There are a lot of investment rules and strategies floating around out there. I’ll list a few of them here and my thoughts on them. (This is a page I’ll likely return and add to over time as I run across new references that apply here.)
Market Timing – There is an investment saying that sums this up well: “Time in the Market is more important than Timing the Market.” I don’t know who coined this, but I’ve heard it said by investors such as Warren Buffett and Kevin O’Leary.
My thoughts: If market timing was doable, the people selling books to teach you to do it, wouldn’t have to sell books! They’d already be rich. The stock market is very efficient at valuing things, but conversely, it can be fickle. The prices of stocks are the product of groupthink and that herd mentality can result in irrational exuberance running the market up beyond where it should be and conversely, a stampede towards the door can cause stocks to drop without cause. The ability to sit back and ride through these ups and downs will allow your portfolio to grow. This goes back to my comments on shoe box investing. The market’s general trend is up, but there are bumps and potholes along the way.
This also plays into two other strategies:
- ABB – ABB stands for Always Be Buying. This is a version of Dollar Cost Averaging. If the market is up, buy. If the market is down, buy. If the market is going sideways, buy. This acknowledges the market’s general upward trend and the inability to time the market. This is because POOP happens…
- POOP – Another acronym! Like in your day-to-day life, POOP always happens… POOP stands for Panic, which leads to Overselling, which leads to Opportunity, which leads to Profit. Again, like in your day-to-day life, you never know when POOP will happen. Stay invested. Keep investing. This is the best way to profit from POOP rather than get pooped on.
.The Rule of 72 – The Rule of 72 is pretty simple. Divide 72 by the interest rate you’re receiving and the result is the number of years it takes to double your money.
My thoughts: Not much to add here. This is a pretty good rule of thumb for calculating return. If you start investing in stocks and run that against the average stock market return of 10% and your money grows pretty quickly! Remember, this rule assumes you leave the money to grow and reinvest your returns, making this is a good way to look at long term savings vehicles, such as 401(k)s and IRAs which lock your money up for retirement.
The 50% Drop Rule – The 50% Drop Rule was expressed by Charlie Munger, Warren Buffett’s partner at Berkshire Hathaway. Stated simply, if you can’t stomach a 50% drop in your portfolio value, you need to reconsider your commitment to stock market investing and your goal of long term wealth.
My thoughts: This relates back to Shoe Box Investing. You are investing in stocks for the long term, so it’s best to buy them and hold them. Remember, you weren’t planning on selling them anytime in the near future, so why do you care what today’s price is? You only care that you did your due diligence and the stock you purchased is a good one. If you chose well, it will bounce back. Market swings rarely have anything to do with underlying company values. The 1929 stock market collapse that triggered the Great Depression affected the stock speculators that were buying stocks on margin. Those that owned the stocks of good companies and trusted their purchases, held onto those stocks and profited on the other side.
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The 4% Rule – The 4% rule has been around since 1994. It was created by retirement advisor, William Bengen, based on stock market returns from 1926 to 1976. In a nutshell, the rule states that if you start your retirement with a first year withdrawal of 4% of your portfolio and increase that withdrawal each year by the the rate of inflation, even through the worst times in the 50 year analysis, your portfolio will last 30 years.
My thoughts: Even Bengen has recently said the rule isn’t a rule, but a guideline, and probably should be closer to 4.5% to 4.7% in current times. It is unlikely that your rate of withdrawal would or should be the same every year. Similar to just using 3.14 as the value of Pi rather than taking it out to infinite decimals, this rule gives you some guidance on what you can expect from your portfolio. In reality, you’ll likely want to spend more at the beginning of retirement and the 4% Rule gives you a reference to when you’ll have an issue going forward if you’re spending too much. This is usually referred to a guardrail approach, i.e. the 4% Rule is the white line adjacent to the berm, but you can bump up to the fast lane with higher spending some years and lower spending in others depending on your needs and the performance of the economy. Recalculate where you would be using the 4% rule each year and it gives you some measure of if you’ve gone too far off track.
The 375 Rule – The 375 Rule is more of a future planning tool than the 4% rule is. It is based on some of the same criteria, i.e. a 30 year retirement and a 4% rate of withdrawal, but it also factors in a 20% tax rate. This requires you to figure your current monthly expense and multiply them by 375 to get the savings required to generate that return using the 4% rule.
My thoughts: The 375 Rule is a great place to start for retirement planning. It requires you to do some self-analysis and figure out your budget, and then it gives you a number to shoot for. The validity of that being the actual number needed is a little questionable as it doesn’t necessarily take into account the one-offs, such as buying a car or taking a vacation, but it’s a reasonable goal. The number would also vary based on how much of your money has been placed in Roth & HSA accounts, where withdrawals aren’t taxed.
It isn’t a one and done. As your lifestyle changes, assuming it improves, you’ll want to refigure your monthly burn rate and recalculate the number as necessary. It’s probably a reasonable exercise to revisit each year when you do your taxes, since you’re already in the mode of financial review.
The 60/40 Rule – The 60/40 Rule has long be touted as a safe investment strategy. It is based on a division of investments with 60% in stocks and 40% in bonds. It’s based on historical performance. Historically bonds are safer, but don’t have as much upside as stocks. Historically, stocks and bonds move in opposite directions as well, so when stocks fall, bonds rise, giving you a cushion. The mix is tilted towards stocks since they generally have the opportunity for more upside and at times, bonds don’t provide enough portfolio growth to overcome inflation and taxes.
My thoughts: The 60/40 rule does smooth out the ups and downs of the market, but if you have the discipline or just the ability to procrastinate about making changes to your portfolio when the market goes down, stocks have more ability to bounce back. There is also the issue, that unless you have enough money to buy individual bonds, you’re forced to buy bond funds. While they provide diversification, you’re at the whim of other bond holders who may exit, forcing reduced cost sales, and driving your fund value down. Not that this doesn’t also happen with stocks, but the result isn’t as locked in as with bond funds. In my opinion…
For better or worse, my temperament has led me to lean towards stocks, stock mutual funds and stock ETFs. While we own a few mutual funds that mix bonds in with their stocks, we never owned a bond fund until we bought one on recommendation or our financial advisor. And it went down and hasn’t recovered in several years now. (One of the few things I listened to him on and the results weren’t good.) It’s a minor part of our portfolio as it is a holding in our HSAs. While there is some diversification in the 60/40 rule, I don’t think there is nearly enough. Both sides of the 60/40 assets need to be diversified to truly smooth things out. But smooth doesn’t get you large returns. If you can afford to swing for the fences, then do so! Your ability to do so depends on how much you’ve saved and what your time horizon is.
Our diversification from stocks has been real estate in lieu of bonds. Real estate follows different whims than stock and bonds, but diversifying into real estate has the same effect of putting some money on a different track that follows different cycles. Theoretically, real estate has the same potential for appreciation of the underlying asset and dividends paid via rent.
And since this is all way different advice than what you’d get from a Certified Financial Planner, this is a good time to remind you… this is just me telling you what I believe and how I invest. You need to educate yourself and maybe spend the money for a real plan. Don’t just take Uncle Kevin’s advice after three beers at the barbeque…
The 70/30 Rule – The 70/30 rule as expressed by Toby Mathis basically says, live on 70%, then put 10% towards debt reduction, 10% towards investments and 10% toward charity. If you can’t put aside 10% for charity, give in another way, such as volunteering. When you’ve paid off your debt, add that 10% to the investment category.
My thoughts: This fits with Becky’s and my general policy of living below your means. We’ve always given to charity, but mostly, in lieu of cash, we have given our time. We’ve also generally been more aggressive with savings, but that’s because we could be.
One of the important things to know about giving your time to charity is, you end up with introductions to a lot of charitably-minded people. A lot of people with money are charity-minded. Associating with people with money, can lead to investment tips, key introductions and job opportunities. Most of you have heard me talk about the Yei-Yei’s Game Room, the underground bowling alley and arcade Easterday Construction built. I at least partially credit the opportunity to do that project to meeting, befriending, and proving myself to the owner as we both worked on the Marshall County Community Foundation (MCCF) board and the MCCF Investment Committee.
The 50/30/20 Rule – I first heard this referenced by Dave Ramsey and it recommends dividing your income into three categories: needs (50%), wants (30%) and savings (20%).
My thoughts: This isn’t a bad policy, but I lean towards the 70/30 rule above. I truly think there is value in giving back. Dave Ramsey also promotes giving back as well, but I’m not sure how that fits in the 50/30/20 rule. I guess that’s part of the 30% wants…
The 8-4-3 Rule – Another over-simplified rule, that basically says, if you invest a set amount, say $500, on a monthly basis at a reasonable return, say 10% which is the average return of the stock market, the account balance will grow, steadily but slowly for the first 8 years. Then if you stay on course, the account value will double over the next 4 years, at which point the power of compounding really kicks in and your money will double again in the next 3 years…
My thoughts: This rule leaves out one crucial factor… Taxes… It works fairly well in a tax exempt savings vehicle such as a 401(k), but in other accounts, that 10% return may be reduced by as much as 2% due to the tax hit.