1, 2, 3 panic! The US stock markets are getting crushed in 2016 as the Fed goes forward with their multiple rate hike path. China is in a tailspin and oil is heading towards all-time lows.
It’s a good thing that most of us are super savers, have a diversified net worth, actively rebalance our portfolios, and haven’t confused brains for a bull market!
We’ve also been preparing for downturns all year with posts such as: “Are We In Another Financial Bubble,” and “Creating A More Defensive Portfolio With Bonds,” so I suspect most of us are doing just fine. But what about other people who might feel like jumping out the window because they went on margin? Or how about that starry-eyed person who thought the grass was greener at a startup?
In this post, I’d like to go through the implications for various types of people if there is a sustained market correction. It’s nice to say that all of this is really just noise since we’re investing for the long run. But over the next one-to-three years, a lot of things could change if the pummeling continues.
Besides, it’s always good to have plans for various scenarios, whether they come true or not. Let’s imagine a current scenario of a 20% correction in the stock market.
IMPLICATIONS FOR STARTUP EMPLOYEES
You’ve got to face reality that your lottery ticket is not going to make you rich. Since you aren’t going to be rich, then you might as well enjoy the journey! It is imperative that you ASK the founders what is the latest condition of the company’s financials e.g. what is the burn rate, how long will the company last if revenue stays flat or goes down, etc. An implosion in the public markets means that private investors will be much more stingy in funding companies that aren’t clearly on the path to profitability.
Paul Graham, founder of Y Combinator admitted that 93% of his companies fail, even though his accelerator has less than a 5% acceptance rate. The only people getting rich are the founders or employees in the inner circle who’ve been able to raise enough money to cash out to rabid Venture Capitalists.
The Secretly guys who cashed out for $3 million each and shut down their company within 12 months, while leaving their employees in the dust, are winning. Sure, they may never be trusted again, but who cares? One guy drives a Ferrari and has $3 million bucks! But Zirtual management is not as lucky, and neither are the 400 employees who got let go at 1:30am Monday morning via e-mail. The need for funding is imperative given most startups don’t make money for years.
There’s just no liquidity for most startup employees. Even if you are eligible to offload 10% of your shares in the latest Series D round (not many startups get that far), you’re going to feel tremendous peer pressure from management to not do so. Your next pay raise or promotion might be at risk.
I say, screw the pressure! Your mission is to try and get as liquid as possible, because that’s what any smart founder who has brought his/her company this far is doing. Trust me, I’ve spoken to many, and all of them want to desperately cash out a large part of their holdings.
You’re already accepting 20-50% below market pay in hopes of making it big with your equity. Don’t get bullied into not turning some of that stock into cash. Strongly consider applying to companies that have massive cash on their balance sheets. You can always say you at least tried the startup world with no regret.
IMPLICATIONS FOR ENTREPRENEURS
Raise as much cash now and seriously rethink your desire to ever go public. Once you go public, your happiness will drop drastically. You’ll now have regulators watching your every move. You’ll have thousands of new masters, even though some might own a tiny amount of stock.
By staying private, you can manipulate folks into thinking everything is great. You don’t have to disclose your financials, and you’ve got Venture Capitalists out there dying to give you money. Raise more money from them ASAP. What do they care? It’s not their money they are investing, it’s their limited partners’ money.
Do you know how hard it is to hold on to your employees when your stock is cratering? It’s virtually impossible. Seriously, who the hell wants to work at Twitter? It’s a shit show that does not even have a full-time CEO. Even with the stock in the dumps, it still paid its new CFO over $70 million dollars after just one year of work! Talk about demoralizing for everybody else. His nickname while at GS was “Anthony No Bonus,” after getting the bullish internet stock calls totally wrong.
Just do what most smart co-founders do, and cash out at every single round. Use your funny money to buy something tangible that will last far after the bubble bursts. There is absolutely nothing wrong with the lifestyle business. In fact, the lifestyle business is what it’s all about!
IMPLICATIONS FOR EVERY DAY EMPLOYEES
Let’s say you’re like most people that don’t count on equity options to make you rich. You’re getting a 1-5% raise every year and have come to grips you’ll have to work for 40 years before you can retire. This life sucks if you don’t at least like what you do.
The only way out of this situation is to start building multiple income streams through side hustles. If you don’t like your job five years in, you sure as hell won’t like your job 10 years later. But if you start developing different income streams now, in 10 years, these streams may provide enough fire power for you to break free and do what you really want to do, even if the pay is much lower.
Since you’re in your job for the long run, unlike many ADHD-suffering startup employees who hop around every 1-3 years, these violent downturns in the stock market should be viewed as buying opportunities. For the first 20 years of your career, the amount you save in your 401k or other retirement portfolios will make up the majority share of your portfolio’s total value.
At the very least you should be maxing out your 401k. Hopefully you’ve got some 401k match program or company profit sharing to help add to your retirement account as well. Once you’ve maxed out your 401k, shoot for 20% or more in after-tax savings. You’ll eventually build a financial nut so large that it’ll hopefully start returning more money than you put in every year.
But remember, try to retire by a certain age, not after accumulating a certain financial figure. Your life expectancy is pretty certain at around 80 years old. On the other hand, there’s always one more dollar you can make.
IMPLICATIONS FOR PROPERTY INVESTORS
Real estate usually follows the stock market with a 12 month lag. If the stock market stays flat-to-down over the next 12 months, we should expect the real estate market to finally flatline or decline by 2017.
When equities are tumbling, fixed income is generally rallying. As a result, you’ve seen the 10-year yield decline from a 2015 high of 2.48% to now only 1.95%. Mortgages rates have also fallen by a commensurate ~0.5% across different durations as well, which is why you should refinance if you’ve haven’t done so already.
There might be a short-term knee jerk reaction where investors transfer capital from the stock market to the real estate market as we saw post 2000. That said, in the long run, real estate appreciation is tied to corporate and individual earnings power.
I strongly suggest those with more than a primary residence to deleverage through principal pay down, increase savings, or sell a property. I’ve personally paid off the remaining $100,000 of a rental property mortgage I took out in 2003 this year even though the mortgage was only 3.37%. So far, no regrets. When my tenant’s lease is up in June 2016, I am strongly considering selling as well to not only cash out, but simplify life.
IMPLICATIONS FOR FINANCIAL FREEDOM FIGHTERS
Many of us regulars are financial freedom fighters. We want to achieve financial freedom sooner, rather than later. As a result, we’re often trying to find the quickest way to make enough money so we never have to work again.
Trying to accumulate wealth quickly almost always results in the need to take more risk. There are those people who literally have over 90% of their net worth in the stock market. Meanwhile, others have leveraged to the gills and bought multiple properties in currently hot locations.
If you don’t have the liquidity to hold on during downturns, you will be crushed. You’ll be forced to sell your positions during the worst times, and when things finally recover, you’ll start hating everybody around you.
I don’t have a problem if you want to take concentrated positions in things you really believe in. Just know that in every transaction, there is a buyer and a seller. Both buyer and seller believe they got a good deal. Depending on your time horizon, one of you is going to be wrong, sometimes very wrong.
Having a risk-free fund in CDs or a money market account is a must. During a bull market, everybody makes fun of people with boring old cash. But cash can definitely be considered an investment. Only an ignorant idiot or someone trying to sell you a product would ever advise against having a certain amount of cash in your net worth. Focus on cash on hand and cash flow.
Here’s a sample of a recommended net worth allocation. Having anywhere from 10% – 30% of your net worth in risk-free assets is a good move. There are several more frameworks to look at if you click the chart and read the post.
IMPLICATIONS FOR RETIREES
For those of you who are already retired, these market moves should mean very little. You’ve seen the worst before, and all of this is just noise. Your investment portfolio should have no more than a 50% weighting in equities. As a result, you may actually be making money if your portfolio is heavily weighted in bonds.
With debt levels at zero or close to zero, Social Security paying out, and a steady stream of dividend income, interest income, and alternative income coming in, you are sitting golden. You can’t take it with you, so the focus on cash flow is key.
Only after a 50% decline in the stock market, should your worry-meter begin to rise. Good thing the chance of another 50% decline is minimal. Corporations have much more cash. Consumers are much less levered. And the creditworthiness of borrowers has steadily increased since the crisis.
Enjoy life to the max, make sure your estate is properly planned, and ignore the markets!
EVERYTHING WILL BE OK
When I was an Associate back in 2001, my Director said I was lucky I didn’t make much in the first place after I lamented about my bonus getting slashed by 50%. I wasn’t very happy with him at the time, but now I’m ecstatic I was poor during the dotcom collapse!
For younger folks, or folks who don’t have a lot of money, a stock market correction is fantastic if you actually deploy some capital and hold on. Unfortunately, a lot of people just talk about investing if the market collapses, but get too wigged out to do anything once the market actually does.
For older folks, you’ve gone through enough cycles that your net worth is hopefully properly diversified to weather the reoccurring tsunamis. And even if you were too stubborn not to diversify, at least you’ve developed new income streams to keep the boat afloat.
The worst case is that we’ll all have to go back to working minimum wage jobs flipping burgers or picking up passengers for a living. I’ve done both, and I can tell you that life isn’t so bad making less. So long as we have each other, everything will be OK!
In case you’re wondering, here’s what I’m doing in this downturn:
- I’ve accelerated my dollar cost averaging given we’re seeing 2%+ corrections.
- I’ve talked to a private wealth manager to hear his thoughts and what he’s seeing.
- I spent several hours writing and updating this 2,400 word post to address those of you who have concerns.
- I’ve come up with a game plan as to what I must do in terms of generating income over a one, two, and three year time frame.
- My savings machine is on the maximum setting. I plan to save 80%+ of my after tax income until the end of the year, and at least 60% for the first six months of next year to build as much fire power as possible to low ball on a property or invest in equities.
- I’ve reassessed my personal burn rate (budget) to see if there have been unnecessary spending over the past six months I can cut out.
- I’m negotiating better terms, or not investing at all in any startups.
- I’ve written out a list of things I want to spend money on now instead of have it disappear into thin air.
- I’ve run my portfolios through a free Investment Checkup so that I know exactly what my current asset allocation is e.g. cash balance, equity and fixed income exposure compared to recommended exposure.
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!