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REduce your exposure or RE-enter the market?

The new year is always a time to REview, REthink, and REsolve to do the things we slipped up on last year. With the stock market making significant moves, this year’s financial REflection seems more pressing than most.

As the calendar flips to 2019, it is high time for American expats to consider either RE-entering the market or REducing our exposure to the market.

The Current State of the Market 

The stock market became more volatile in 2018 than it has been in recent years and many large swaths of the market are in full-blown correction territory (meaning they’ve lost 10% or more) and a bear market is not out of the question. If you’ve missed any of that news, I’d love to know the address of that rock you’ve been living under. 

Will things get better in 2019 or worse? No one knows and those that say they know have been wrong more often than right over the years. It is pointless to predict if the market will be going up or down in the next 12 months. Rather, we very much should be asking for how long we will be investing (12 months or 12 years)? And how have we handled the recent volatility?

RE-entering the market

This may sound crazy, but the increased volatility and drop in prices, may be the moment you’ve been waiting for. Andrew Hallam rightly says,

If you’re going to be working, and putting money into the markets for at least the next five years, you need to HOPE for lower market levels!

Thinking Correctly About Market Fluctuations

Unless you will be needing your funds in the near future (say less than 5-7 years), then you WANT the market to go down so you can buy low-cost, widely diversified ETFs and mutual funds…on sale! Historically, the American economy has always bounced back. Historically, the world economy has always bounced back. If it happens again, you just bought into the market when stocks were on sale.

You may wonder why we’re talking here of RE-entering the market. If you weren’t an investor in 2008 and 2009, needing to RE-enter won’t make much sense to you. However, a lot of people lost a lot of money in that period. The reaction of many was to get out of the market. That was their first mistake. They sold after the market decline. They sold low and lost a ton of money.

The second mistake a lot of these people made was that they stayed out of the market. Their nerves were shot, their pride was hurt, and their resolve had melted away. Consequently, they’ve been holding their money in CDs and savings accounts for ten years. Investopedia says it well:

The bottom for the Financial Crisis was March 9, 2009, when the S&P 500 hit 676.53. If you had $10,000 to invest at that time, it would have bought you 148 shares of the SPDR S&P 500 ETF (SPY)…. As of Oct. 5, 2018, the S&P 500 stands at 2,888.07 and SPY trades at $288.10…. Thus, holding all of your shares, your investment would be worth $42,638.80. Pretty good for a $10,000 investment.

In about ten years those who exited the marked missed out on a gain of about 400%!

In 2015 and 2016 they were still nervous about re-entering the market. In 2017 and 2018 they realized their mistake, but they thought the market was so high that they shouldn’t re-enter it then.

If you were one of those who ran from the market and stayed on the sidelines for the next ten years, it may be time to start to step back in while the market has given up some of those highs that bothered you in 2017 and 2018.

REduce your exposure to stocks

Unlike those who abandoned the market, there are also those blessed investors who stayed invested in the market or began investing for the first time in about 2008. They’ve basically seen their investments go up and up without large hiccups for ten wonderful years. Their portfolios have quadrupled, their net worth has soared, and they were feeling pretty good about themselves until the volatility struck in 2018. In December we’ve seen significant “corrections” in the market. For the first time, these investors who were ahead by 400% took a loss of 10, 15 or 20% at the end of 2018.

Those of us in this situation need to be asking ourselves how 2018 felt to us. If someone could eavesdrop on our self-talk what would they have heard as the market unceremoniously jettisoned some of our gains?

Were we saying things to ourselves like, “Hey, stocks go up and stocks go down, but it is no big deal because over time they should generally trend higher. I’m properly diversified and have a solid plan. I’ve got a long time frame to work with. I can weather this storm.” If that was you, you might be in good shape.

If, on the other hand, we felt a bit panicky in recent months and our finger has been hovering over the “Sell” button, it may very well be time to limit (just a little!) your exposure to stocks.

Why might REducing be necessary?

Here’s a possible scenario: In 2008 Expat Edward decides he should invest 70 percent of his $100,000 nest egg in low-cost, widely-diversified mutual funds and 30 percent in safer things like CDs and Treasury Bonds. At 50 years old, that wasn’t a bad choice.

After ten great years for stocks and ten years of rock-bottom interest rates on CDs and bonds, his stocks have grown to about $280,000 and his CDs and savings accounts to only about $34,500. Things went very well for Edward because stocks did well, but can you help Expat Edward see what his ratio has become today? Is it still the 70% stocks and 30% savings/bonds that he was aiming for in 2008?

Assuming our expat friend wasn’t able to add a dime to his savings, his net worth now sits at $314,500 with a full $280,000 of it in the S&P 500 or similar investments. His 70% investment in stocks in 2008 has suddenly become a whopping 89% of his net worth in 2018.

What’s more, Expat Edward isn’t exactly getting younger. At age 60, he might want to consider having only 50% of his funds in the stock market. That 89% figure is looming large!

REducing the exposure REduces the pain

Massage
REducing the exposure REduces the pain

Let’s imagine for a moment that the S&P 500 drops 20% in the last week of December. That would hurt, right? Now, it’s good news that Expat Edward’s savings/bonds are still holding firm (because they simply don’t drop 20% ever!). Let’s crunch the numbers to see just how much this would hurt if Expat Edward hadn’t ever rebalanced his savings, if he had rebalanced to 70% the day before the December decline, and if he had rebalanced to a more age-appropriate 50% on that same day. Do you see where this is going?

REducing Exposure to Stocks

Exposure to S&P 500Loss with 20% drop in S&P 500Total net worth after lossPercentage decline in net worth after loss
89%-$56,100$258,40018%
70%-$44,030$270,47014%
50%-$31,450$283,0509%

While it’s nice to have outrageous exposure to stocks when things are going up, few people can (or should) face an 18% loss at 60 years of age. By REducing his exposure from 89 to 50% in the S&P 500, Expat Edward reduces his losses from 18 to just 9%! That’s a savings of nearly $25,000 just by appropriately REducing his risk.

What if it had been worse than a 20% decline? What if the market were to lose 30 or 40 or 50% in 2019? If Expat Edward dislikes what the $56,100 the stock market took from him in a hypothetical 20% loss, how much more will he dislike it if it drops by much, much more in 2019? He has let his exposure to stocks increase to 89% when it probably should have decreased to 50% or so. This is no time to get out of the market, but it may be a good time to REduce our exposure to more reasonable levels.

Going forward…

For the investors among us who have made great gains in the last 10 years, it may very well be time to REduce our exposure to the stock market. For the reticent investor who has stayed on the sidelines because prices seemed too high, it may very well be time to RE-enter the market.

Are we predicting a bear market in 2019? No. Are we predicting a renewal of this 10 year bull? No. We are predicting a market with ups and downs that requires patience, planning and discipline.

As January rolls around, let’s consider all of those RE- words and how they apply to our finances going forward: REview, REthink, REsolve, REbalance, RE-enter, REduce and certainly REcommit to spending less than we earn, saving aggressively, and investing wisely in low-cost, widely diversified funds.

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Mark Mason

Missions is my calling. Finances is my hobby. Helping you is my pleasure. "Mark" is my ultra-ego.