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.
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.
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:
- Get a job (later you can be self-employed or have a business )
- Build an emergency fund of 3-6m spending in cash
- Avoid / pay off all expensive debt
- Get trained / qualified / promoted / experienced / paid more
- Avoid lifestyle inflation as your income goes up
- Start investing
- Have a target asset allocation
- Paydown your mortgage early
- Keep investing during crises
- 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 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 your way of taking yourself back to your tolerance for risk. It also embeds a process to buy low and sell high. So how do you rebalance?
One way to rebalance is to direct new monthly savings and portfolio income (e.g. dividends, interest) into the asset class that is underweight. So cash dividends and new contributions get used to buy equities until you are back at 75:25.
A faster way to rebalance is where you sell some bonds (the asset class that is now above its target % allocation) and buy equities (the asset class that is below its target asset allocation). It’s good to check where you are versus your target asset allocation say once a quarter.
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 investing. Your 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
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
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 aJeremy Grantham, Reinvesting When Terrified, March 2009
subtle shade less black than the day before.
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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