We could wax eloquent about how it’s important to “buy the dip” or “buy when the market is off”, but I don’t know that this approach would carry more than platitudes. So let me walk through how I’m looking at this current market correction and see if there is anything to learn. We don’t ask our clients to do anything that we wouldn’t do if we were in their shoes, and I’m in some shoes that many others are in, so this might be helpful.
Disclaimer: This is also a great place to say that this is my approach alone, and is not meant as individual advice to you per se. You need to think through how concepts discussed here can apply (or may not apply) to the specifics of your situation, and you should run these thoughts by your financial advisors and any other relevant professionals. The following is – as always – intended to supplement your good sense, not replace it.
Current state: As of this writing, the general stock market is off around 10% from its most recent high, putting it at levels commensurate with 7 months ago. Said differently, if I thought that last week’s price on my favorite stock was accurate, I now have an opportunity to time-travel back to 7 months ago when it was on a ridiculous sale. So, should I do that? Here’s how we evaluate it.
1. Internal evaluation: My wife and I are constantly monitoring how much liquid cash we have as expressed by the number of months we could go without a paycheck and sustain life (ex: if you had emergency funds of $45,000 on a monthly budget of $11,000, you’re at roughly a 4-month reserve).
Our comfort level is no less than 3 months for money that we could access in 72 hours, and 6 months for money that we could access in 2 weeks. For some, this two-week rule fudges the line of what a true emergency fund is, and they can be mad. We are not dumping the second half of our emergency fund into funds designed to track the S&P 500, but neither are we letting it sit idly and lose to inflation. Maybe that can be a future blog post. It’s important to note, however, that if for any reason we do not have the cash described above, WE ARE NOT BUYING THE DIP. We will not take what we have and need to go speculate and earn what we don’t have and don’t need. Period.
2. Forward evaluation: If we find that we have cash available to invest above the thresholds described above, we then look ahead in the next three years and see what big ticket items are coming down the pike. These are things that don’t require cash this week, but they will soon, and we don’t want to tie up that cash in investments that may need longer to make money. Warren Buffet said that the trick to compounding interest is not to interrupt it unnecessarily.
The flip side of this is the discipline not to invest for 7 years that which you will need within 3 years. So, if we want to take a trip with the family, that’s not an emergency fund-worthy expense, but if we invest that money at all, it will be very cautiously and for the shorter term.
3. External evaluation: If we have accounted for short range expenses in step 2, we move to evaluate the current market. Is there something wrong with the market right now? Are there good reasons it is down right now? What are the wise people doing? What are fools doing? Are there geopolitical or health crises about to unfold? Is public policy about to change in an adverse way? This is where our political bias and our internal propensity to fear can easily lead us astray.
Many investors are tempted to go from faith to fear the moment their preferred political party is out of power. This is short-sighted, and often leads those in power to be too brash, and those out of power to be too fearful. It also helps to know whether the investments you’re making today are for 3 years, 5 years, or more than 10 years. Much of the cash that we put to work here is intended to be held long after the current administration is gone, and even beyond the next one in some cases. So, if my wife and I see something that the blue team or the red team is doing that is harmful, there’s a good chance we still buy in, predicting that our long-term investments will survive and outlast ill-fated policy decisions.
4. Execute and protect investments from ourselves: Yes, you did read that correctly. We’re not nearly as worried about the market doing something crazy (it definitely will) as we are concerned about our own self-discipline to stick to our strategy. We’re not old investors, but we’re old enough to have lost money in both bull- and bear markets. Looking back, we can see that most of our losses in the market were self-induced by selling too soon, and most of our gains have come from patience and discipline, supported by sufficient cash on the sidelines so that the investments on the field can stay there.
These are the steps we go through every time we come to a bear market, every time we hear “oh you should buy the dip”. And much like an electrician installing a new breaker or a surgeon removing an appendix, we find that having a checklist to walk through in our minds saves us a lot of unnecessary drama later. You’ll probably notice that we didn’t cover hardly at all what to buy once you determined whether you should invest. This is intentional. What you should buy is highly individualized, and nearly impossible to cover in this format. But that might not stop us from trying to cover it in a future post.
Tim Weddle Financial Advisor