PrepperNomics 107: The Markets Are Falling! The Markets Are Falling!

I hate giving stock market advice, but in the past couple weeks I have heard some really stupid, apocalyptic, reactions to the recent market gyrations. 

Salty thought I might want to do a post on the subject, but my initial reaction was negative because so many people want there to be something wrong, that trying to be rational is difficult.

I am tempted to just say “If you don’t understand the stock market, why are you investing in it?”  Unfortunately, I already know the answer to that question.  For the past decade, interest rates have been so low that the stock market has been one of the few places you could get a decent return and still get out quickly if you needed to. 

Furthermore, 401k’s and IRA’s tend to place your retirement assets into stocks, so lots of people have a stake in the stock market, even if their goal is not to invest in stocks, but simply to set aside funds for retirement.

As a result, we are stuck with the question of why so many people are in the market, despite having no idea how it works, and what should they do about it?

ERISA

It used to be that large companies offered pensions, fixed monthly income for retirees based on their salaries during their career with the company.  Unfortunately, a few large companies went bankrupt, leaving their retirees high and dry. 

As a result, Congress passed a law in 1974 named the Employee Retirement Income Security Act (ERISA).  ERISA required that if a company was going to offer a defined benefit pension plan, then funds had to be set aside in trust to cover the pension, that companies that already had pensions needed to fund the trusts backing them over time, and that insurance payments be made to the Pension Benefit Guarantee Corporation (PBGC) to cover any pensions where the company went bankrupt with insufficient funds in the trust.

This solved the problem of pensions going bust, because companies quit offering pension plans and those that already had them have gradually been modifying them and taking actions to reduce exposure, like offering 401k plans instead.  You can’t lose a pension if you never had it in the first place! ☹  ERISA proved again the Law of Unintended Consequences.

401k plans typically offer a variety of investment choices, but most employees have no idea how to pick and choose investments, and most of the choices involve stocks, so folks wind up exposed to the stock market, because their 401k or IRA winds up invested in stocks. 

The easiest way to avoid this problem is there will also be one or more fixed income choices in the 401k.  If you wish to avoid stocks, use the fixed income choices.  You have just eliminated exposure to stocks.

The Stock Market Predicted 9 of the Last 5 Recessions!

The stock market goes up and down for all sorts of reasons, including some that never get figured out.  There are a lot of competing pressures on stock prices and how they will cancel out at a specific point in time is hard to predict.

During the financial crisis the stock market lost 54% on the Dow Jones Industrial Average and approximately the same amount on other market averages.  The financial crisis was primarily about mismanagement of housing finance. 

Why did stocks decline? 

Short of having money in a checking account, stocks are easy to sell and are a place to draw money from rapidly if you have some financial pressure, e.g. your house is losing value and your job just disappeared.  ☹  The problem is the stocks may have also dropped in value while all the other problems are affecting you adversely.

On the other hand, stocks can rise rapidly, as they have since the last election.

What to Do?

So, we are in a world where you may not be able to easily avoid investing in stocks.  Stocks go up and down much more than you are comfortable with. 

What can you do to sleep at night?  Over time, stocks have performed well.  Unfortunately, they tend to do worst when you can least afford the loss.  Murphy’s Law applies to the stock market too!  ☹

There are two approaches that will minimize your risk.  You have probably heard of “Diversification”, which is simply a fancy word for “Don’t put all your eggs in one basket.”  Individual stocks will not all go up, or down, at the same time. 

By diversifying, you protect yourself from a falling stock by only having a small amount of money in that one stock, while other investments are either going up, or at least not going down so fast.

The other method is known as “Allocation”.

Allocation means to spread your investments across asset classes, including stocks, bonds, foreign stocks, commodities, real estate, etc. 

The concept is similar to diversification, but diversification is generally within an asset class, while allocation is across asset classes.  The trick is to figure out what proportions of your assets should be in various asset classes to have the risks of each asset class offset by the other asset classes.

This may seem like it isn’t worth the trouble to figure out, but fortunately the work has been done for you.  Simply Google “No Brainer Portfolios”. 

You’ll find articles on several portfolios with set ratios of various asset classes.  You can simply buy and sell once a year to bring the portfolio back to the right ratios to keep the portfolio “balanced”. 

The assets used in the No Brainer Portfolios are mutual funds, so diversification within each asset class is achieved by the mutual fund.  No work is necessary on your part.

Conclusion

The stock market, and individual stocks, have a significant level of risk.  If you are not financially knowledgeable, or are not comfortable with stocks, then avoid investing in stocks, and invest in something you are comfortable with, . . . like Mosin Nagants!  😊 

If you must invest in stocks, stick to stocks you have confidence in, or use good allocation and diversification approaches to minimize risk.