The people of Great Britain decided to shoot themselves in the foot and punch the rest of us in the face by leaving the European Union (Leave: 51.9%, or 17,410,742 votes, versus Remain: 48.1%, or 16,141,241). As a result, the pound fell to its lowest levels in 31 years and global markets are down anywhere between 3% – 11% on the first day of trading after the vote.
This “black swan” event is another reminder why I prefer real estate over stocks. In real estate, there aren’t so many random exogenous variables that pound your investment to bits. Rental income is sticky and there are things you can do to improve the value of your property.
Unless you are a multi-billionaire, being a minority investor with no say in your investment is just the way of life for equity investors. In this article, I’d like to discuss why Great Britain chose to exit the EU, and what may happen next.
Why Great Britain Voted To Leave The EU
* Less fees. Britain’s exit would mean the UK could save roughly $9 billion in annual EU membership dues. Countries such as Germany and the UK have been subsidizing EU countries like Greece, Spain, and Portugal for their excessive spending. Eventually, you get sick of taking care of people who are unwilling to take care of themselves.
* Less regulations. The EU has strict environment and labor regulations. Difficulty laying people off is one of the main reasons why unemployment rates are so high in many EU countries. Why risk hiring someone who might be a virus for years?
* More control over migration. Brexit supporters feel the EU’s migration policy plans pose a threat to the UK’s sovereignty and safety. They don’t want to be forced to accept migrants that may hate British values.
* Lower consumer good prices. The BBC reports an exit from the EU could lower prices in the UK by roughly 8 percent.
At the end of the day, the British people want what everybody wants: the freedom to choose. I respect this a great deal.
Freedom to choose is why I left Corporate America to start my own company. I was tired of not getting paid what I thought I was worth. And I didn’t want to subsidize underperforming departments anymore. So instead of complaining, I engineered my layoff to get a severance package. I knew my income would suffer for at least two years, but it was a sacrifice I was willing to make to be free. Four and a half years later, I do not regret leaving the mothership at all. Perhaps the same will be said by Brexit voters in the future as well.
On the negative side of Brexit, unemployment will rise as companies, domestic and foreign, move out of the UK. For companies that decide to stay, there will be hiring freezes due to uncertainty. People nearing retirement will either have to delay retirement or live on less than they expected. Meanwhile, investors who are long UK-denominated assets will all lose money. The typical reaction to shocking events is to sell first and ask questions later.
On the positive side, a weaker pound should help exports and lighten the cost of visiting the UK. My 2nd round Wimbledon center court debenture tickets cost $1,300 each back in 2014 for goodness sake! I’ve also been looking to buy a Range Rover Sport for a while now, although it is owned by Tata Motors of India. A free-falling economy will also cause home prices to drop, enabling those who had been priced out to potentially buy at an affordable price if they can keep their jobs. Finally, less wealth equals less congestion.
Overall, Brexit is bad for short-term investors and good for folks who believe freedom is more important than money. Big government has slowly squeezed away our rights. The people have spoken against globalism.
What’s Next After Brexit?
Now that the vote is done, Prime Minister Cameron, who is resigning, can either ignore the will of the people, or invoke Article 50 of the Lisbon Treaty to begin the formal legal process of leaving the EU. Under Article 50, a two-year notice is required to officially exit the EU. During this period many negotiations and agreements will have to be reached. The consultancy PWC estimates that it will be about four years after invoking Article 50 before the UK can officially exit.
Given everything is rational, there’s still a good chance the UK could change its mind if things get bad enough during this 2-4 year period of exit negotiations. If the UK ends up not leaving, then we could have one of the best buying opportunities between now and 2018 if the markets continue to sell off. If it turns out the UK economy gains during this exit grace period, all will be fine.
The knee-jerk reaction everyone seems to have is to buy the dip. But seldom do markets reverse course after only one day of correction. What investors should be thinking about is what will Germany do? Germany subsidizes Greece and Portugal even more than the UK. What will become of Spain, Italy, Ireland, and other EU countries if they eventually need a bailout? As the principle stakeholder in the EU’s well-being, Germany’s reaction will go far towards either calming fears or fanning flames. Let’s hope other countries like France don’t consider leaving as well.
The world is highly interconnected. The main fears are uncertainty regarding trade, currency, investments in Britain, British investments abroad, and what happens to the rest of the EU. All these issues will take plenty of time to work themselves out. In the meantime, we’ve got to review our investment game plan.
Review Your Game Plan
Financial Samurai readers know that since early 2015, my outlook for the stock market and real estate market has been bearish. We’ve been aggressively saving our money, refinancing our mortgages (10-year yield now at ~1.49% as of 6/27/16), and paying down debt to prepare for a two or three year fade. The good times are over. Unemployment risk is going up. Valuations are going down. We must do our best to optimize our existing income streams and create new income streams while we still can.
I recommend everyone do the following:
1) Review your portfolio. Go through all your positions and ask yourself whether they fit your objectives. If they do, carry on. If they don’t, rebalance your positions to fit your risk criteria by adding more or selling. It’s important to assess your European, Asian, and US exposure as well. Europe alone went down 10% in one day the day after Brexit compared to “only” 3% in the US. Portfolios have a sneaky way of going out of proportion if you don’t review and rebalance them at least once a quarter.
2) Review all your cash positions. During times of market volatility cash is king. You should not only review your cash positions in your pre-tax retirement portfolios (401k, IRA, Roth IRA, etc), you should also review your cash positions in your post tax portfolios (online brokerage, wealth management accounts) and your day-to-day savings accounts. Make sure you have enough fire power to take advantage of potential future sell-offs. Also make sure you have enough cash where you feel comfortable lasting for 6 – 12 months in case your income takes a hit.
3) Review your net worth allocation. Once you’ve gone through your portfolios and cash positions, it’s time to take a holistic view of your overall net worth. Do you have at least 5% of your net worth in risk-free assets like cash, CDs, and Treasury bonds? If not, better get going. Are you risking more than 60% of your net worth in any one asset class? If so, try and diversify more. You don’t want to be the typical American who lost their shirt when the housing market collapsed or the dotcom bubble burst. Make sure you have a mix of offensive and defensive positions that also provide an income stream.
4) Run your financials through a retirement planner. It’s important to make sure your assets and income projections are on track. Good retirement planners are great at highlighting your income shortfalls or spending excesses because it uses your real data. It’s harder to fudge your numbers as people so often like to do. Once you know your shortfalls, you can take steps to improve your situation.
I’ve spent time reviewing my investment portfolios, cash positions, and retirement cash flow projections. The results have me deploying 35% of my cash holdings into US index ETFs like VYM and DVY from my rollover IRA, SEP IRA, and Solo 401k. My retirement portfolios have ~30% cash weightings on average. I won’t be deploying any of my cash sitting in my bank account before 100% of my retirement cash is invested. We’ve still got the US Presidential election to contend with!
Recommendation To Build Wealth
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Updated for 2019 and beyond. Brexit is still happening!