Lessons learned from the debacle

[haha]

And had you listened to your gut in 2004 and backed off your equity exposure, you would have missed out on an additional 35% gain prior to the market peak in 2007.

I learned long before this meltdown that neither my head nor my gut is smart enough to time the market. This is exactly why I've worked hard to find an AA I can live with no matter which way the market is headed.

Very good thing to remember!

I am reading an interesting book right now called "On Being Certain- Believing You are Right Even When You're Not".

I think it might be good reading for any investor. It demonstrates very convincingly that most of these gut feelings of certainty are generated internally by the limbic structures of our brains, and have little if anything to do with external reality.

Ha

 

[headingout]

Enjoyed this thread: a best of FIRE. My lessons learned:

• 50/50 asset allocation works for me in good times and bad. Though games I played with valuing SS into my portfolio led me into buying equities too soon into the downturn.
• Pure buy and hold doesn't cut it, especially if you dabble in hot areas such as commodities. I neglected to sell some very profitable positions because I thought the rest of the market was a sensible buy-and-hold investor, like me.
• I learned how to tax loss harvest. (And will probably dislike the resultant paperwork at tax time as much as expected.)
• It's OK to sell in a falling market (to tax loss harvest, or simplify your portfolio): just don't change your allocation to equities. (I didn't.)
• No matter what, keep DCA'ing. (I doubled my 401K contribution in November, then again in March.) But once/month is adequate. I tried weekly investments and it was just a lot of transactions with no apparent benefit.
• Rebalancing is a dark art, and achilles heel on the long-term investor. I started way too soon, early 2008, and was out of serious gunpowder by the summer. I learned that market trends can take years to develop, but a serious breakdown in a bull market (summer 2007) is a warning sign.
• A steady job looks darn good when the economy tanks. You can even love your job for a while, based on that.
• An emergency fund and liquidity are essential to peace of mind and bargain hunting. Our lifestyle never felt threatened in any way. In fact, we were able to shop for bargains, and increase our charitable contributions late last year.
• Diversification is no panacea: but patience may be.

 

[ziggy29]

If you're reasonably young and looking for a job, don't underestimate the value of job security and a pension while considering the "total compensation" of the offers you get. Having those things can make stock market volatility a lot less relevant to your day to day life and your ability to retire.

 

[Moemg]

I also learned that having a cola pension with health benefits is like having a net underneath a high wire walker . You may fall but you'll survive .

 

[harley]

- You jump in while things are still falling at your peril: I was early and often and suffered for it. Simply put, next time I wait for things to convincingly bottom before jumping in and pulling out the stops.

While I think this is a great idea, how do you suggest applying it?

Personally, I don't think we're anywhere near the end of this downturn. I think there is still a large amount of bad news to come, which will result in more significant drops in the various markets. So if you assume "the immediate flames are out", is now the time to be getting back in? I don't think so. However, I could easily be wrong (again). The March bottom may have been it. My point is, how can you know? The only way I can find peace of mind is sticking with my AA and rebalancing schedule, come hell or high water.

Of course, if anyone has a better suggestion that is easy to apply and pretty much foolproof from a future point of view, I'm listening.

 

[bubba]

Personally, I don't think we're anywhere near the end of this downturn. I think there is still a large amount of bad news to come, which will result in more significant drops in the various markets. So if you assume "the immediate flames are out", is now the time to be getting back in?

I've been pondering this as I tend to agree that there's more bad news to come out. What about deciding at what point you would sell and then actually bail? Is this market timing? I have too many shs of a particular stock that I should have sold a long time ago. But, no, I followed it to the bottom. Now, it's recovering slightly. I don't believe it will see it's previous high, but possibly there will be a bit more recovery. Right now, I'm treating it like a mental stop loss, and the question is will I really bail if the stock drops to x per share? I hope so, because like someone said up-thread, I believe I've learned that buy and hold isn't the proper course for me any longer.

 

[Midpack]

Personally, I don't think we're anywhere near the end of this downturn. I think there is still a large amount of bad news to come, which will result in more significant drops in the various markets. So if you assume "the immediate flames are out", is now the time to be getting back in? I don't think so. However, I could easily be wrong (again). The March bottom may have been it. My point is, how can you know? The only way I can find peace of mind is sticking with my AA and rebalancing schedule, come hell or high water.

You could be right, but an awful lot more from the whole financial mess has already been discounted in. Unless you are talking about problems completely outside the whole housing bubble, Wall St overleveraging, prolonged artificially low Fed interest rates, to big to fail Corp failures, deficits/debt/stimulus, etc. mess - I think we are near the bottom. But I too, "could (very) easily be wrong."

 

[Delawaredave5]

Excellent thread - thanks for everyone's openness.

My equities were very diversified globally - I was 60% stocks - but I was convinced my risk exposure was much less lower than 60% all US stocks.

Key Learning: the whole world can tank at the same time....

 

[bbbamI]

I learned that my Grandpa with only a fourth grade education was much more intelligent than I imagined. Many times he told me; stay out of debt, do not put all of your eggs in one basket and find pleasure in simple things. That's the way he lived his life.

Fortunately, I listened to him and followed his example. Well....most of the time.

 

[audreyh1]

What I learned Part I - Macro View

What I learned - macro view:

Even though the market was reaching new highs in 2007 and quite a bit of concern was expressed about valuations and the housing bubble on this forum, I kept noticing that market valuation metrics continued to improve since 2003. The economy was doing well and things were nowhere near as wildly overvalued as in 1999 when I retired. I guess since it wasn't 1999, I wasn't worried! We had gone through a pretty long bear 2000-2002, so I guess I wasn't expecting another soon. I had let my equity allocation creep up slightly over the years for tax efficiency reasons and was content with my allocation.

Even though the housing bubble was obvious and the housing market had clearly topped in 2006 and coming down, I thought that the housing troubles might be somewhat insulated from the rest of the economy. Even though parties who had invested in mortgages and people taking out stupid mortgages would be hurt and financial institutions would be hurt, not to mention all the real estate related businesses, I honestly didn't understand how this might impact the rest of the economy and corporations or most people's investments.

Of course when everything hit the fan and the financial system started to collapse it became painfully clear that the "rest of the economy" would suffer tremendously if they were not able to get the financing they needed to continue normal operations, because the financial institutions weren't just "damaged", they were imploding!

What I did not realize was the extensive leverage the financial institutions had used while goosing the housing bubble, and how much of their own koolaid they had drunk. I never imagined they would get caught holding their own questionable paper - excessively leveraged no less!!! The actions taken were so outrageously stupid I just couldn't image that financial professionals would do what they did (echoes of Greenspan?). I still think the crisis would have been relatively minor and contained within the economy if it hadn't been for the outrageous leverage of the financial institutions and the ridiculous wishful thinking use of CDSs. It's not right that financial institutions making irresponsible decisions for short term gain and bonuses can wreck the financial system and screw up the rest of the economy. There is clearly such a thing as "too big too fail" and it has to be policed.

I'm not sure how these insights will help me in my investing future. I am not changing my investment strategy going forward other than very minor tweaks (next post). Even if I had become concerned like others in late 2007, I probably would not have done much different other than perhaps decide to go back to my equity allocation pre-creep. That was only a 3% difference - very minor.

Perhaps I have a new respect for long-term market cycles. Being cautious by nature, I had made contingencies for a long downturn by being sure I had a good portion of the portfolio in bonds and cash in my portfolio. I also maintained a 1 to 3 year expenses in cash cushion outside of my portfolio which very fortunately I had topped off mid 2008 - pure luck that. These things really let me sleep at night during an incredibly stressful worldwide market crisis.

Audrey

 

[audreyh1]

What I learned Part II - My Investment Strategy

What I learned - some details per my specific investing strategy:

• My AA worked OK. I had let my equity allocation gradually drift upwards in 2006-2007 mainly because I was annoyed with the distributions being thrown off by my portfolio, and a higher equity allocation was slightly more tax efficient. The drift was tiny - just 55% to 58%. After this debacle I decided that such a drift was not a good idea, that I should be lowering my risk over time, and that once I reach 55 I will probably lower my equity exposure 1% per year.
  
  
• I was shocked by how many times my rebalance triggers fired in 2008, it used to take a pretty good divergence! I rebalanced in July of 2008, and again in October even though I decided to wait for a wider margin for out-of-balance. Came very close again in Nov, but I decided to wait until mid Jan when I usually have to deal with distributions and taxes in my portfolio. I rebalanced in Jan. Triggered again in March, but recovered so fast that I didn't bother. If this rally continues (knock on wood), I will be rebalancing again soon - but fortunately on the recovery! I'm keeping my wider margin, but it still has my head spinning! Still, whether this is a bear market rally or the start of a new bull (who knows!?!) rebalancing on the up is a way to protect myself against possible future declines.
  
  
• I ran up against my minimum bar of years needs in cash+bonds in my portfolio that I had established early in my investing plan. I never expected this to happen - or certainly hoped it wouldn't. I had initially set the bar at 10 years living expenses. When I started getting close in Oct 2008 and Jan 2009, I decided to keep it at 12 years, so that if things deteriorated further I would have more ammunition for rebalancing if I wanted. This limit then forced my hand in terms of my equity allocation. Late Oct of 2008, I could only rebalance to 56% without going below the 12 year limit. Mid-Jan of 2009 it forced the equity allocation down to 55%. I've decided that I will stick with 55% on the way (hopefully) up, and then in a few years start the gradual reduction of my equity allocation over time.
  
  
• If I hadn't topped off my short term cash fund (outside of the AA portfolio) to 3 years of living expenses in mid 2008, I would have sat there like a deer in the headlights. Knowing that I shouldn't need to draw from my retirement portfolio until late 2010 at the earliest gave me the comfort level I needed to catch all those falling knives! And boy did I catch some, but it doesn't bother me because I figure they will eventually pay off.
  
  
• I was really surprised and disappointed with the performance of my bond funds during this time period. In particular my core bond fund DODIX. These bond funds got hit hard at the same time my equity funds were creamed, so my portfolio suffered overall and rebalancing wasn't nearly so rewarding. And it meant I hit my minimum cash+bonds limit more quickly that I might have. I had no idea that DODIX has such a low exposure to Treasuries. Fortunately I went into this bear market with a relatively high allocation to cash in the portfolio - 10% - so that helped with the rebalancing. Even though DODIX ended up flat for 2008 and has performed very nicely year-to-date, I am looking for a core bond fund that is less correlated with my equity bond funds. Right now VBISX is looking like what I need - very high quality short duration bond fund less correlated to equity funds (as recommended by Armstrong). I will gradually transition over.

Audrey

 

[ziggy29]

I learned that my Grandpa with only a fourth grade education was much more intelligent than I imagined. Many times he told me; stay out of debt, do not put all of your eggs in one basket and find pleasure in simple things. That's the way he lived his life.

That's another thing I've learned: as a society we largely forgot the "money lessons" learned by those who lived through the 1930s, and a lot of people are having to learn those all over again today -- all too often, the hard way.

 

[audreyh1]

I think that is why these kind of things repeat every 70 years or so. As the generation which really learned the hard way fades away, the lessons learned from the experience is lost to their descendants.

Audrey

 

[Lusitan]

Good idea for a thread, Brewer.

Here's what I've learned (so far) from this downturn:

1) Asset alloction: my current asset allocation is right for me right now, but I'm reminded of the importance of moving to a more conservative allocation as I get older and closer to FIRE. Not a new concept, but one that we all have a tendency to forget when times are good.

2) Rebalancing: I learned that I'm emotionally OK with ...
(a) watching the value of my portfolio plummet (given that my asset allocation is right for my age)
(b) switching new investments to all-equities to balance out my sinking stock holdings (even though it felt like throwing money down a big black hole, I kept up the contributions and actually switched them to 100% stock index funds back in the fall)

But, I learned that I'm too chicken to ...
(c) actively rebalance existing bond holdings into stocks during a crash like we've seen.

And therefore I'm glad I'm holding a target retirement fund as the core of my portfolio which handles the auto-rebalancing on its own. For whatever reason, I'm OK with watching my prior stock investments crash, and I'm OK with throwing new money into a crashed market, but I'm not able to muster up the courage to sell solid fixed-income assets and rebalance those into stocks after a crash. It doesn't make sense, but emotionally, that's how I reacted.

3) Emergency fund: a six-month emergency fund is not enough for my situation (married w/kids, single-income family), I've decided to keep it at 12 months of post-layoff expenses (which includes COBRA costs).

4) Trusting my gut: I learned that (a) my hunches about market bubbles are worth something but that (b) my tendency is to call the bubble far too early on in the business. What this tells me is that I should factor my beliefs into my long-term investment allocation, but not expect short-term confirmation. (i.e., and it tells me that if I spot a housing bubble and tell my wife over dinner that we should wait until this "crazy situation" corrects itself before buying a house, I should be prepared to wait five years before seeing said correction take place ... and that we'd better be able to factor that into our plans)

5) Misc: it's time to purchase a firearm and learn how to use it properly (but only after the bubble in guns & ammo prices is over); something I've wanted to do for a while anyway but never got around to it.

 

[Independent]

I learned that predictions are unpredictable...

Or, as Yogi said, "It's tough to make predictions, especially about the future".

In terms of personal investing, it means that any investment plan that involves me outguessing the market is bound to fail. Like Lusitan, I call bubbles way too soon. I thought we had "irrational exuberance" even before Greenspan said it.

What I learned is that I shouldn't give up my skepticism and jump in when it looks like "it really is different this time". Fortunately, I didn't, but it was close.

 

[Notmuchlonger]

I think that is why these kind of things repeat every 70 years or so. As the generation which really learned the hard way fades away, the lessons learned from the experience is lost to their descendants.

Audrey

Give this crash a few years to recover. You still start seeing the posts. That should be the ultimate sell signal

"Why not 100% stocks?!!?"

 

[haha]

While I think this is a great idea, how do you suggest applying it?

Personally, I don't think we're anywhere near the end of this downturn. I think there is still a large amount of bad news to come, which will result in more significant drops in the various markets. So if you assume "the immediate flames are out", is now the time to be getting back in? I don't think so. However, I could easily be wrong (again). The March bottom may have been it. My point is, how can you know? The only way I can find peace of mind is sticking with my AA and rebalancing schedule, come hell or high water.

Of course, if anyone has a better suggestion that is easy to apply and pretty much foolproof from a future point of view, I'm listening.

You are 100% correct. When I bought in after the 2000-2002-03 fall values looked so-so but better than they had for a very long time. They were, and markets soared. In September 2008, values looked better than they had a for a long time, but that was really just the early stages of a waterfall decline. (And in Sept 2008 by objective measures they were better than in late winter 2003.)


I belive that one can avoid huge mistakes as to valuation, but over time he will never optimize timing.

Ha

 

[audreyh1]

Give this crash a few years to recover. You still start seeing the posts. That should be the ultimate sell signal

"Why not 100% stocks?!!?"

Quite honestly - I do not expect to see such a post to be common for another 10 years yet. People really got burned badly this time. I think the average joe retail investor will be extremely skeptical about equities going forward. Burned badly twice in 10 years. That's a tough experience to get over. People can become quite irrational about it.

There has been a lot of cash on the sidelines since 2002. Pundits keep remarking on how much cash there is and how it could flow into the market. Well, that cash has kept building during the 2000s and built even more over the past year. I think it will stay on the sidelines for quite a while longer. People are so focused on not getting burned right now.

When that cash finely starts coming off the sidelines in a big way - that is the ultimate sell signal.

Audrey

P.S. Love your new avatar image! I need a sign like that to post inside my home-on-wheels.

 

[ziggy29]

Quite honestly - I do not expect to see such a post to be common for another 10 years yet. People really got burned badly this time. I think the average joe retail investor will be extremely skeptical about equities going forward. Burned badly twice in 10 years. That's a tough experience to get over. People can become quite irrational about it.

Not only that, but it was possible to avoid getting burned badly in 2000-02 with a large stock allocation IF you were adequately diversified with small caps, emerging markets, REITs, value stocks and perhaps some gold miners.

This most recent bear, on the other hand, was pretty indiscriminate. All equity asset classes -- large and small, growth and value, domestic, developed international and emerging -- got creamed together with an unusually strong correlation.

Speaking of which, there's another lesson learned -- diversification, while definitely useful in the general case, may be of little use in the worst case.

 

[audreyh1]

Well - if you had a chunk of cash as part of your portfolio AA and owned a US government bond fund like FGOVX as a big part of your bond stake, you did have asset classes that behaved well while every thing else tanked. This was a very good lesson in how different types of bond funds diverge during a crisis.

Audrey

 

[growing_older]

All my models of asset allocation, acceptable mortgage debt, and emergency fund size (and source) were based on assumptions that were too optimistic.

I failed to consider the possibility that job loss would occur at the same time as market meltdown at the same time as severe industry contraction - and also at the same time as maximum job burnout. I saw folks get hit by this triple (quadruple?) threat and they sometimes take a LONG time to find work.

What I propose to do about it:

1. stop counting untapped HELOC as part of emergency fund

2. build emergency fund to 4+ years expenses

3. lower equity AA, but only slightly, as I was mostly okay with the idea of riding out the horrible decline and had no urge to sell out at bottom

4. reduce mortgage debt further - ideally to zero asap

 

[ejman]

Well - if you had a chunk of cash as part of your portfolio AA and owned a US government bond fund like FGOVX as a big part of your bond stake, you did have asset classes that behaved well while every thing else tanked. This was a very good lesson in how different types of bond funds diverge during a crisis.

Audrey

Yes, a very good lesson indeed. looking at returns from 10/9/07 thru last Friday I show the following IRR per Quicken:
Vanguard Inter Term Treas : +10.26%
Vanguard Inter term Bd: Flat
Vanguard Wellesley : -6.76%

 

[ziggy29]

Well - if you had a chunk of cash as part of your portfolio AA and owned a US government bond fund like FGOVX as a big part of your bond stake, you did have asset classes that behaved well while every thing else tanked. This was a very good lesson in how different types of bond funds diverge during a crisis.

True. I should have been more explicit, but I meant to refer specifically to diversification among *equity* asset classes as being helpful in 2000-02 but nearly useless in 2008 and early 2009.

 

[audreyh1]

Well, I certainly expected to go through periods where all equity asset classes were punished. That is not surprising during a severe economic downturn. And some were punished more than others. IMO 2000-2002 was a notable exception rather than what can be normally expected. What surprised me was how hard the higher quality bond funds were hit.

Audrey

 

[redduck]

Lessons learned from the debacle:

1. Like so many others, I thought I was fairly well-prepared (and conservative) with my diversification plan--all neatly sliced and diced. Wrong. So, so wrong.

2. I thought I was reasonably well-prepared re: my equity/bond/cash allocations. Wrong. I could have done better holding only pssst Wellesley (as others have mentioned regarding their own situations).

3. That I'm not interested in percentages . I'm interested in being financially/psychologically comfortable. So, I want a to have good amount of cash coupled with high quality bond funds. Anything over maybe ten years worth of spending money can be put into equities.

4. I need to remember not to compare my investments to others. I need to keep on eye on my own goals and figure out how to accomplish them. I need to establish a game plan and stick by it unless I see it's not working (or it's obviously flawed--or I get a sudden surge of hormones kicking in).

5. And, other than the above, I really won't know if, or how well, I actually learned anything, especially if this incredible turndown turns out to be just a quiz worth 25 points and not the final exam which is worth, let's say 75 points. From my past history, I'm not ready to take the final exam and I'm guessing neither are most of us. It's like when the test has lots of questions on material that wasn't in the book and the prof never discussed in class...

And then most of the class complains, "Hey, the test wasn't fair." And, you know, guess what?: the prof. doesn't give a sh*t.