Then I lost 5% on the first day I invested the cash and I was also happy about it.
From 2013 through the middle of 2016, the S&P 500 went up about 42%. My wife and I had a large amount of our investable assets sitting in cash, but we have no regrets about this decision.
Then, we chose to invest a large portion of that cash on June 22, 2016. I know the exact date because it was the day before Great Britain voted to leave the European Union and all I need to do is Google “Brexit vote date”. The next day the market went down 5% in a single day. We don’t regret this decision either.
This is a discussion on market timing, emotions, goals, and how to make good financial decisions, even if the outcome is less than desirable.
My middle daughter was born in 2013 and my wife and I knew we wanted three kids. We could still fit in our place at the time, but we wanted to start our search for a house that could fit our future family.
We weren’t in a rush. We wanted to take a few years to find the right place at the right price. Anyone who was looking at real estate in the Bay Area from 2013 to 2016 is aware that the “right price” just didn’t exist. If you weren’t overbidding, you weren’t getting the house. We placed 10 offers over those three years before finding our current home. We signed and initialed hundreds of pages of disclosures and reports. All the while, the money we had saved to be a down payment was sitting in cash.
This is the key when it comes to making confident financial decisions. What is the money for?
We were still saving consistently in 401k’s and all of this money was, and still is, invested 100% in equities. A diversified portfolio of US Large Cap, Small Cap, International Developed, and Emerging Markets stocks. No fixed income, no bonds, no cash in retirement accounts. The money we aren’t touching for decades is invested as aggressively as possible (within reason…no Bitcoin, but that’s a discussion for another day).
But money that we wanted ready any given month sat in cash. I don’t even know what the interest rate on the savings account was and I don’t really care. The important part was that it wouldn’t go down. If the stock market went down 40% instead of up 40%, this would not have prevented us from buying the house we wanted when the opportunity came along.
Your personal risk tolerance matters. How would you feel if you saw your retirement accounts cut in half? Would you be able to sleep at night? Can your rational brain remind you that this money isn’t needed for a couple more decades? If you can’t stomach that, you don’t need to be as aggressive. It changes the math in terms or how much you need to save, how long, and what is available to future lifestyle, but it is manageable.
Along with your individual comfort level, the time frame for the money matters. Even if you like being aggressive, if you need the money in the next year or two, you don’t have time to wait out the years it takes stocks to recover from downturns. Trying to get the extra return in that one year isn’t worth dramatically altering your lifestyle and goals if a normal cyclical downturn happens.
What you want to do with the money is more important than getting a better rate of return.
After we got lucky with the right house, we had some cash that wasn’t needed for the down payment. We were faced with the same questions that my clients often ask. What do we do with this money? How do we invest it? When do we put the money in?
My wife and I were already saving sufficiently in 401k’s for retirement, 529 plans for college for our children, and no longer needed a down payment on a house. We decided this should be invested aggressively for long term purposes. I chose an asset allocation similar to that in our retirement accounts, but optimized for tax efficiency since we didn’t have the benefit of tax-deferred growth that 401k’s and IRA’s provide. I deposited the check and made the investment purchases on June 22, 2016.
A common fear among clients is “What if I invest this money and it immediately goes down?” “Is there anything coming up that it might make sense to wait for a dip, then put the money in?”
The short answer is that you cannot predict markets in the short term.
No one can predict markets in the short-term.
There is no way you can guess what is going to happen the next day, week, or month. And probably not even the next year. On a long enough time frame we can start to make predictions within a range of possibilities and on the scale of decades markets tend to display a reversion to the mean of long term historical averages. But trying to predict what day or month to move from cash to stocks is virtually impossible.
One way some people deal with the emotional fear of seeing an investment go down immediately is to ‘dollar cost average’. Instead of putting in all the money in one day, spread it out over a few months. Maybe one third this month, one third next month, and the final amount the last month. While this is not a bad strategy per se, academic research has shown that this tends to be an unnecessarily conservative strategy implemented as a reaction to emotions rather than coming from a sound investment philosophy. You are more likely to lose money via opportunity cost as the markets go up and you buy at higher values each subsequent month, than to see the markets go down in the exact time frame you chose. This is a different form of dollar cost averaging than making systematic savings and investments from your pay check into your 401k. There are extensive benefits to consistently making the regular contributions regardless if the market is up or down, but just in terms of the math, it doesn’t make sense to wait to make an investment just for the purposes of trying to time the market.
In fact, when we made our investment, even if we could predict the next day perfectly and see the 5% drop coming, if we had chosen to dollar cost average we would have still lost money. The market rebounded within a week and a month later was up another 4%. Dollar cost averaging would have lost us money.
We can’t predict markets in the short term, so when we were looking to buy a house within the next year or so, we left the money in a savings account even as the market went up. Then, when it came time to invest cash, we can’t predict the markets in the short term, so we did not dollar cost average our investment, even though it went down the next day.
I use these examples to illustrate the difference between the decision making process and the outcome. Because I was confident in our decision making process, I was at peace when the outcomes seemed to go against us. Trying to judge a decision and how we feel about a decision is part of what leads to regret and anxiety. I don’t think in terms of how much more money we would have if we were invested in the stock market instead of cash from 2013-2016. For the same reason, I don’t think in terms of how much money we would have if we only invested in the S&P 500 instead of a more diversified equity portfolio. I know what our goals are, the lifestyle we want to live, and the financial decisions we need to make to achieve those.
But these financial decisions are based on concrete timing and specific lifestyle factors. Sometimes clients have more amorphous concerns or goals, such as…
What should I do with my company stock?
This is one time where the outcome is a little more positive for us, but you may still wonder if we could have done better.
My wife is an Engineering Manager at Shutterfly. She’s a rock star and has been earning grants of RSUs over the years. When I help clients make decisions around their company stock, I have already gone through this decision making process with my wife.
For several years, Shutterfly was trading in the $40’s. It might go down into the high $30’s or up into the low $50’s, but bounced around in the $40’s mostly. In 2018 they announced they were purchasing LifeTouch and the stock jumped into the $90’s. Given this information, what would you do with your company stock? Sell everything vested? Hold on to it because it looks like it’s going up more? Sell some, if so, how much?
This is kind of a trick question. The point isn’t to try to guess what is going to happen in the future, but to ask ‘what is the money for?’ If you’ve been following the timeline from earlier, this was after we had purchased a house, we were confident we were saving enough for retirement and kid’s colleges. This is money we wanted to grow for the future without anything specific in mind. We were ok taking on the risk of leaving it in a single stock because we weren’t depending on this growth for specific goals. BUT we didn’t want too much of our net worth in a single stock.
Our decisions around company stock were based on concentration risk.
When the stock price doubled and the percentage of our net worth in Shutterfly stock doubled, we sold half. If the stock price had gone up more, we would have sold more. If the stock price had gone up less, we would have sold less. You can see this also helps support an organic buying low and selling high. The principle works the same as rebalancing your portfolio, but across your entire net worth, not just the diversified asset allocation.
Over the remainder of 2018, the stock price actually fell back down to the $40’s before recently being taken private at $51 per share.
Even now, in retrospect, do you feel like I should have sold all of it? Again, we can’t try to make buy and sell decisions based on trying to predict the markets in the short term. If we needed the money for some other goal and didn’t feel comfortable with the risk of leaving it invested in her company stock, we would have been selling out of her RSUs as they vested over the years. We wouldn’t have had as much stock to sell in the $90’s. And if we wanted to be even more aggressive and swing for the fences, we would have held the stock and been bought out at $51 this year.
Finally, how did I know to sell in the $90’s instead of the $80’s a month before or after? I wholly admit this part was just luck. It was just when the trading window for employees was open after a quarterly earnings call. That’s how life works. You make a good decision then luck and randomness come in to play and sometimes it works against you, sometimes it helps you. As long as you focus your time, energy, and emotions on the decision, you can find peace, regardless of the outcome.
Serenity Prayer
May God grant me the serenity to accept the things I cannot change,
Courage to change the things I can,
And Wisdom to know the difference.
Aaron Agte, CFP®, founder of Graystone Advisor, is a fee-only Financial Planner located in Foster City, CA, serving clients virtually in the Bay Area and across the country. He specializes in helping couples with stock options, RSUs, and other equity compensation.
@AaronAgteCFP