net worth didn’t drop as much as the stock market because we have alternative investments to help cushion the sharp decline.

Recent Correction

Let’s see how we did during the recent stock market correction.

recent stock market correction

Personal Capital made it easy to compare our portfolio against the S&P 500 index. The S&P 500 index fell 10% in about 2 weeks. Our portfolio dropped too, but not as much. This is due to the stabilizing influence of our 20% bond allocation and 10% alternative investments. (This chart doesn’t include our rental properties.)

It’s interesting to see how investors reacted to this latest correction. Some investors got scared and wondered if they should sell some stocks. Many investors took the advantage of the dip to buy more stocks. I didn’t do much except making the regular contribution to my 401k. After 22 years in the stock market, I don’t get excited by 10% anymore. I’ll consider buying more after it drops 20%.

BTW, don’t forget to increase your 401k contributions. The 401k contribution limit increased $500 this year. You should max out your 401k contribution every year. It’s the easiest way to build wealth over the long term.

Near retirement

When the market fluctuates like this, it’s best to ignore the movement and focus on increasing your saving rate. It’s actually really good for long term investors when the stock market drops. We can buy more shares for the same amount of money we regularly invest. This is a good buying opportunity for young investors who have a lot of time left. The market will recover and your portfolio will benefit from these gut wrenching drops. Once you’ve gone through a few of these, you’ll learn how to ignore the short term volatility.

This kind of volatility is much harder for investors who are very close to retirement. If you need to start withdrawing from your retirement fund soon, you’ll need to be more conservative. Now is the time to check your risk tolerance. It will be different than when you have many years of work ahead of you. For those near retirement, it’s best to be a little more conservative. Here are some steps you can take.

  • A bigger cash cushion. A retiree should have at least 18 months of cash. This cash cushion would help you ride out most bear markets. Retirees need to fund their cost of living and it’s best to avoid selling when your investment is down. The average bear market lasts for 15 months.
  • Double check your risk tolerance. Most people become more conservative as they age. Retirees need to ask themselves if they can stomach a 40% drops in the stock market. How will this affect their net worth? If not, then they will need to fix their target asset allocation.
  • Consider funding your core expense with very safe investments. If you’ve saved enough, you can use safe bond investments to fund your core expenses. This will decouple your core expenses from the stock market.

Focus on your saving rate

Investing isn’t that difficult. You just need to come up with an asset allocation you can live with and stick with it. This can be challenging for young investors because a big drop seems scary. However, it’s best to keep investing because your portfolio will benefit in the long run. Focus on increasing your saving rate and ignore what the stock market is doing day to day. Everyone who has been through some crashes knows that you need to keep investing through thick and thin.

When I started investing, I focused a bit too much on maximizing the ROI and made many rookie mistakes. Nowadays, I just focus on my saving rate without worrying too much about ROI. I just need to keep investing through all market conditions. It’s simple and stress free.

Did your portfolio fluctuate much over the last few weeks? What’s your strategy for getting through the stock market roller-coaster ride?

*Sign up for a free account at Personal Capital to help keep track of your investment. I log in almost every day to check on my accounts and cash flow. It’s a great tool for DIY investors and I highly recommend it.

Image by Tim Gouw

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Joe started Retire by 40 in 2010 to figure out how to retire early. He spent 16 years working in computer design and enjoyed the technical work immensely. However, he hated the corporate BS. He left his engineering career behind to become a stay-at-home dad/blogger at 38. At Retire by 40, Joe focuses on financial independence, early retirement, investing, saving, and passive income.

For 2018, Joe plans to diversify his passive income by investing in US heartland real estate through RealtyShares. He has 3 rental units in Portland and he believes the local market is getting overpriced.

Joe highly recommends Personal Capital for DIY investors. He logs on to Personal Capital almost daily to check his cash flow and net worth. They have many useful tools that will help every investor analyze their portfolio and plan for retirement.
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{ 32 comments… add one }
  • Ernie Zelinski September 4, 2015, 1:31 am

    I agree with you about the importance of saving. No doubt my stock portfolio fluctuated a lot, not only over the last few weeks, but over the last year or so. I am too lazy to look.

    Ultimately, however, I know that my net worth is going up nicely. That’s because I also have a lot of money in cash deposits and my saving rate (both in percentage and actual amount) is lot higher than most people’s. I am spending a lot more money than I ever have in my life and am still always surprised when I calculate how much my net worth has gone up over the last 5 years or so. So I must be doing something right. That something is saving a lot of money.

    • retirebyforty September 4, 2015, 10:20 am

      Cash is king in this environment. Saving a significant percentage of your income is the best thing most of us could do. Of course, having more income helps tremendously.

  • John C @ Action Economics September 4, 2015, 4:47 am

    I did the same thing when I started investing too, I invested in individual stocks and looked at the short term returns of mutual funds. When I realized the real difference is made by my contributions early on, I worried less about “hitting a home run” and I put everything into index funds and focused on throwing more cash in. My portfolio has seen a decent dip the last couple weeks, but nothing another month of contributions won’t overcome.

    • retirebyforty September 4, 2015, 10:22 am

      Experience is the best teacher. 🙂 A few speculative stocks are fine, but our core investment should be in low cost index funds. For most people anyway.

  • Steve Miller September 4, 2015, 4:50 am

    Hey Joe,

    Do you keep track of your total net worth and your liquid net worth (invested assets)? I do that so that I can compare our 4% spending rule against the liquid net worth vs. the total net worth.

    Just curious if you do something similar.

    • retirebyforty September 4, 2015, 10:27 am

      Yes I do. I have these bins set up in my spreadsheet.
      – Liquid: dividend stocks in our taxable account, checking, saving, CD, etc..
      – Retirement: 401k, Roth, IRA, and other tax advantaged accounts
      – Illiquid: real estate, personal loan, and pension.
      We haven’t started our draw down yet so I don’t worry too much about liquidity.

  • Justin @ Root of Good September 4, 2015, 5:38 am

    Our net worth went a little crazy (by -$74,000) in August, but we’re still as wealthy as we were back in February, so I’m totally fine with the volatility. No panic selling, no sleepless nights. I’m a little disheartened that I don’t still have a paycheck that I can use to dump even more money into the markets, but that’s okay too since we have “enough” already.

    • retirebyforty September 4, 2015, 10:28 am

      Yeap, I wish I have more cash to buy more dividend stocks. That’s the downside of no having a full time job. 🙂

  • Tawcan September 4, 2015, 6:58 am

    Haven’t calculated our net worth since we only check every quarter but I have no doubt our net worth dropped a bit due to the recent market drops. Like you said, focusing on the savings rate to so you can invest more stocks during down market is more important in the long run. This is exactly what we’re trying to do. Save, save, save, buy assets, buy assets, buy assets.

    • retirebyforty September 4, 2015, 10:29 am

      That’s a great way to go. No need to check your net worth while the market is volatile. It won’t change anything. Great job!

  • Mr. Utopia @ Personal Finance Utopia September 4, 2015, 7:38 am

    That’s good advice about focusing on increasing one’s savings rate instead of trying to chase down the investment vehicle with the highest return. There’s nothing wrong with trying to maximize your return, but pumping more money in via increased savings will get you to financial independence much faster.

    And, is my suspect eyesight deceiving me? Does that picture show your net worth at $1.99M? If so, wow. That’s awesome. I read your monthly financial updates but didn’t realize you guys were doing that well.

    • retirebyforty September 4, 2015, 10:31 am

      Of course, we try to maximize our ROI too. But I’m just not very good at it. I’ll have to be content with market return and have fun with just a few speculative stocks.
      Thanks! The net worth is some what inflated. Our properties aren’t value correctly and we’d have to pay a ton of tax and fees when we sell. We also have have to pay tax when we withdraw from our retirement accounts.

  • freebird September 4, 2015, 7:44 am

    Joe, this hits home with me, as I reviewed my end-of-year records for the past 25 years, some years were great, others not good at all, and overall I pretty much matched the indexes after many thousands of hours spent trying to beat them. I ended up doing well not because of my investment performance but rather due to my large and persistent cash input over the long haul, in other words the magic of dollar cost averaging. I was lucky to the extent that trying many different ideas over the years helped diversify my holdings, but while it was interesting to learn about many industries, it wasn’t very productive.

    Anyway remember that when you dollar cost average, VIX is your friend because you acquire more shares at the lower prices.

    • retirebyforty September 4, 2015, 10:34 am

      That’s great! I think most regular investor realize that at some point in their investing career. It’s really difficult to beat the market. Do you buy VIX? It seems like a difficult fund to invest in. You have to be on the ball for that.

      • freebird September 4, 2015, 11:32 am

        Oops, sorry, no I meant that ‘volatility’ helps you when you dollar cost average, that’s all. Volatility is nothing to be concerned about if you’re not trading, you actually benefit from the stock price swings when you’re accumulating. Of course decumulation in such an environment takes a different strategy.

  • Stockbeard September 4, 2015, 10:57 am

    Joe, you say you have dividend stocks in your taxable accounts. Shouldn’t you optimize here, and have most of your dividend stock in your non taxable accounts (IRA?) which are not taxed on that kind of capital gain?

    Or did I understand something wrong here?

    • retirebyforty September 4, 2015, 11:53 am

      We have dividend stocks in our taxable account because we plan to use the dividend to help pay the bills once Mrs. RB40 retires. At that point, we won’t pay much tax. For example, we didn’t have to pay tax on dividend in 2013 because our income was in the 15% tax bracket.

  • DP @ Someday Extraordinary September 4, 2015, 11:46 am

    This is good advice. In fact, one of the biggest lessons I’ve learned is that it is wise to have some funds available for when the market does become volatile. Those dips at the end of August – especially that 1,100 point Dow drop – often present huge buying opportunities to a shrewd investor.

    Understanding cycles and using them to your advantage can pay huge dividends. You can’t be afraid of them. I just posted an article on cycles that was published on Seeking Alpha, as well. Use them to your advantage! You’re right – focus on savings and not your returns in the short term. The long term will work out!

    -DP

    • retirebyforty September 5, 2015, 8:44 am

      That’s the hard part about being semi retired. We don’t have as much cash infusion. We had to keep some cash on the side for these opportunities. Also this is why you need bonds.

  • Jason September 4, 2015, 6:23 pm

    This is fantastic how you have done over the past year. And you are dead right about finding your specific strategy. Even though I invested, when I first started, in mutual funds that had fairly long track records. I didn’t even consider fees or other items. It is only over the past year or so that I have moved half of my investments into index funds. I only wish I had larger capital to dump more money into the market.

  • Sylvia @ Miss PF September 5, 2015, 8:05 am

    My savings rate is what I am going to focus on this year. I am going to try to save 5% more than last year.

    • retirebyforty September 5, 2015, 8:46 am

      Good luck! 5% increase is a great number.

  • nicoleandmaggie September 6, 2015, 10:16 am

    I have no idea how our portfolio has been doing. Most likely it has been matching the ups and downs of the stock market with some cushion from bonds, just as it has been designed to do. The best thing for a long-term investor to do is to pick a sensible strategy (that takes into account risk) with low fees and diversification and to automate it. The money will be there when I actually need it.

  • Financial Samurai September 6, 2015, 12:55 pm

    This is good advice. We must control what we CAN control. I’m encouraging my community to dial up their savings to MAX MODE from now through the new year.

  • Mr. Tako February 19, 2018, 12:24 am

    We have a large enough dividend income and cash cushion that I don’t mind the market fluctuations.

    Our strategy has never been to rely on the market being “up” to fund our financial independence. It’s worked out great so far!

  • Michael @ Financially Alert February 19, 2018, 2:03 am

    I used to try and pick the winners too! And, I also chased the funds that performed the year before… glad that’s out of my system now. 😉

    I don’t get too excited anymore these days when the markets fluctuate. Index funds keep me diversified and earning 8-10% annually is good enough for me in the long run.

  • Angela @ Tread Lightly Retire Early February 19, 2018, 5:06 am

    As someone who is 5+ years from our FI date, this is exactly my strategy. However, I just had one little stock prior to the recession, so I haven’t experienced a big drop yet. I’m reading as many of these posts as I can now to remind myself to stay the course when the time comes.

  • Tom @ Dividends Diversify February 19, 2018, 5:18 am

    Joe, It is a simple, but time tested and timeless strategy you have to navigate the volatility. No need to make it more complex than necessary. Tom
    Tom

  • Young FIRE Knight February 19, 2018, 6:05 am

    I’m taking this advice to heart. My goal this year is to increase my savings rate from 30% last year to 50% this year.

    That way I’ll have so much more money on hand to invest and watch it grow regardless of how the market performs!

  • Chris Urbaniak @ deliberatechange.ca February 19, 2018, 6:31 am

    Happy Family Day and President’s Day, everybody.

    Thanks, Joe, for the reminder about focusing on savings rate. It also has the impact of reducing the amount you’ll need for retirement! Win-win 🙂

    Chris

  • Ms. Frugal Asian Finance February 19, 2018, 7:08 am

    Great advice, Joe! I took your advice for my laid off post and told Mr. FAF we need to up our savings game. I’m getting anxious about a market crash and being laid off. The best thing we can do is stock up in that previous cash.

  • Mrs. Groovy February 19, 2018, 7:35 am

    This volatility is exactly why we’ve kept cash on the side for our first few years of retirement. Even though we’re no longer investing, I’m taking the long view and refuse to get caught up in the madness. For those who can, I totally agree with you, just keep socking more away.

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