Author Topic: Taking advantage of crashes/bubbles - where does the investment money come from?  (Read 6983 times)

bnoooogers

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I'm only about a month in to MMM and finance in general (I'm 25), so hopefully this isn't too dumb of a question. I did some forum searching, but couldn't find an answer to this seemingly basic question.

I just read http://www.mrmoneymustache.com/2013/05/07/how-to-prosper-in-an-economic-boom, in which MMM seems to essentially advocate market timing (by adjusting asset allocations at peaks/troughs - though I don't know how you're supposed to know a priori when those are). He brings up other points as well, like how moving upmarket in real estate is possible due to exaggerated price variation at the higher end of the market, but even those investments beg the question: where does investment money come from during a crash?

Selling securities? They themselves are expected to recover, and probably more so than real estate (excepting the housing-driven 2008 crash), right? Cash on hand? MMM has made a point of NOT even having any cash, instead preferring 'springy debt'. He claims to scarcely even own bonds! So taking advantage of low prices sounds great, but after a bit of inspection, it seems that to take advantage of them you have to hedge much harder than MMM lets on. Prices are low for a reason, after all: nobody has any money!

What am I missing?

GrowingTheGreen

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Where does investment money come from during a crash? Cash accounts. The phrase "cash is king" is well-known for a reason. I was just starting my career when home prices were bottomed out. I had money, but not enough to invest in a rental property. I went the stock market route and made a very healthy return on every cent invested, but I vowed to myself, "when this happens again, I'll be ready."  One of my many goals is to have a $50k cash account. Yes, I know it's not earning money. But it will be there when the poop hits the proverbial propeller and I can use it to kick some ass. Will I know when the exact bottom is? No. But when people are freaking out and sale prices dip, that will be my sign to start looking. Greedy in times of fear, right? :)

The easiest way for the average investor to "time" the market is to rebalance their portfolio two times a year or when their asset allocation is off by a set percentage. When you rebalance because your allocation is out of whack. What would cause it to become out of whack? When stock prices drop and it causes your portfolio to become more bond-heavy. What do you do? Sell assets that are on the "high" side of your portfolio to buy assets that are on the "low" side.  Boom. You just sold high and bought low. Are you going to be able to time this perfectly? Absolutely not. Will you be "buying high and selling low"? Absolutely.

Jeremy E.

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I'm only about a month in to MMM and finance in general (I'm 25), so hopefully this isn't too dumb of a question. I did some forum searching, but couldn't find an answer to this seemingly basic question.

I just read http://www.mrmoneymustache.com/2013/05/07/how-to-prosper-in-an-economic-boom, in which MMM seems to essentially advocate market timing (by adjusting asset allocations at peaks/troughs - though I don't know how you're supposed to know a priori when those are). He brings up other points as well, like how moving upmarket in real estate is possible due to exaggerated price variation at the higher end of the market, but even those investments beg the question: where does investment money come from during a crash?

Selling securities? They themselves are expected to recover, and probably more so than real estate (excepting the housing-driven 2008 crash), right? Cash on hand? MMM has made a point of NOT even having any cash, instead preferring 'springy debt'. He claims to scarcely even own bonds! So taking advantage of low prices sounds great, but after a bit of inspection, it seems that to take advantage of them you have to hedge much harder than MMM lets on. Prices are low for a reason, after all: nobody has any money!

What am I missing?
What you should take away from his article, is that you should focus on buying stocks during a crash, and consider focusing on paying down debt during a boom. Also to rebalance your accounts at least annually.

dachs

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Where does investment money come from during a crash? Cash accounts. The phrase "cash is king" is well-known for a reason. I was just starting my career when home prices were bottomed out. I had money, but not enough to invest in a rental property. I went the stock market route and made a very healthy return on every cent invested, but I vowed to myself, "when this happens again, I'll be ready."  One of my many goals is to have a $50k cash account. Yes, I know it's not earning money. But it will be there when the poop hits the proverbial propeller and I can use it to kick some ass. Will I know when the exact bottom is? No. But when people are freaking out and sale prices dip, that will be my sign to start looking. Greedy in times of fear, right? :)

The easiest way for the average investor to "time" the market is to rebalance their portfolio two times a year or when their asset allocation is off by a set percentage. When you rebalance because your allocation is out of whack. What would cause it to become out of whack? When stock prices drop and it causes your portfolio to become more bond-heavy. What do you do? Sell assets that are on the "high" side of your portfolio to buy assets that are on the "low" side.  Boom. You just sold high and bought low. Are you going to be able to time this perfectly? Absolutely not. Will you be "buying high and selling low"? Absolutely.

I have questions about that. As far as I understood rebalancing will not improve your performance in comparison to a 100% stock portfolio, even though the stock portfolio might be a lot more volatile. So having 100% in stocks and just ignoring the markets situation will give you a better performance (or that's what happened in the past). An alternative (that will not work) is to have lots of cash and buy when the prices go down. The problem with that is that you don't know when prices will go down (nobody knows) and in the meantime you will miss out on the dividends. So the most reasonable approach I've seen so far was the one described in Benjamin Graham's book that said you should always be somewhere between 25% and 75% in stocks (and accordingly 75 to 25% in bonds). You can adjust the allocation depending on when you think that stocks are relatively cheap or expensive. So my questions would be what factors do you use to know wether or not they are expensive right now? P/E ratio? Dividend yield?...

Another thing to consider is that usually, when stock prices go down, the economy will have some trouble as well. And do you really want to spend lots of your cash when you might lose your job within the next year?

Jeremy E.

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Where does investment money come from during a crash? Cash accounts. The phrase "cash is king" is well-known for a reason. I was just starting my career when home prices were bottomed out. I had money, but not enough to invest in a rental property. I went the stock market route and made a very healthy return on every cent invested, but I vowed to myself, "when this happens again, I'll be ready."  One of my many goals is to have a $50k cash account. Yes, I know it's not earning money. But it will be there when the poop hits the proverbial propeller and I can use it to kick some ass. Will I know when the exact bottom is? No. But when people are freaking out and sale prices dip, that will be my sign to start looking. Greedy in times of fear, right? :)

The easiest way for the average investor to "time" the market is to rebalance their portfolio two times a year or when their asset allocation is off by a set percentage. When you rebalance because your allocation is out of whack. What would cause it to become out of whack? When stock prices drop and it causes your portfolio to become more bond-heavy. What do you do? Sell assets that are on the "high" side of your portfolio to buy assets that are on the "low" side.  Boom. You just sold high and bought low. Are you going to be able to time this perfectly? Absolutely not. Will you be "buying high and selling low"? Absolutely.
The problem I have with holding onto more cash than I need in my emergency fund, is that it is basicallly market timing which I'm not a fan of. You don't know if the market will crash tomorrow or in 15 years, and trust me if it goes up every year for the next 5 years, you'll be kicking yourself if you've got 50k in cash. Historically the best time to invest is now. The stock market always goes up.

Jeremy E.

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Where does investment money come from during a crash? Cash accounts. The phrase "cash is king" is well-known for a reason. I was just starting my career when home prices were bottomed out. I had money, but not enough to invest in a rental property. I went the stock market route and made a very healthy return on every cent invested, but I vowed to myself, "when this happens again, I'll be ready."  One of my many goals is to have a $50k cash account. Yes, I know it's not earning money. But it will be there when the poop hits the proverbial propeller and I can use it to kick some ass. Will I know when the exact bottom is? No. But when people are freaking out and sale prices dip, that will be my sign to start looking. Greedy in times of fear, right? :)

The easiest way for the average investor to "time" the market is to rebalance their portfolio two times a year or when their asset allocation is off by a set percentage. When you rebalance because your allocation is out of whack. What would cause it to become out of whack? When stock prices drop and it causes your portfolio to become more bond-heavy. What do you do? Sell assets that are on the "high" side of your portfolio to buy assets that are on the "low" side.  Boom. You just sold high and bought low. Are you going to be able to time this perfectly? Absolutely not. Will you be "buying high and selling low"? Absolutely.

I have questions about that. As far as I understood rebalancing will not improve your performance in comparison to a 100% stock portfolio, even though the stock portfolio might be a lot more volatile. So having 100% in stocks and just ignoring the markets situation will give you a better performance (or that's what happened in the past). An alternative (that will not work) is to have lots of cash and buy when the prices go down. The problem with that is that you don't know when prices will go down (nobody knows) and in the meantime you will miss out on the dividends. So the most reasonable approach I've seen so far was the one described in Benjamin Graham's book that said you should always be somewhere between 25% and 75% in stocks (and accordingly 75 to 25% in bonds). You can adjust the allocation depending on when you think that stocks are relatively cheap or expensive. So my questions would be what factors do you use to know wether or not they are expensive right now? P/E ratio? Dividend yield?...

Another thing to consider is that usually, when stock prices go down, the economy will have some trouble as well. And do you really want to spend lots of your cash when you might lose your job within the next year?
I agree that 100% stocks is an ideal portfolio, I have this portfolio as well and I don't have to rebalance. Rebalancing is for those that want to mix in some bonds to keep their asset allocation from getting out of wack. With 100% stocks, you can ignore the economy and just pump as much money into more stocks as you can all the time. All I do is buy VINIX in my 401k and VTSAX in my IRA/taxable account. Although with this strategy it doesn't matter how the stock market is valued, you can find the value of it with the S&P 500 PE Ratio.

Dollar Slice

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Even if you're 100% stocks you could potentially rebalance between sectors. E.g. between small/medium/large cap, or between domestic and international.

catccc

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One way to take advantage of crashes without putting out additional cash is through tax loss harvesting, if you are already invested.  Did it for the first time last year when markets slumped in August, and my tax situation is better for it.  $400 for a few clicks, not huge, but not chump change, either.  And I'm only in the 15% tax bracket.

GuitarStv

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I maintain a mix that's something like this:

20% US Stocks
20% International Stocks
20% Canadian Stocks
40% Bonds

When the market is doing well, the stocks gain more value than the bonds.  When I re-balance, it forces me to sell stocks when they're high to buy more bonds.

When the market is doing poorly, the bonds are worth much more than the stocks.  So I re-balance and sell some of the bonds to fund more stock purchases.

This way you don't have to try and market time by keeping wads of cash stashed around the house, and you're always buying low/selling high.

GrowingTheGreen

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Even if you're 100% stocks you could potentially rebalance between sectors. E.g. between small/medium/large cap, or between domestic and international.

Precisely.

GuitarStv: Yes!
« Last Edit: March 04, 2016, 09:18:22 AM by GrowingTheGreen »

GrowingTheGreen

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Where does investment money come from during a crash? Cash accounts. The phrase "cash is king" is well-known for a reason. I was just starting my career when home prices were bottomed out. I had money, but not enough to invest in a rental property. I went the stock market route and made a very healthy return on every cent invested, but I vowed to myself, "when this happens again, I'll be ready."  One of my many goals is to have a $50k cash account. Yes, I know it's not earning money. But it will be there when the poop hits the proverbial propeller and I can use it to kick some ass. Will I know when the exact bottom is? No. But when people are freaking out and sale prices dip, that will be my sign to start looking. Greedy in times of fear, right? :)

The easiest way for the average investor to "time" the market is to rebalance their portfolio two times a year or when their asset allocation is off by a set percentage. When you rebalance because your allocation is out of whack. What would cause it to become out of whack? When stock prices drop and it causes your portfolio to become more bond-heavy. What do you do? Sell assets that are on the "high" side of your portfolio to buy assets that are on the "low" side.  Boom. You just sold high and bought low. Are you going to be able to time this perfectly? Absolutely not. Will you be "buying high and selling low"? Absolutely.
The problem I have with holding onto more cash than I need in my emergency fund, is that it is basicallly market timing which I'm not a fan of. You don't know if the market will crash tomorrow or in 15 years, and trust me if it goes up every year for the next 5 years, you'll be kicking yourself if you've got 50k in cash. Historically the best time to invest is now. The stock market always goes up.
Don't get me wrong. I'm not an "all cash" kind of guy. About 50% of our income is going straight into the stock market. I'm increasing my cash account in proportion to my investments balance. In other words, I don't have $50k in cash and $0 invested. $50k is the goal when I hit the $1mm mark. At that point, $50k is 5% of my portfolio. Using the 4% rule, that means I would have to decrease my spending by $2k annually. I'm ok with that.

zephyr911

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MMM seems to essentially advocate market timing
Rebalancing isn't timing. You can do it at fixed intervals if you want, or you can do it based on relative percentages, but the point is maintaining an ideal AA, not timing. You don't have to know what the market is doing next to rebalance, and you don't have to care.

Quote
Cash on hand? MMM has made a point of NOT even having any cash, instead preferring 'springy debt'. He claims to scarcely even own bonds! So taking advantage of low prices sounds great, but after a bit of inspection, it seems that to take advantage of them you have to hedge much harder than MMM lets on. Prices are low for a reason, after all: nobody has any money!

What am I missing?
The fact that you're working, earning more than you spend, and investing more all the time. And if the market takes a shit, you can work even harder at saving so you can invest more, you think about giving up things you normally wouldn't, because the likely returns are extra high. Or you might make slightly different decisions about employment, based on how much each option would enable you to invest. You might dial up a side hustle so you can buy more. And so on.

I have actually considered holding my FT job longer if the market tanks, just so I can invest more. Most of my FT paycheck is already being invested, and I won't need the job for long, but I'm not miserable here, and I'd gladly stay longer to keep investing a few grand a month at discounted share prices. I have always planned to overshoot my minimum FI number just to have more to give away, and that'd be a prime opportunity to make a few months of work count for millions someday.

Jeremy E.

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Even if you're 100% stocks you could potentially rebalance between sectors. E.g. between small/medium/large cap, or between domestic and international.
If you're 100% in VTSAX you don't need to rebalance :D

Dollar Slice

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Even if you're 100% stocks you could potentially rebalance between sectors. E.g. between small/medium/large cap, or between domestic and international.
If you're 100% in VTSAX you don't need to rebalance :D

If I'm 100% in AAPL I don't need to rebalance, either, but that doesn't mean it's a good idea... ;-)

I could see that argument being made for VTWSX, but not VTSAX.

I personally balance total US with total int'l because the expense ratio is lower on both of them than holding VTWSX.

Jeremy E.

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Even if you're 100% stocks you could potentially rebalance between sectors. E.g. between small/medium/large cap, or between domestic and international.
If you're 100% in VTSAX you don't need to rebalance :D

If I'm 100% in AAPL I don't need to rebalance, either, but that doesn't mean it's a good idea... ;-)

I could see that argument being made for VTWSX, but not VTSAX.

I personally balance total US with total int'l because the expense ratio is lower on both of them than holding VTWSX.
http://jlcollinsnh.com/2012/09/26/stocks-part-xi-international-funds-2/
I'm sure there are arguments against this, but I agree with it enough to follow it.

Dollar Slice

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If I'm 100% in AAPL I don't need to rebalance, either, but that doesn't mean it's a good idea... ;-)

I could see that argument being made for VTWSX, but not VTSAX.

I personally balance total US with total int'l because the expense ratio is lower on both of them than holding VTWSX.
http://jlcollinsnh.com/2012/09/26/stocks-part-xi-international-funds-2/
I'm sure there are arguments against this, but I agree with it enough to follow it.

Fair enough.

I think there is more upside in emerging markets so I want some international exposure. Also, looking at our current political climate I'm not sure this is a basket I want to keep all my eggs in.

Jeremy E.

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If I'm 100% in AAPL I don't need to rebalance, either, but that doesn't mean it's a good idea... ;-)

I could see that argument being made for VTWSX, but not VTSAX.

I personally balance total US with total int'l because the expense ratio is lower on both of them than holding VTWSX.
http://jlcollinsnh.com/2012/09/26/stocks-part-xi-international-funds-2/
I'm sure there are arguments against this, but I agree with it enough to follow it.

Fair enough.

I think there is more upside in emerging markets so I want some international exposure. Also, looking at our current political climate I'm not sure this is a basket I want to keep all my eggs in.
I don't base my investments off politics, I don't think the president affects stocks very much.

Dollar Slice

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I don't base my investments off politics, I don't think the president affects stocks very much.

And I don't think the "current political climate" means "who is the president right now?" but let's not derail any further :-)

thedayisbrave

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For me, it's my rental income.  Comes in every month regardless of what the stock market is doing.


Travis

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I took advantage of the last couple months by reducing the amount of cash in my emergency fund.  It means I currently have 1.5 months of expenses in the bank rather than 2.5.  I have a very secure job that I know I'll have for the next 3 years at least.  If something comes up that my current emergency fund can't handle, I can float the expense until next month and just rebuild the fund.

Retire-Canada

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Where does investment money come from during a crash? Cash accounts. The phrase "cash is king" is well-known for a reason. I was just starting my career when home prices were bottomed out. I had money, but not enough to invest in a rental property. I went the stock market route and made a very healthy return on every cent invested, but I vowed to myself, "when this happens again, I'll be ready."  One of my many goals is to have a $50k cash account. Yes, I know it's not earning money. But it will be there when the poop hits the proverbial propeller and I can use it to kick some ass. Will I know when the exact bottom is? No. But when people are freaking out and sale prices dip, that will be my sign to start looking. Greedy in times of fear, right? :)

Run some simulations on how much return you lose holding $50K long term and how much return you'd have to get just to break even vs. having it invested. As a way to boost your portfolio returns I think this is a terrible idea.


zephyr911

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Preach, RC! My e-fund is a credit card... even if I had to carry a balance, my local real estate is returning higher rates.
But, when you're saving 6 months worth of expenses in 2-3 months, balances don't get carried for long.
I get the whole "dry powder" theory, but I can't think of any current investments that would have been worth not making for the last year just to build up cash, not even with all the buying opportunities I see now. I'd rather stay invested and work for more of it until I don't have to anymore.

Seppia

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While what you suggest is clearly the way to go, one has to keep into account how (ir)rational he/she can be during a big crash.
Personally, I know that it simply is no sound math, but I like to keep a certain % in cash (I do believe that right now bonds provide "return free risk" as Buffett would say), that I would probably throw into the stock market in large part should it suffer a huge drop.
It's not sound but I know having some flexibility to average down would help me a lot psychologically.

JrDoctor

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Their are many ways to skin a cat.  One of the benefits of my job as an NHS doctor is that I wont lose my job in a downturn and I wont immediately see a decrease in wages ( just a general paycut due to inflation and 'once off' events like loss of free accomodation and destruction of pensions).  It means even during downturns ill plug the same cash in day in day out.  The downside is poorer renumeration, but at least there are no rainy days, even if there arent any sunny ones either, just cloudy.

Contrast that with someone who does well in booms and then business/cash flow dries up in busts, they need to save money so at that point they have some dry powder to carry on doibg what they were doing in the boom.  You dont want to just be buying stocks during the high periods do you?


zephyr911

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Contrast that with someone who does well in booms and then business/cash flow dries up in busts, they need to save money so at that point they have some dry powder to carry on doibg what they were doing in the boom.  You dont want to just be buying stocks during the high periods do you?

Good point there, and I realize if I were in sales I'd act differently than as a government employee. I'd have to do something pretty awful to lose my job, and even in a government shutdown I end up getting paid in full, just late.
If you're in a field where income really tracks market performance, it probably just makes more sense to be conservative in general - e-fund, pay down mortgage more, etc, have everything paid off so debt service doesn't eat you in a downturn, definitely look for some low-cost rentals in diversified economies that'll pay you when you're not getting paid... possibilities are endless.

Retire-Canada

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Good point there, and I realize if I were in sales I'd act differently than as a government employee. I'd have to do something pretty awful to lose my job, and even in a government shutdown I end up getting paid in full, just late.

I do contract work. It comes and goes. I just had my hours reduced 25% and that could drop by another 25% on this current contract. I could replace the lost hours and then some next week. There is no telling.

My e-fund is a $30K LOC. Of which I used $4K to invest extra in the recent downturn and I'm paying that back a bit each month.

I'm invested in 6 ETFs that are globally diversified so even if I had nothing I could add to my investments as a buying opportunity came about I would just rebalance my ETFs to move money from those selling high to those selling low.

If my contracts are going strong I'll put my monthly savings to work according to my AA and use part of my LOC if it seems like a good opportunity.

The one thing I won't do is still on a large pile of cash and watch that opportunity cost eat away at my potential returns.
« Last Edit: March 10, 2016, 04:04:48 PM by Retire-Canada »

zephyr911

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The one thing I won't do is still on a large pile of cash and watch that opportunity cost eat away at my potential returns.
An investor after my own heart. The LOC is probably where I'd end up - maintaining a bit more equity as a cushion, to avoid being stuck with high-interest debt in a downturn.

Tyler

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While what you suggest is clearly the way to go, one has to keep into account how (ir)rational he/she can be during a big crash.
Personally, I know that it simply is no sound math, but I like to keep a certain % in cash (I do believe that right now bonds provide "return free risk" as Buffett would say), that I would probably throw into the stock market in large part should it suffer a huge drop.
It's not sound but I know having some flexibility to average down would help me a lot psychologically.

IMHO, understanding how your asset allocation relates to your pain threshold and using that information to invest in a manner according to your preferences is a tremendous use of math.  :)  No need to be defensive -- you're doing a great job!  Everything has a tradeoff, and good money management is about a lot more than simply squeezing the last possible tenth of a percent out of your returns at all costs. 
« Last Edit: March 10, 2016, 02:23:19 PM by Tyler »