A Simple Investing Plan For Tumultuous Times
Summary Equity markets have been, and still are, a fantastic source of wealth preservation and generation. This article presents an extremely simple, minimal effort investment plan, based on market ETFs, aimed at simply capturing market returns. The reasoning behind my approach is discussed, as are possible uses, advantages and disadvantages and some investing obstacles that need to be identified, but that can be avoided. Finally, I suggest some ways of moving away from the default plan presented and into additional investing strategies. If you are looking to time the market, buy on a dip, or buy gold, this article is not for you. The future is always uncertain. Price changes are nothing new, they are an inherent part of market behavior. However, price changes tend to stir up a lot of emotion, something that does not always lead to better investing decisions. In this article, I describe an extremely simple and minimal effort investing plan that can be used as a default strategy in tumultuous, bear or bull markets alike. The plan can be used by an investor getting started at managing their private portfolio, an investor not sure what to do with their savings, or an investor simply looking to spend minimal time on managing their savings. It is readily available to anyone, and can be used as a default plan throughout your investing life. As such, it can be used either to fall back on when needed, or as a benchmark to help assess your investment making decisions. The core idea of the plan is to buy an equity market ETF over time by purchasing at regularly spaced intervals. I discuss the reasoning behind such a strategy, possible advantages and disadvantages of such a plan, as well as some ways of developing it further. For many private investors, there should be no need to ever move to anything more complicated. Even so, I present some initial ways to customize it further and add in more elements, depending on the individual investor, and mainly to add interest. Background and Context Buying stock of a profitable company is different than buying other financial products. Stocks have the potential to create returns not derived solely from trading. It’s not a zero-sum game. If the company makes money, this income will hopefully make its way back to the investor through either dividends, or retained earnings leading to higher market price. For these reasons and more, stocks, as an asset class, have backwinds blowing in their favor that other financial contracts do not. For anyone able to save money over time, it is therefore extremely helpful to consider how the attractive qualities of stock ownership can be taken advantage of. Some companies will be more profitable than others. Some companies will either never become profitable to investors, or turn to losses over time. It can be surprisingly difficult and time consuming to sift through the over seventeen hundred public companies available to choose from on the NYSE/NASDAQ alone. Luckily, the advantageous features of equity investing can be easily taken advantage of using a broad equity market ETF. Recent market turmoil does not change any of this. It is part of market behavior, and always has been. It is said that a wise man accepts, while the fool insists. Price changes in the market, both up and down, should be accepted by anyone involved in purchasing stocks. Price fluctuations can be viewed as creating opportunity – we all want to buy low and sell high. There are two basic obstacles towards successfully doing so: (1) Obtaining a sound evaluation which allows to judge when prices are high, or when they are low, and (2) The psychological ability to be a contrarian; to sell when most others are eager to buy, and buy when most others are eager to sell. Both these obstacles require time and effort. At a personal level, they may require specific skills which may differ from one person to the next. Instead of looking to profit more from price fluctuations, another approach is to simply avoid making mistakes that may result from taking the wrong action in a changing environment. This is the minimal effort approach and is the one I will focus on for the duration of this article. The greatest risk is buying in at a very high price. Buying on multiple occasions ensures that even if one purchase is made at a bad (i.e. high) price, other purchases will soften the effect and provide better returns. Of course, this also means that you won’t buy in at an all-time low either. What you will get by buying on multiple occasions over time, is exactly what the plan is intended for – market returns. Market returns are underrated. They don’t produce the same excitement that a tech IPO does, but they are nothing to sneeze at. The table above shows the returns of the S&P 500 market index, including dividends, over the past two decades. Returns that an investor would receive from simply owning the index for ten years are stated as well. These figures refer to the ten years ending December 31st of the year stated in the left most column. Finally, annualized returns for the same ten-year period appear in the right most column. As you can see, over a longer period, returns are rarely negative, with only 2008 and 2009 showing negative ten-year cumulative returns over this period. As long as you are able to save money over time, the plan below does not include selling. This ensures that these losses would have remained on paper only (and the low prices at the time would have provided good buying prices). Buying during periods of very high market valuations (e.g. circa 2000) is not avoided completely by the plan. Instead, buying over multiple periods causes the buying prices to average out. The above purchasing behavior should therefore ensure the investor positive returns. The Basic Plan Buy only one security – the S&P 500 Index ETF. Time purchases using only a calendar. Make new purchases every 6 or 12 months. That’s it. Any broad market ETF will do. The SPDR S&P 500 Trust ETF SPY is the most popular, and I refer to it throughout this article, but there are other equivalent ETFs that should be just as good. If you are starting with a large chunk of money, you could split it up for your first 6 purchases at 6-month intervals. If you are able to save part of your income, simply use whatever you have saved over 6 months to buy more SPY. If you already have a portfolio with many positions, you can convert all or parts of it into SPY every time you make a sale. It should be simple to gradually convert any portfolio into SPY over time, regardless of the starting point. But is now a good time to buy? I discussed possible near future market valuations based on historic data in a previous article . The plan presented here is based on multiple acquisitions made at predetermined intervals. In that light, now is as good, or bad, a time to buy as any. It does not matter in regard to this investing approach. Advantages Of The Plan 1. You will spend virtually no time managing it. You do not need to read any news, any investing advice articles, or listen to any talking heads on TV. You definitely don’t need to know what is going on in the stock market, China, Greece, the Federal Reserve or any other media topic. 2. The costs of this plan are as close to nothing as you can get. The plan calls for 1-2 transactions a year. Using an online brokerage account will reduce costs significantly. In total, costs should not come out to be more than a few dollars for the entire year. These savings alone will add up more than you might expect. 3. Over time, you will outperform most other investment funds. It may sound odd, but it is a rather established result that most managed funds will produce lower returns to an investor than those received from passive market investing. For many managed funds, a key reason is fees. Many other reasons exist as well. For example, many funds diversify into additional asset classes other than stocks. Historically, stocks tend to outperform other asset classes. It should be no surprise, therefore, that a fund with (for example) only 50% equities will attain lesser gains when compared to a broad stock market index. Additionally, there is no reason that the distribution of money management skill should differ from that of any other skill. Skill or ability in any discipline has a long tail distribution (where the average is greater than the median). Most people show weak, or below average ability at any specific skill or discipline, while some show decent ability, and a small subgroup are exceptional. This type of distribution can be observed for throwing a football, dancing, mathematics, and it is true for managing money as well. Some funds will be managed by exceptional money managers, while most won’t. The hiring of money managers, and fund selection in general, if done with the goal of obtaining better returns, shares many similarities with stock selection. One cannot avoid in-depth analysis if interested in making a good choice. Often times, evaluation of money management skill is done based on historical performance. A manager or fund able to produce an easily reviewed exceptional long-term past record will also be able to demand much higher fees. This may again reduce returns to the investor. While the issue of fund selection is still much broader than discussed here, it is not the focus of this article. The plan presented is based on the fact that most funds will provide lesser results while identifying the ones that don’t requires additional effort. Disadvantages Of The Plan 1. It’s boring. This should be a non-issue since we are interested in making money, not having fun, right? Unfortunately, on a day-to-day basis, it can become an issue for some. This plan really is not much fun, and you will need to get your kicks outside of investing if you follow it. On the plus side, if you do follow it, you will be able to have a lot more fun thanks to the time it will free up, and the money down the road. In the meantime, if this is an issue, later in the article I will present some ways to make this plan a little more interesting as well as require more active involvement. 2. You don’t get to beat the market. Everyone wants to “beat the market” (author included). However, doing so requires a lot of time and effort. Also, sometimes overeagerly chasing greater returns can lead to worse performance, not better. It is surprisingly difficult to attain returns that are considerably better. Doing so either requires a considerable effort, or blind luck. The latter is usually short lived. The basic plan presented aims to take advantage of the attractiveness of market returns. Nothing more, and hopefully, nothing less. If it helps, you can think of it this way: You won’t beat the market, but you will do much better than most people. Unfortunately, you may have to wait a few years to get your “I-made-more-money-than-you-in-the-stock-market” moment, or at least wait until the next market correction. 3. There are ways to get outsized returns. This plan ignores them completely. Equity markets provide a wide selection of choices. Between the NYSE and NASDAQ alone, there are more than seventeen hundred issues to choose from. These markets include all the largest public companies, including such monsters as Apple (NASDAQ: AAPL ) and Google (NASDAQ: GOOG ) (NASDAQ: GOOGL ). In the broader universe of financial contracts to choose from, there are all kinds of financial papers just waiting to be traded for outsized gains. I describe some possible ways of dealing with this disadvantage further on in the article, by allocating part of your portfolio to other investments. 4. It seems so extreme. Just one security? It’s actually extensive diversification over the best asset class. Probably a lot more diversified than most portfolios. The single security represents 500 companies (actually 502 at last count ). Diversification is a whole topic onto itself. The addition of treasury bonds to the plan, as well as incorporating other investment strategies is discussed below. Incorporating Treasury Bonds Into The Portfolio Incorporating treasury bonds can be done to address either of the following two goals: (1) Additional diversification into another asset class. (2) Allowing more activity while still maintaining good automatic decision making. Over the short term, bond prices tend to move in the opposite direction of stock prices. If stocks drop (or rise) significantly in price in a short period, the owner of an all-stock portfolio may feel that some kind of response is required of them. As stated before, I do not believe this to be the case. However, if such an itch needs to be scratched, a good option for doing so is rebalancing the portfolio between equity and bonds. If either of the above issues is a concern, incorporate the following two steps into the plan: Hold no more than 25% of the portfolio in Treasury Inflation Protected Securities (TIPS). Rebalance the portfolio if it skews more than 10% off the 25/75 division. TIPS are a fantastic security. They are US treasury bonds where both the principle and coupon are pegged to inflation. I have a strong preference for TIPS bought either at auction, or below (inflation adjusted) par value on the secondary market. If so bought and held to maturity, they will ensure a profit (although possibly a small one) and act as perhaps the best inflation hedge attainable. Unfortunately, at the time of writing, government-backed bonds are very expensive and do not offer much. TIPS, even if bought at auction, are sold with very low coupons. For this reason only, they were not included in the most basic plan. However, incorporating TIPS bought at, or below, par value for a 25% stake of the portfolio should still offer many advantages as discussed. Also, since this plan takes a very long-term approach, there is no reason that bond markets will not return to lower prices in the future. In this case, incorporating TIPS into the portfolio will be very advantageous. I do not recommend buying any other type of government bond, and I recommend against buying any kind of bond ETF. The reasons for this are perhaps the subject of another article. Going Past Market Returns Add the following steps if you want to incorporate or experiment with more investing strategies: Allocate 10% of the portfolio for doing whatever you want. At the end of the year, examine your results, and reallocate the portfolio based on your conclusions. If you want to make huge gains in a short period of time, go for it. Keep most of your money in SPY. Use only a small amount of your portfolio for other adventures. Over time, once a year, re-evaluate the performance of your “adventurous” portion of the portfolio and compare it to the results achieved by the remainder of the portfolio following this basic plan. If you are happy with your results, divert more money into direct active management. Perhaps adding 10% or 20% more. The important point is to do so incrementally, and at predetermined times. If you are able to make great investment decisions, and have the time and will to do so, the basic plan will be of no further use to you. Exiting it gradually will allow a learning period, and hopefully prevent jumping ahead too soon. I do not know of any discipline worth pursuing that does not require years to develop an ability for, and yet more years to master. Investing is no exception to this. The simple plan presented here allows to enjoy gains while still learning. It also acts as a fall back plan if better results cannot be achieved. Self evaluation is very personal and not at all simple. However, doing so is extremely beneficial and it too can be developed over time. The Extended Plan Summarized Allocate 10% of the portfolio for doing whatever you want. Of the remaining portion, h old 7 5% in SPY and 25% in TIPS Use additional received funds from savings, dividends, or interest to buy more SPY and TIPS using only a calendar to time purchases every 6 or 12 months. Rebalance the portfolio if it skews more than 10% off the 25/75 division. Reevaluate on a predetermined 12-month basis. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.