Building Wealth

For the first 30 or so years of working, saving and investing, you’ll be first in the mode of getting out of the hole (paying down debt), and then building your net worth (that’s wealth accumulation.). But don’t forget, wealth accumulation isn’t the ultimate goal. Decumulation is! (a separate category here at the Hub).

What on Earth is Happening?

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image from wikimedia commons

By Noah Solomon

Special to the Findependence Hub

Markets ended the first part of the year on a particularly sour note. Over the past four months, the MSCI All Country World Stock Index fell 12.9% in USD terms. High quality bonds, which have held up well in past episodes of stock market weakness, have failed to provide any relief, with the Bloomberg Global Aggregate Bond index falling 11.3%. Given the “nowhere to hide” atmosphere of markets, even a 60%/40% global balanced stock/bond portfolio suffered a loss of 12.3%.

Markets have entered a phase which differs from what we have witnessed over the past several years (and arguably over the past 40). In the following, we have done our best to share some of our most closely held beliefs about markets and investing, which we hope can serve as a guidepost for helping investors navigate the current market regime.
 

It just doesn’t matter … until it does

Most of the time, it doesn’t matter much whether your portfolio is positioned aggressively, defensively, or anywhere in between. Nonetheless, the fact remains that the big money is made or lost during the most violent bull and bear markets.

Defining a “normal” return for any 12-month period as lying between -20% and 20%, the S&P 500 Index behaved normally during 65.7% of all rolling 12-month periods between 1990 and 2021. Of the remaining 34.3% of periods, 29.0% were great (above 20%) and 5.4% were awful (worse than -20%)

Average 12-Month returns during Normal, Great, and Awful periods:

As the table above demonstrates, during normal periods there has not been a significant difference in average returns between the S&P 500 Index, the Bloomberg U.S. Aggregate Bond Index, and a balanced portfolio consisting of 60% of the former and 40% of the latter. It is another story entirely during the 34.3% of the time when bull and bear markets are in their most dynamic stages. The good news is that there are some key signals and rules of thumb that offer decent probabilities of reaping respectable gains in major bull markets while avoiding the devastation from the worst phases of major bear markets.
 

Don’t fight the Fed

It is with good reason that the “Don’t fight the Fed” mantra has achieved impressive longevity and popularity. The monetary climate – primarily the trend in interest rates and central bank policies – is the dominant factor in determining both the stock market’s major direction as well as which types of stocks out or underperform (sectors, value vs. growth, etc.). Once established, the trend typically lasts from one to three years.

When central banks are cutting rates and monetary conditions become more accommodating, it’s a good bet that it won’t be long before stocks deliver attractive returns. In late 2008/early 2009, central banks responded to the collapse in financial markets by cutting rates aggressively and embarking on quantitative easing programs. This spurred a rapid recovery in asset prices. Similarly, to offset the economic fallout of the Covid pandemic, monetary authorities flooded the global economy with money, which acted as rocket fuel for stocks.

Conversely, when central banks are raising rates and tightening the screws on the economy, the effect can range from limiting equity market gains to causing a full-fledged bear market (not an attractive distribution of outcomes). Once the Fed began hiking rates in mid-1999, it wasn’t long before stocks found themselves in the throes of a vicious bear market that cut the S&P 500 Index in half over the next two to three years. Similarly, when the Fed raised its target rate from 1% in mid-2004 to 5.25% by mid-2006, it set the stage for a nasty collapse in debt, equity, and real estate prices. When it comes to stocks, bonds, real estate, or most other asset classes, it’s all fun and games until rates go up, which ultimately causes things to break.

Markets don’t care what you think: NEVER fight the tape

The importance of not fighting major movements in markets cannot be overemphasized. Repeat as necessary: Fighting the tape is an open invitation to disaster. This advice not only applies to the general level of stock prices, but also to the relative performance of different sectors, value vs. growth, etc.


Ignorance, which can cause people to fight market trends, is a valid justification for making mistakes during the earlier stages of one’s investment experience. But after suffering the consequences, there are neither any excuses nor mercy when you fight the tape a third or fourth time. The markets only allow so many mistakes before they obliterate your wallet.

The perils of following rather than fighting trends are well summarized by investing legend Marty Zweig, who compared fighting the tape and trying to pick a bottom during a bear market to catching a falling safe. Zweig stated:

“If you buy aggressively into a bear market, it is akin to trying to catch a falling safe. Investors are sometimes so eager for its valuable contents that they will ignore the laws of physics and attempt to snatch the safe from the air as if it were a pop fly. You can get hurt doing this: witness the records of the bottom pickers on the street. Not only is this game dangerous, it is pointless as well. It is easier, safer, and, in almost all cases, just as rewarding to wait for the safe to hit the pavement and take a little bounce before grabbing the contents.”

To be clear, there is no free lunch in investing. Being on the right side of major market moves necessitates getting whipsawed over the short-term every now and then. Inevitably, you will sometimes be zagging when you should be zigging and zigging when you should be zagging. You can get head faked into cutting risk only to watch in frustration as markets rebound, and you can also get tricked into becoming aggressive just before a decline in stock prices.

The stark reality is that only geniuses and/or liars buy at the lows preceding major uptrends and exit the very top before the onset of bear markets. Realistically, you can only hope to catch (or avoid) the bulk of the big moves. Getting whipsawed every now and then is a small price to pay for reaping attractive returns during the good times while avoiding large bear market losses.
 

You don’t need to be perfect. But you’d better be flexible

It doesn’t matter whether you are an aggressive or conservative investor, so long as you are a flexible one. The problem with most portfolios (even professionally managed ones) is that they are not flexible. Conservative investors tend to stick with defensive portfolios heavily weighted in high grade bonds, utility stocks, etc. They never reap huge gains, but they also never get badly hurt. Aggressive investors, on the other hand, often buy risky stocks or speculate in real estate using high degrees of leverage. They make fortunes in boom times only to lose it all in bad times when the proverbial tide recedes.

Neither approach is sound by itself. Being aggressive is okay, but there are nonetheless times to gear down and be a wallflower. By the same token, there are market environments in which even conservative investors should be somewhat aggressive. Continue Reading…

Die with Zero?

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By Bob Lai

Special to the Findependence Hub

Recently I met up with a good friend for a much-needed chat. Over the course of a few tasty cans of beer, my friend mentioned that he recently listened to the “Die with Zero” audiobook and really enjoyed the key messages of the book.

Curious, I borrowed the book from the local library and finished reading it in two days.

The book’s author, Bill Perkins, suggested that we should all aim to die with zero dollars in our bank account, or at least as close to zero as possible. He argued that too many people spend unnecessary energy working extra years only to earn money that they wouldn’t be able to spend in later years and die with a large sum of money in their bank accounts. This is definitely different from the traditional belief of saving money during your working career and spending your savings once you’re retired.

Why die with $200k in your bank account, considering it took you an extra five years to save it, when you could have stopped working five years earlier?

Perkins believes that our lives are the sum of our life experiences which can be quantified and optimized. Therefore, we should focus on spending our money when we are younger and obtain as many life experiences and memories as we possibly can.

My friend now believes in spending his money in the most optimal way to obtain memorable experiences for himself and his family while keeping a focus on saving for retirement in the best approach. This is similar to what I’ve been preaching on this blog – find your own personal balance between spending money to enjoy the present moment and saving money for your retirement.

The fallacy of “save-save-save” mentality 

For many of us on the financial independence retirement early (FIRE) journey, we think about saving money constantly. We think about what’s the best way to save money and how to boost our savings rate, so we can become financially independent earlier.

But the “save-save–save” mentality isn’t actually healthy. It’s actually giving the FIRE movement a very bad vibe.

I’ll be honest, I was certainly guilty of focusing purely on our savings rate early on our FIRE journey. I wanted to cross the finish line and hit the escape button. Over time, however, I found that I wasn’t enjoying the small things in life. I felt frustrated when we spent money eating out or having a cup of coffee and treats at a cafe; I was having arguments with Mrs. T over these small expenses, because I wanted to save more money to expedite our FIRE journey.

When I stepped back and looked at the bigger picture, I realized that the “save-save-save” mentality wasn’t healthy. It was actually quite detrimental, especially to my relationship with Mrs. T.

The idea of becoming financially independent faster but without my lovely wife was not a price I was willing to pay. I realized there’s a fallacy in the “save-save-save” mentality.

Continue Reading…

Is it time to time the market?

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By Steve Lowrie

Special to the Findependence Hub

Has market news got you thinking it might be time to rethink your market positions?  It’s certainly understandable if the economic uncertainty unfolding in the daily news has left you wondering – or worrying – about what lies ahead.  No matter how you feel about the U.S. entering into a trade war with China, it’s hard to deny that the prospect is currently causing considerable market turmoil.  It is also hard to avoid the recent financial media obsession with an “inverted yield curve” (a rare situation when short-term bond maturities are yielding more than longer-term maturities).

You might have heard that each U.S. recession since the 1970s has been preceded by an inverted yield curve.  However, perhaps for the sake of sensationalism, not all articles correctly report that this relationship does not always hold true.  In reality every yield curve inversion does not lead to an imminent recession and/or lower equity prices.  Recent analysis by professors Eugene Fama and Ken French tested this very hypothesis.  Using data from the U.S. and 11 other developed markets, they found “no evidence that inverted yield curves predict stocks will underperform bills (bonds).”

Regardless of how the coming weeks and months unfold, are you okay with gritting your teeth, and keeping your carefully structured portfolio on track as planned?  This probably doesn’t surprise you, but that’s exactly what we would suggest.  Unless, of course, new or different personal circumstances warrant revisiting your asset allocation for reasons that have nothing to do with all the tea in China.

That said, the recent news is admittedly unsettling. If you’ve got your doubts, you may be wondering whether you should somehow shift your portfolio to higher ground, until the coast seems clear.  In other words, might these stressful times justify a measure of market-timing?

Here are four important reminders on the perils of trying to time the market – at any time. It may offer brief relief, but market-timing ultimately runs counter to your best strategies for building durable, long-term wealth.

1) Market-Timing is Undependable 

Granted, it’s almost certainly only a matter of time before we experience another recession.  As such, it may periodically feel “obvious” that the next one is nearly here.  But is it?  It’s possible, but market history has shown us time and again that seemingly sure bets often end up being losing ones instead.  Even as recently as year-end 2018, when markets dropped precipitously almost overnight, many investors wondered whether to expect nothing but trouble in 2019.   Continue Reading…

Should financial planners worry about FIRE?

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By Mark Seed, myownadvisor
Special to the Financial Independence Hub

A recent post in the Financial Post caught my eye, why some financial planners seem worried about the FIRE movement.

My reaction is, they need not worry too much about any FIRE movement. I believe some financial planners might have bigger issues to contend with. More on that in a bit.

Why is FIRE so hot?

As a refresher, FIRE stands for “Financial Independence Retire Early.”

Some FIRE investors strive to save as much of their income as possible during their working years, hoping to attain financial independence at a young age and maintain it through the rest of their life: aka retirement.

A common goal of many FIRE-seekers is to build enough capital and wealth whereby they can largely live off their portfolio value in perputuity or thereabouts. Some of them even leverage an outdated financial study to help them realize their goal: the 4% rule.

The 4% rule (a general guide for a sustained safe withdrawal rate (SWR)) used by many early retirees, was the result of using historical market performance data from 1926 to 1992 by U.S. financial planner Bill Bengen. In general terms, the “4% rule” says that you can withdraw “safely” 4% of your savings each year (and increase it every year by the rate of inflation) from the time you retire and have a very high probability you’ll never run out of money.

You can find the details of that study here.

4% rule

However, the first challenge of many related to this rule is that this study was published almost 30 years ago. A lot has changed since then, including real returns from bonds. There are also products on the market now that allow investors to diversify far beyond the mix of large-cap U.S. stocks and treasuries that the Bengen study was based on. In fact, the abundance of low-cost investing products should be what many financial planners should fear the most, a point I’ll come back to soon.

Certainly, in my personal finance and investing circles, I don’t know of many FIRE-seekers that live by any strict 4% rule. Thank goodness they don’t.

Even though the 4% rule remains a decent rule of thumb to start any early retirement discussion with, it’s a flawed concept for many of today’s early retirees aged 40 or less.

  1. The 4% rule was based on a 30-year retirement horizon. However, a FIRE investor’s retirement could last 50 years or even more. So, while spending in line with the 4% rule could give an early retiree a very good chance at not outliving their money, a 50-year “retirement” timeline could be disasterous if said early retiree was striving to live through a prolonged period of low stock market returns.
  2. This rule was used to demonstrate a safe withdrawal rate associated with only U.S. assets: a mix of U.S. stocks and treasuries to be more exact. There is little doubt that if an investor uses a broader, more globally diversified portfolio with U.S. and international assets leading the way, I suspect their chances of financial success would increase. In fact, Vanguard said they would.
  3. Finally, the 4% rule assumes a constant dollar-plus-inflation spending strategy: straight-line thinking that assumes your spending will follow a very linear path over many retirement decades. My hunch is: of course that won’t happen. Sure, maybe in the first retirement year you spend your desired 4% and at best, maybe next year you spend a bit more accounting for inflation. However, just like asset accumulation is dynamic so will your spending patterns be in retirement. This means you should strongly consider a Variable Percentage Withdrawal (VPW) approach that largely takes into account the flexibility to raise your spending “in good years” and decrease your spending in “bad years.”

Further Reading: Why you should follow a VPW drawdown strategy.

With any retirement drawdown plan, the ability to operate in a spending range will be very key to the longevity of your portfolio. I hope to follow some form of this approach myself in semi-retirement.

Which brings me back to our case study in the Financial Post.

Why financial planners shouldn’t be worried about FIRE

For Kristy Shen and Bryce Leung, a couple from Toronto who retired at 31, they gave up the dream of owning a million-dollar home in Toronto and decided to travel the world instead.

For Kristy and Bryce, their goal was always financial independence and not so much the retire early part. As Kristy explained on my site:

“The idea of retiring from our job and living off passive income seemed so weird and foreign to us, so at first we dismissed it as an idea that only tech entrepreneurs or trust fund babies could pull off.  Then we woke up and realized our savings had hit half a million bucks, and we were like “Hey, why not us?””

Why not indeed.

And so, by living off about $40,000 per year (you can see one of their income reports here), travelling and writing (likely earning some money from their blog and book), they’ve realized their goal of financial independence and then some. Six years past their “retirement date” their portfolio is now worth a cool $1.8 million thanks to a major market bull run in recent years.

However, there are some financial planners in that post that argue there is no magic in personal finance.

“People make money off putting out something that seems magical … like the latte factor. I’ll just skip a cup of coffee every day, and you get rich. But the math doesn’t work — unless you’re having 17 lattes a day.”

While true, citing longevity risk from these planners as yet another major risk for Kristy and Bryce to contend with is definitely reaching here. To argue that our millennial millionaire couple has to worry about spending $40,000 or so per year from a $1.8 million portfolio is a “problem” many Canadians would love to have.

The FIRE movement has been great for many reasons, and people have been doing it for decades before it became an internet thing. FIRE-seekers have: Continue Reading…

What’s the real deal with Mutual Funds?

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By Anita Bruinsma, CFA

Special to the Findependence Hub

Mutual funds stir up heated debates all across the internet. Fund companies sing their praises while others say they are taking you to the cleaners. It can be confusing – are they good or bad? What’s the real deal with mutual funds?

A game-changer for investors

Mutual funds democratized the stock market, making investing accessible to more people, and this was a very good thing. Before the popularization of mutual funds in the 1950s, it was more difficult to get your money invested in the stock market: you needed a stock broker to buy stocks for you and you needed a fair amount of money. 

The idea behind a mutual fund is simple: collect money from a group of people and hire professional money managers to invest this pool of money into dozens of stocks, generating a return for the investors. It’s the pooling of money that is so powerful: it allows a fund to be diversified, giving investors exposure to a myriad of stocks instead of just a few.

As an individual investor, you’d need a lot of money to get that kind of diversification. And whereas a broker would charge a large commission for every trade, a mutual fund has economies of scale, making the costs lower overall. Plus, as a mutual fund investor you don’t need to know one single thing about the stock market. What a win for the masses!

The downside

So why do mutual funds get a bad rap sometimes? It’s mainly because sales practices around mutual funds have a muddied history. Investment advisors who are making recommendations to their clients about what to invest in might be influenced by sales commissions, possibly encouraging them to put their clients’ money into funds that pay them the most commission. Worse, these commissions (and other perks that used to be permitted) were not always properly disclosed to clients. Regulations have improved in this area, but sales commissions can still influence an advisor’s choice of funds. Continue Reading…