The inestimable advantages of having a plan

There’s nothing quite like a global pandemic or a zombie apocalypse to focus the mind and bring perspective to our first world problems.

Tough times have the potential to bring out the best in people.

But recent events have reminded us that humans don’t deal well with invisible threats. We fail to plan for unforeseen events and “tail risk”.

We don’t just have a cash emergency fund just for the things that we can predict, we have a cash emergency fund for the things that we can’t predict.

Black Swans

It’s hard to predict something you haven’t seen before. We don’t know what we don’t know. For years, people in Europe thought all swans were white. It took just one sighting of a black swan in the New World to destroy a belief that people had held for thousands of years.

COVID-19 was not a black swan event. In The Black Swan, Nassim Taleb warned about pandemics as one example of extreme events that hide unseen in the tails of distributions that are anything but normal. Things that have happened before and are predicted to happen again are, by definition, not Black Swans.

The COVID-19 crisis has however reminded us of the importance of digging a well before you are thirsty. It’s been the ultimate reminder of the need for a cash emergency fund.

The crisis also shows the benefits of having a plan. Most people do not have a plan. They go through life like driftwood on the ocean, being swept this way and that by what’s happening around them. Life is something that happens to them, rather than being shaped by them.

Shit happens

Luck certainly plays a big role in life. Shit happens and one thing that’s certain in life is that your plan will have to flex and adapt as circumstances change. But you still need some sort of plan.

The bare bones outline of your financial plan might be something like this:

  1. Get a job (later you can be self-employed or have a business )
  2. Build an emergency fund of 3-6m spending in cash
  3. Avoid / pay off all expensive debt
  4. Get trained / qualified / promoted / experienced / paid more
  5. Avoid lifestyle inflation as your income goes up
  6. Start investing
  7. Have a target asset allocation
  8. Paydown your mortgage early
  9. Keep investing during crises
  10. Repeat until financially independent

Your plan is personal to you and your circumstances. It doesn’t have to be complicated but it does have to be yours. You can discuss your plan with other people. They can help you refine it. But only you can take ownership and live it.

Asset allocation

Asset allocation is an important part of your investing plan. Asset allocation is the way that your net worth is divided up between different asset classes.

In simple terms we can put asset classes into 2 groups. First we have “engine” assets. These are risk assets like equities and rental properties. These are the “engine” of the portfolio; they power it and drive it forward.

Diversification is the only free lunch on Wall Street. In the equities (shares) element of the portfolio, we want to be globally diversified. This can be done very simply via a global tracker fund. Single market trackers (e.g. a FTSE 100 tracker) are not good enough.

Then we have the assets that act as “shock absorbers”. Assets such as cash and government bonds reduce risk and volatility in your portfolio. They help smooth the rollercoaster ride of equities.

Imagine someone with a target asset allocation of 75% equities : 25% bonds. During recent stockmarket falls, the actual split may have changed to say 69% equities : 31% bonds. Rebalancing is how you take yourself back to your target asset allocation of 75:25.

Write it down

Your plan needs to exist outside of your head. You need to write it down. Writing is thinking. It’s a powerful process by which you organise your thoughts.

Writing your plan down is also a form of pre-commitment.

Odysseus was the legendary Greek king, soldier and hero of the Odyssey. When Odysseus faced the perils of The Sirens, he told the sailors on his ship to plug their ears and tie him to the mast so he could hear their enchanting song that lured men towards the rocks and certain death. When he heard their song, he ordered the sailors to untie him but they bound him tighter. When they had passed out of earshot, Odysseus was safely released.

In this analogy you are Odysseus, our hero. The Sirens are the talking heads on financial TV, news clowns presenters in the mainstream media and the panickers in online discussions about investingYour written plan is the mast and the rope.

A plan does not need to be some lengthy bureaucratic report. It can just be one side of A4 paper or a spreadsheet.

Talk to someone

Yes, I’m biased but you should talk to someone about your plan. A robust plan is one that has been looked at and challenged by someone that’s on your side.

If you have a wise and rich patrician uncle who has mastered the wealth accumulation game, lucky you. Go to their chateau or private members club. Talk to them, learn from them, pick their brain.

Although I’m a huge sceptic of most wealth managers (if you see thick cream paper and stone lions, statues and columns printed on glossy brochures…run away) there are some good financial planners out there. This is a good option if you want someone to i) do the paperwork ii) make decisions for you and iii) stop you doing something bonkers like panic-selling during a crash.

Yes, its possible to do it on your own. You can learn from your own expensive mistakes (as I did). But it generally works out cheaper to learn from other people’s mistakes. Don’t be penny wise, pound foolish.

Reinvesting when terrified

If you are fortunate enough to be overweight cash right now (perhaps from a windfall, house or business sale or inheritance) then you need a plan to scale out of cash and into “engine” assets.

To put some numbers to this, if you are sat on £120,000 of spare cash and are nervous about going all-in in one move in these volatile times, how about scaling in? You could pre-commit to invest £10,000 per month for 12m to smooth out the ups and downs of the rollercoaster.

You may only want to invest when the market has turned the corner and is heading upwards. But sadly, they don’t ring a bell at the bottom. What I do know is that it’s best to buy shares when they’re temporarily on sale. The sales won’t last long forever.

For those with a sensible plan, now is a time to be brave. If you wait until you think everything is safe, prices will already have moved against you.

Be aware that the market does not turn when it sees light at the end of the tunnel. It turns when all looks black, but just a
subtle shade less black than the day before.

Jeremy Grantham, Reinvesting When Terrified, March 2009

A final punch in the face

Let us recall the wise words of Mike Tyson:

Everyone has a plan until they get punched in the mouth.

Mike Tyson

Don’t tell him I said this but Mike Tyson was rubbish with money. He earned $400m of prize money and still went bust so, let’s be honest, he’s probably not the best personal finance guru out there. But he does know about getting punched in the face.

I will however leave you with this thought. The only thing worse than having a plan and getting punched in the face is NOT having a plan and getting punched in the face.

Do you have a plan?


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9 comments

  1. Haha, I was thinking about the wisdom of the Tyson quote too, coming from a guy who didn’t “know how to money”.

    I was diversified well when this hit, and my bonds are significantly cushioning my losses. It’s nice. I had a plan, I got slightly punched, but I got punched in 2000 and 2008 as well. I know how to get punched and I’ll still come at ya. Yo Adrian!!

  2. so many people appear to be living from pay day to pay day.
    This pandemic shows them up. This is the time you need your emergency fund.
    Im a tad overweight in cash so i might be making a few trades when isa opens.

  3. Marky P · · Reply

    Thanks for this TEA,
    One of the “many things” that has infuriated/perplexed me over the last couple of weeks is the bleeding hearts from allegedly established businesses and their pleading for Govt salvation.
    Btw Govt salvation ultimately means any UK / every other countries tax payer(s) as people seem to forget that Govt’s are merely tellers for their money. Govts do not have their own money. That’s another blog update there alone.
    But I digress, why is their no legislation to enforce any registered business to hold a liquidity fund balance on their balance sheets rather than maxing out dividend / profit payouts year after year. Easyjet paid out a dividend only last week whilst the impact of the current pandemic was already known
    I worked in the Lloyd’s Insurance market for 30 plus years before the Escape Plan was implemented last summer. Our Syndicates (companies to laymen) were required to calculate the following each year; A reserve to meet known future liabilities arising from notified claims plus associated costs and an IBNR (Incurred but not reported) fund for those claims that were as yet unknown plus an additional margin for other events like loss of invest income or currency fluctuations. this was independently and stringently assessed by appointed auditors before year end accounts were signed off . Against this a Solvency test was applied to ensure liquidity could be maintained against that and on-going business activity. Even my friend who runs a single independent Estate Agent maintains a 6 month liquidity fund to cover his running costs, salaries etc for him and his staff in the eventuality of hard times. That this is not law rather than best practise is astounding to me.
    The same rules apply to those in paid employment or the self employed – but I fear we live in a society that now spends everything earned – some on the lowest incomes admittedly may have little choice but I fear wants and needs have become somewhat confused in modern societies.
    I’d refer back to Maslow’s Hirearchy of Needs and suggest that the blending of
    Self Esteem and Self Actualisation have now become intrinsically associated with Physiological and Safety Needs rather than separated from and additional to.

  4. Being 100% equities, I’m getting punched in the face with knuckledusters but I’m absolutely ok with that. I feel like my risk tolerance is even higher than I initially thought.

    Bought a bit a couple of weeks back, buying more tomorrow and then every fortnight from here on out. Bring it on!

  5. Julie K · · Reply

    Of all the conversations I have ever had with anyone about my finances this is the most helpful. I actually have some guidance to follow!! Only took 50 years.

  6. Great post and so true. How can life go according to plan if you don’t have a plan!

  7. Barn Owl · · Reply

    Sound and timely advice as usual. A small point but the fat tailed probability distribution cannot be quite right because the area under the curve for both the normal distribution and the fat tailed one must be the same. The chart shows the fat tailed distribution with a larger area underneath.

  8. This is an interesting post. I am a fully paid up member of have a plan. But you should also test your plan against events and this event throws up some challenges.

    You are right this event is not a black swan. In fact, if you take the emotion out of the equation it is actually a pretty small event. On a personal level (and I live with someone who is very high risk) it will be a relief if your loved ones do not die due to this virus. On a global level we started 2020 with almost 8 billion people on the planet and even if all Governments had done precisely nothing to combat this virus we would have ended 2020 with almost 8 billion people on the planet.

    However, the impact of this small event has been rather dramatic.
    Financially the big news is the willingness of Governments to print huge globs of money to stave off this crisis. Interest rates are around zero and debt has soared. It does make me wonder who is buying all this debt and how Governments are going to manage to service it – not now as rates are so low but when it expires. The $ strengthening and stock market falls are pretty minor next to that and will likely reverse. Interestingly gold and silver both fell too.
    Socially, panic buying has been interesting to watch. Lots of people, presumably armed with 14 packs of loos rolls and a months supply of food, decided the actions to mitigate the spread of this virus did not apply to them whilst even well prepared health systems struggle to cope with the number of ill people.

    Short term for this crisis, any sensible plan worked. The “stock market always recovers mantra” is very likely to be fulfilled, the virus will be tamed. Longer term the impact of global Government debt is less clear. Large debts have seldom turned out well in history.

    But what concerns me more is what happens when something more serious comes along. A genuine black swan perhaps. Given the impact of this “small” virus event – especially socially – what would we be confronted with if there was a “big” event. How should our plan adapt to that possibility?

    In the FIRE community I often hear that “the stock market always recovers” and if it does not then “who cares? We are all buggered anyway.” But I think there is also a middle ground where we are a bit buggered but not totally. Has anyone got a plan for that possibility?

  9. […] TEA on the benefits of having a plan (31) […]

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