Violent stock market corrections of 10% or more happen almost every year. Doing nothing is considered one game plan. But doing nothing because you couldn’t be bothered to think about how scenarios might play out is really lazy. It’s better to be lucky, than good. However, what if you’re neither?
Since writing the post, Stock Market Meltdown Implications For Everyone, many of you have asked for specific advice on how to deploy your capital into the markets. Given everybody’s financial situation is different, I’m just going to suggest a five step framework, and use myself as an example.
I’ve lost a ton of money in the markets before, having invested during the Asian financial crisis of 1997, the dotcom bubble of 2000, and the economic collapse of 2008-2009.
What has helped me get through difficult investing periods is simply coming up with an investing game plan to account for different scenarios. The fear of investing gets minimized, and rational action takes over.
An Investing Game Plan
Step 1: Figure Out Your Liquidity Need
I currently need at least $30,000 in the bank to feel secure. Any more than $30,000 feels like I’m wasting opportunity to invest somewhere since money market accounts pay almost nothing. Any less in the bank, and I start to feel uncomfortable just in case a financial catastrophe happens. My liquidity need has fluctuated between $10,000 – $100,000 in the past mainly due to job security and upcoming expenses.
Once you figure out your minimum cash need, you can implement an investing game plan with the money above your minimum. A good minimum liquidity benchmark is six to twelve months worth of living expenses.
You can currently get a pretty good online savings rate with CIT Bank to park your money. The other way is buying 3-month treasury bonds.
Step 2: Assess Your Current Position
Based on my neutral view on the stock market at the time, as a new year’s goal, I accumulated $70,000 over my $30,000 minimum liquidity need. My current overall stock / bond allocation is roughly 70% / 30%. Meanwhile, my public market investing portfolio (as opposed to private equity and venture debt) makes up roughly 21% of my overall net worth. My comfortable net worth allocation range in public markets is 20% – 30%.
Figure out how much money you are willing to invest beyond your minimum liquidity need. Analyze your current equities / fixed income split. And calculate what your total public market investment exposure is to your net worth and adjust accordingly.
Step 3: Reaffirm Your Investment Horizon
My investment horizon is 22 years, or age 60 for both pre-tax and post-tax investment accounts. The idea is to match the minimum age at which I’m able to withdraw money from my 401k, SEP-IRA, and Solo 401k accounts penalty free with my after tax investments. The hope is to never need the money due to existing cash flow from other income streams. But one never knows and I will reassess when the time comes.
Any time horizon longer than 10 years should help investors become more disciplined. I’ve found that if your investing time horizon is less than three years, you become either much more risk averse or too risk loving. With your main investment portfolio, it’s wiser to shoot for singles and doubles.
The longer you can stretch your time horizon, the less concerned you will be about market meltdowns. Reaffirm your investment horizon.
Step 4: Divide Your Excess Capital Into Multiple Tranches
If you had unlimited ammunition to buy, you’ll eventually be able to pick the bottom. This is one of the basic goals behind Dollar Cost Averaging. Once every two weeks or month, deploy a certain percentage of your disposable income into an investing portfolio in hopes of buying some shares at lower prices.
But if the stock market is collapsing by 5%, 10%, 20%+ in short periods of time, you might as well become more aggressive in your Dollar Cost Averaging approach if you have a long investing time horizon. This is where you should consider creating at least three super tranches to purchase securities with the capital beyond your minimum liquidity need.
I’ve been investing $5,000 – $20,000 a month in the market since leaving Corporate America in 2012. The $70,000 in extra capital is divided into five tranches of between $10,000 – $15,000 each to deploy into the market. This capital is in addition to the monthly $5,000 – $20,000 deployments.
I’ve split the $70,000 into five because the volatility is enormous. For example, on Monday August 25, the Dow Jones declined by 1,080 in the morning and rallied by 970 points to be only down 110 by mid-day. But by the afternoon, the Dow started crumbling again to close down 580 points. Such volatility makes it harder to find a good entry point.
Step 5: Create A Capital Deployment Plan
Armed with five tranches of up to $15,000, I plan to deploy each tranche after every 2% or greater downward move. I use 2% or greater downward moves as a signal for excess capital because major indices generally move up or down by only 0.5% the majority of days. Furthermore, with five opportunities to buy at -2% or greater, I’m making an implicit assumption that I think with a high probability the stock market will correct by at most 10% and then flat-line or begin to recover again.
If the S&P 500 only corrects by 1% or less, then I will not be deploying extra capital. I’ll simply continue my normal $5K – $20K a month dollar cost averaging plan and sit on excess capital until better opportunities arise. If the S&P 500 corrects between 1-2%, then it’s a judgement call. Maybe I’ll invest just $3,000 in extra capital.
Let’s say the S&P 500 corrects by 5% to 1,900 from 2,000. I’m still allocating a maximum of $15,000. If the S&P 500 recovers all its losses the next day, and then loses 5% again back to 1,900, I’m not investing another tranche. Instead, I’m waiting for another 2% correction from the 1,900 level to 1,862 or lower before deploying more capital.
So far, I’ve deployed $40,000 of the excess $70,000 capital into this 10% – 15% correction. I didn’t expect to invest the money so quickly, but I’m just following my system. As you will note, the market corrected beyond my expected 10% correction at one point. By having five separate tranches to invest, I’ve saved myself some ammunition if the stock market corrects even further.
Nobody can accurately predict the future. But we know over the long term, the stock market moves up and to the right. Therefore, it’s strategically a good move to keep on investing for as long as possible.
Follow Your Investing Game Plan
Where I’ve blown myself up is when I’ve gotten too cavalier with my investments. For example, in my younger years, I might have deployed all $70,000 during the initial 3% correction and have nothing left to buy during the subsequent 9% – 12% correction. The system keeps me disciplined, and your system will as well because it reduces emotion.
The most important thing every long term investors should do is come up with an investing game plan today and stick with it over the long run. If you keep on investing on a regular basis, the amount of money you can accumulate over a 5, 10, 20+ year period will be enormous. It’s the undisciplined who wake up years later wondering where all their money went.
By investing $5,000 – $20,000 a month since June 2012, a brand new portfolio I created at the time is now over $500,000 three years later. I call it my “Unemployment Fund.” The idea was to see how much I could grow a portfolio from scratch with no job, just my passive income streams, and an online business that generated less than $100,000 a year in revenue at the time.
I encouraged a personal finance client to join me in creating a new Unemployment Fund of her own in 2012 because she wanted to eventually leave her soul-sucking job as well. We motivated each other, and her portfolio is now over $300,000 while earning less than $150,000 a year. By accumulating this amount, she got the courage to engineer her layoff in 1H2015 and become a rockstar freelancer instead!
Losing money in the stock market feels terrible. But if you come up with a tailored investing game plan and stick to it, you’ll be able to drastically minimize the anxiety of stock market investing. Your portfolio will likely grow larger than if you didn’t have a plan and you’ll have a much greater appreciation for money as a result.
Track Your Net Worth Easily For Free: In order to optimize your finances, you’ve first got to track your finances. I recommend signing up for Personal Capital’s free financial tools so you can track your net worth, analyze your investment portfolios for excessive fees, and run your financials through their amazing Retirement Planning Calculator. Those who come up with a financial plan build much greater wealth over the longer term than those who don’t!
Updated for 2020 and beyond.