Author Topic: for the squeamish  (Read 4478 times)

intellectsucks

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for the squeamish
« on: April 27, 2015, 11:26:40 AM »
Something occurred to me recently that I thought I would bring up.  Mustachianism looks to have really started taking root around 09 or 2010 and only picked up steam during this time.  During that time, the stock market has essentially only risen (minus some minor bumps in the road on the way).  What occurred to me is that some people who have been following MMM and taking his investment advice have never seen a real bear market.  I know that MOST Mustachians look at bear markets as an opportunity to get more stocks at deep discounts, however there are lots of people who simply FREAK OUT when they see their account balances drop and it’s possible (likely?) that some Mustachians who feel this way.  These people don’t know what it’s like to see their account value drop 20% or more.

With that in mind I figured it would be a good topic to discuss other options for people who are severely stressed out by the volatility of stocks.  Here are my recommendations:

Indexed annuities.  These are contracts with insurance companies that will offer you a guaranteed rate of return with the possibility getting a bonus when a certain index performs well (most commonly the S+P 500).  For example: the annuity will never earn LESS than 1%, but will earn whatever gains the stock market earns up to 4.25%.  They also offer the option of giving you a monthly income for live (sort of like a self funded pension).  This pros of this investment are that they will NEVER lose value, they earn more than traditional savings and CDs, and they can either keep up with, or mitigate the effects of inflation.  The cons of this investment are that they are VERY long term investments, usually 5-8 years.  Though most will have an option to withdraw some of the funds each year, the majority of your money will be tied up for a long time and will have HUGE penalties if you pull it out early.

Short term(duration) bonds/bond funds.  Bonds are traditionally more stable investments, will pay regular interest and can also see some limited principal appreciation as well.  The reason I recommend short term bonds and funds is because bonds are very sensitive to changes in interest rates.  The longer the term on the bond, the more sensitive they are (who would want to hold a 10 year bond at 1% when interest rates are 2-3%?).  The pros of this investment is that you can get rates of return that compete fairly well with stocks over time (the returns won’t go as high, but the losses won’t go as low), you should also see less volatility (how often the value goes up and down) than with stocks.  The cons of this investment are that you will still see ups and downs, also there may be limited options for indexed funds because you will be looking for short duration, so you may pay higher fees on the investment.

A few things to keep in mind:  investments like this may not perform as well as stocks, or be as liquid as stocks in the long run.  They will also have different tax considerations as well.  Both of these factors could affect your FIRE date.  Finally, these investments are terrible to get into after selling your stocks in a panic when the market is down.  Do some serious soul searching and be honest with yourself about how you will feel if your investment account balance goes down 30, 40, or 50% this year.  Will you be able to grit your teeth and get through it or will you be losing sleep and starting a new MMM forum thread every other day asking how to keep from selling causeohmygodIsavedsohardforthismoneyandnowimlosingitallandi’llneverretirenowandi’llhavetogobacktoeatingramennoodlesandigaveupallthoselattesandsuvridesfornothingDAMN YOU MMM!!!  Phew. Don’t do that.  The time to decide whether or not they are for you is now, either before investing or while the market is doing well.


nereo

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Re: for the squeamish
« Reply #1 on: April 27, 2015, 11:57:28 AM »
Interesting thoughts.  Studies have shown that most people over-estimate their tolerance to market drops, and many panic and sell at exactly the wrong time.  But thankfully MMM and this forum actively warns against such actions.  Mention anything even closely resembling market timing and you'll have a dozen posters all over you screaming "Ahh!! don't do that!! it's a fool's errand!!"
I also see a lot of the members here were mustachian long before there was a name for it (circa 2011, not 2009).  We've gelled because there are so many ways that one can optimize their life, and while we may be doing great in one area, another could use help.

FWIW, I'd rather spend hours assuring people not to sell everytime the market takes a dive than recommend either Index Annuities or holding a large portion of their portfolio in short-term bonds (especially at today's rates). To some they are useful, but to most they are dangerous.  As MMM himself says, this is not a blog for financial beginners - it's for those that want to master living happily with less financial absurdity.

intellectsucks

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Re: for the squeamish
« Reply #2 on: April 27, 2015, 01:33:36 PM »
Nereo I agree that I would rather spend hours talking people off the ledge during drops than indexed annuities but I would also rather spend hours advocating for indexed annuities or short duration bonds instead of cds ans savings accounts.

I work in finance and frequently see people who were heavily invested in stocks, and then completely wrote off all investment afterwards. The way I figure it indexed annuities and short duration bonds kick the hell out of savings and cds earning less than 1%. 

Also the reason for the short duration is to have less volatility even though you sacrfice yield.

Either way I figure investing sub optimally is better than not investing at all.

MDM

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Re: for the squeamish
« Reply #3 on: April 27, 2015, 01:44:10 PM »
Indexed annuities.  These are contracts with insurance companies that will offer you a guaranteed rate of return with the possibility getting a bonus when a certain index performs well (most commonly the S+P 500).  For example: the annuity will never earn LESS than 1%, but will earn whatever gains the stock market earns up to 4.25%.  They also offer the option of giving you a monthly income for live (sort of like a self funded pension).  This pros of this investment are that they will NEVER lose value, they earn more than traditional savings and CDs, and they can either keep up with, or mitigate the effects of inflation.  The cons of this investment are that they are VERY long term investments, usually 5-8 years.  Though most will have an option to withdraw some of the funds each year, the majority of your money will be tied up for a long time and will have HUGE penalties if you pull it out early.

Any option can be made to look sufficiently good by comparing it with something sufficiently bad.  So yes, compared with a full-fledged panic attack that causes one to sell everything at the bottom of the market an indexed annuity is good.  Compared with more reasonable investment practice, however, indexed annuities (aka variable annuities) are poor choices.

But don't take my word that "marketing efforts used by some variable annuity sellers deserve scrutiny" - see FINRA's investor alert: http://www.finra.org/sites/default/files/InvestorDocument/p125846.pdf

Jersey Brett

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Re: for the squeamish
« Reply #4 on: April 27, 2015, 02:09:55 PM »
Ah yes, the wildly successful Quantitative Easing (QE). What happens when it finally fails and interest rates begin to rise?
Most likely that is when the market begins to correct and all you can do is hope you have enough cash and guts to take advantage of the bargain basement pricing.

I am a market timer. I studied hard to be one and I do it well. I will know that the market is crashing before you do. When people say you can't time the the market it is like saying you can't build a car. I can't build a car personally, but people with the skills to do it can. If you don't have the time/interest to learn how markets move then an index fund is probably best for you, but it will be a bumpy ride over the next 2 years. For my part, I'm glad I learned some of the rules of the world's biggest casino.

I have an article on QE on my website MOD EDIT: Link removed. PM Poster if you'd like link.
« Last Edit: April 27, 2015, 05:47:22 PM by arebelspy »

nereo

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Re: for the squeamish
« Reply #5 on: April 27, 2015, 02:32:34 PM »
Nereo I agree that I would rather spend hours talking people off the ledge during drops than indexed annuities but I would also rather spend hours advocating for indexed annuities or short duration bonds instead of cds ans savings accounts.
Either way I figure investing sub optimally is better than not investing at all.
I'll agree with that.  Any investment is better than storing hoards of cash or buying commemorative coins.  I just see this a blog for advanced financial techniques.  For people who want to freeze their credit cards in a block of ice or pay off a low interest debt before a larger, high interest one because it will make you "feel good" there are places to go for that. 

Quote
I am a market timer. I studied hard to be one and I do it well. I will know that the market is crashing before you do. When people say you can't time the the market it is like saying you can't build a car. I can't build a car personally, but people with the skills to do it can. If you don't have the time/interest to learn how markets move then an index fund is probably best for you, but it will be a bumpy ride over the next 2 years. For my part, I'm glad I learned some of the rules of the world's biggest casino.
I am going to trust you that you can successfully time the market.  My comment was more along the lines that very few people can successfully time the market, so very few people should try.   After all, the simple alternative (DCA index investing) can get almost everyone to FI in a reasonable amount of time.

Jersey Brett

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Re: for the squeamish
« Reply #6 on: April 28, 2015, 08:15:41 AM »
I agree Nereo, very few people should try and time the market. On Motley Fool they say 99% of the people should just get index funds. Maybe that's right. It is just too passive a choice for me personally.

dragoncar

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Re: for the squeamish
« Reply #7 on: April 28, 2015, 08:46:57 PM »
Definitely a possibility for recency bias here. Another alternative is the permanent portfolio (which has been discussed many times here and on bogleheads and has its own forum too)

Heckler

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Re: for the squeamish
« Reply #8 on: April 28, 2015, 09:47:01 PM »
isn't this just simple risk tolerance and asset allocation?  I'm 20% long term bond (VAB) and 10% short term bond (VSB) (actually 7% now, but I'm in process to up that), and I'm not really squeamish about it at all...  The long term bond I plan to hold at least 10+ years, and the short term a minimum of 3 years.

dungoofed

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Re: for the squeamish
« Reply #9 on: April 29, 2015, 06:04:21 PM »
Definitely a possibility for recency bias here. Another alternative is the permanent portfolio (which has been discussed many times here and on bogleheads and has its own forum too)

Was going to mention the same.

Furthermore, you could say that proponents of PP watching their gold holdings deflate over the last five years would be somewhat better prepared mentally.

innerscorecard

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Re: for the squeamish
« Reply #10 on: April 29, 2015, 10:23:27 PM »
There will undoubtedly be many who fail. It's a lot easier psychologically to make that monthly contribution when you can see it go up after you make it. What if you can plainly see, maybe for a period of many years, that money wilt away quickly or slowly after you contribute it? It will be obvious in hindsight that it would have been better to just save cash instead.

It is always in bull markets that people suddenly remember that it is stocks which have the highest aggregate expected returns.

nereo

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Re: for the squeamish
« Reply #11 on: April 30, 2015, 08:28:58 AM »
It is always in bull markets that people suddenly remember that it is stocks which have the highest aggregate expected returns.
... and it is always in bear markets that people say "the market are rigged!  The easy money is behind us!  Buy-and-hold is dead!  We will never see another decade of 7% real-adjusted returns..." and other such unsubstantiated nonsense.

innerscorecard

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Re: for the squeamish
« Reply #12 on: April 30, 2015, 04:02:44 PM »
It is always in bull markets that people suddenly remember that it is stocks which have the highest aggregate expected returns.
... and it is always in bear markets that people say "the market are rigged!  The easy money is behind us!  Buy-and-hold is dead!  We will never see another decade of 7% real-adjusted returns..." and other such unsubstantiated nonsense.

Yes, both in bear markets and bull markets, people always find a reason that the trend will continue seemingly forever.