Asset Allocation – an old word that was in heavy use until the dot.com boom

Back when I was a young investor in the late 80s and early 90s, one of the big topics of discussion was “asset allocation.” As most of you know, this was how you broke down your investments in a variety of buckets (stocks, bonds, precious metals, real estate, etc.) in order to gain the benefits of each and to offset some of the drawbacks.

When you were investing back then, this was a primary part of the discussion, and even folks starting out in their 20s were encouraged to invest in a significant percentage of bonds. Of course, that was when bonds were paying close to double-digits in dividends/interest!

Something odd happened in the late 90s with the dot.com boom – everyone stopped talking about asset allocation, and just started pursuing a 100% growth stock strategy. Due to that, and many other causes, a bubble was formed as everyone bid it up, and then it finally popped in 2000. Many of the growth/IT companies lost 80%-90% of their value, or when out of business completely.

Then 2006-2008, the real estate market was the place to be, and folks ended up going “all in” for houses, condominiums, apartments, and REITS. The prices were bid up again, and then – pfft! Another great crash, this one close to 50% of the stock value being killed – and many folks underwater on their mortgages for a decade.

Now we have hit another “crash” where people using Index funds and Vanguards “buy the whole market” index have priced the market up (over 24 P/E ratio on the S&P 500 before the crash vs. a historical average around 15). While the market is showing signs of recovery (just look at yesterday’s jump), it still is down significantly and will take some time to work its way back, especially if the economy sputters coming out of the Chinese Flu.

I was looking through my investments and allocations, and realized that, if I had been 100% in the S&P500, I would have dropped over $350K during 2020, but since I am at a 70/30 split with our investments, I only ended up down $250K as of the March 23. My allocation helped “ease out the rough parts.”

I wonder if everyone’s pursuit of the “fast buck” or the quick gain (dot.com stocks, real estate, etc.) is one of the major causes of these bubbles. Instead of following the “get rich slowly” kind of attitude, everyone seems to want to chase the brass ring. Yet as we have learned in the FIRE community, just reaching FI does not make you happy – and you need to plan what you are going to do once you reach FI, or you will end up nuts (or going back to work).

It would be nice if that word got out to more people in our society – do not rush it, but enjoy the ride as you go. Plan, but do not try to short-circuit the process. Maybe then, we would have growth without as many mad crashes.

Mr. 39 Months

So how have your FIRE calculations been affected by the recent “Unpleasantness?”

As I write this, the American S&P500 Stock index is down 31.8% from its high on Feb 14, 2020. Trillions of dollars have been wiped out in the span of five weeks, primarily due to the uncertainty of the Chinese Corona Virus. Many folks, myself included, expected some sort of a market correction this year (the P/E ratio of 24+ vs. a historical average of 15 almost guaranteed it). Still, this as been a staggering loss for many, including myself.

My paper losses have been something around $250,000 from the beginning of the year (it would have been $350K if my allocation was 100% stocks). My plans to achieve FI on July 1st of this year are pretty much trashed (even without the recalculation that our financial advisor forced upon me). So how is my morale?

Actually not bad. I think this is due to my age – “with age comes wisdom.” In terms of the Chinese Corona Virus, my generation has been hearing about the end of the world so many times, that this sort of things bounces off. We will get through this like so many other things. In terms of market dropping, I’ve been through 1987, 2000, 2008 and now this. The market will recover, and the younger folks have even more time that we do. It does look like my retirement timeline will need to be reset, but even that doesn’t have me too frustrated.

Like many folks, I’ve been sequestered from work for this past week, working from home. While the workload has been heavy, I’ve been able to get it done. However, I find that I miss the comradery of my work peers, and it has made me realize that I can’t just retire and sit on the porch (most FIRE people can’t either). So when I retire, I am going to have to make sure I have a lot to keep me busy (side hustles, charity work, etc.) In the meantime, I think I will be OK with working a while longer in order to build myself back up to my FI number.

How are you doing in terms of your drive towards FI? How has this drop affecting your plans, if you are already retired or moving towards it? Are you handling this downturn well? What moves have you chosen to make (if any) in your investment strategy or allocation? I hope that you aren’t “overreacting” or panicking like so many folks I hear about. The S&P 500 is trading at a P/E ratio of 17.34 – which is still a little high vs. its historical average. Bonds aren’t selling well, due to the Fed’s interest rate drop. What do you do?

I’d like to hear from other people on how they are reacting to this. One great thing about our community is how much we share, including the “nitty-gritty” details.

Good luck in the weeks ahead!

Mr. 39 Months.

Timing the Market – is now the time to go “All In?”

Like most experienced FIRE investors, I don’t see the recent market “correction” as a disaster – I see it as a buying opportunity! The stock market is the only place where people go into despair when things go on sale. Very odd.

I wrote about the potential for a market correction back at the beginning of the year. At that time, the market timing signals laid out by Ben Stein were heavily weighted towards “do not buy additional stocks.” Note that this didn’t say to sell stocks, only that purchasing additional ones at the inflated prices of Jan 2020 was unwise. In this case, it appears the market timing had some validity.

So now that the market has fallen 30%+, I’m interested in potentially changing my current investment allocation, and purchasing more stock now that it has fallen, and reduce my new investments in bonds. Again, the idea is not to sell your current investments, but to guide you on what to purchase going forward. So what do the tea leaves of market timing say?

If you remember there were four categories of the timing:

  1. Price (Current price of S&P500 vs 15 year trend): For March 17th the S&P500 was at 2,529 vs. a 15-year average of 2,030. The signal is that stocks are still too high, so NO  to new stock investments
  2. P/E Ratio (Current S&P 500 P/E ratio vs 15-year trend): For March 17th, the assumed P&E was 19.03 vs. a 15-year average of 23.4. Since the current P/E is lower, this signal says Yes to new stock purchases
  3. Dividend yield of S&P500 vs 15-year average: For Feb 2019, the dividend yield was 1.97% vs. a 15-year average of 2.05%, so this signal says No to new stock investments
  4. Earnings of S&P500 vs. AAA corporate bond (stock earnings “yield” vs. yield of AAA bonds): For March 17th, the P/E ratio is 19.03, or the equivalent of a 5.25% yield (1/19.03) vs. a current AAA bond yield of 2.94% – thus the stocks are providing a better earnings yield than AAA corporate bonds. This signal says Yes to new stock purchases.

So we are 50/50 on the potential for new stock purchases. It appears the signal is saying that stocks still may be overpriced, even after a 30%+ sell off.

So what to do? I was originally thinking of changing my new investment allocations and going for a 100% stock purchases for new 401K and brokerage account purchases. Now that I’ve run the numbers, I think I’ll stick with my current allocation, and just go with that.

Also, if you remember, I changed my income account from a 25% stock, 25% REIT and 50% bond allocation to a 50% stock/50% REIT allocation – just in time to get hit with this massive sell off. This decision was a completely emotional decision, not based on a lot of analysis. So I’m not very confident in my ability to make decisions without firm analysis and numbers – my emotions seem to be 100% off.

So I’ll keep my current investment allocations (30% bonds, 17.5% REITs, 52.5% stocks in S&P500, small cap and foreign). I believe the market will recover one we get this Corona/Wuhan Flu out of our system.

Retirement Manifesto: Benefits of a Bear Market

Hopefully you are all weathering the storm alright!

Mr. 39 Months

Now is the time of testing…..

Well, it has been an interesting couple of weeks in the market! My beginning of month post noted that I was down about 5.4% for the year on March 1st. Little did I know it was going to get a lot worse!

For the second time in 15 months, folks in the FIRE community (and everyone else) are dealing with a double-digit sell-off of the market. As of close-of-business Monday (Mar 9) the old FIRE standby, VTSAX (Vanguard’s index for the entire market) was down -19.3% from its previous high. The Price-Earnings ratio for the S& 500 in mid-February was 24.24. By Monday, March 9, it was 20.67. Note the historical P/E ratio is around 15, so we still have a long-way to go until the stocks are priced where they are historically.

So what to do? This is why I call this “the time of testing.” So many people in the US and the FIRE community have gotten use to the markets consistently going up, with a few “hiccups,” but nothing substantial. Now two large events within 15 months may have you questioning if it is not time to play it safe, buy some gold, or shift resources to bonds/savings. It would be the “safe play.”

Do not fall for it. All the financial advisors I have talked with, in 2000, 2008 and Dec 2018 say the same relative thing. Have your planned allocation and investment plan, based on your risk tolerance – and stick to it. Continue to invest when the market jumps up, or when the market drops like a stone. In the end, you will be rewarded.

I’ve often heard the story that, while the stock market returns around 10% a year, on average, the typical investor only gets half that. This is because when the market drops; they jump out – solidifying their losses. They then wait to get back in, and miss many positive gains before they finally jump back in. It is for that reason that most successful investors take the “buy and hold” strategy of investing. Warren Buffet is known for saying that the optimum holding period for him is “forever.”

So we are all being tested right now, especially those who are close to retirement, or who have just retired (sequence of return risk?). Will you pass the test?

Wealthy Accountant’s comments on the current situation

Mr. 39 Months

A Life of Continual Learning

One of the financial podcasts I listen to, Stacking Benjamins, had an interesting topic on their Friday show. A financial article/letter was written in which the person took the task the concept of getting to FIRE by cutting expenses alone. Their article went on to discuss the income of the bottom two quintiles of income in the US ($11K and $31K average income) – how can someone cut expenses and save 30%+ if their income is so low, they are barely getting by (or is many cases, not getting by at all). You just can’t cut enough to get to FIRE!

The show’s guests and host generally agreed, and emphasized that they had been pushing this idea before. Only someone making significant amounts of salary can afford to spend $5 on a latte or purchase avocado toast. Their belief was that one could only cut expenses so much, and the key to further improving your financial life is to increase your earnings. As you increase your earnings, you try very hard not to correspondingly increase your expenses. Keep your expenses in line with what you spent before, and save the increases.

Some methods for this include:

  • Put 1% of your income into your 401K when you first get hired, and then every pay raise, put at least an additional 1% of your pay into your 401K. By the time you are 30, you’ll be putting 10%+ away, and will hardly miss it.
  • Setting aside automatic withdrawals to your emergency fund, and once that is fully funded, just shift that money to automatically go into an investment fund (or Roth IRA, etc.)
  • If you get any sort of bonus, put at least half of it away into investments/savings

Yet, how do you go about increasing your income up from the annual pay raises (typically around 3%)? The key is that you have to be able to provide more value than your current work – either to your existing employer, or to a new employer. The other way is to expand your value, on your own (entrepreneur work with a side-hustle). The idea is that you should look to continually improve yourself so that you can make additional money. To improve yourself, you must  dedicate yourself to continually learning new skills and improved knowledge.

New skills/knowledge expands your ability and usefulness. You can now do things beyond your current job function, you can teach others these new skills, and you have increased the flexibility of your boss (or your own situation). This makes it less likely you will be the one chosen to be let go in case of a downturn (you can do multiple jobs) and enhances the ways you can make money in your entrepreneurial endeavors.

So dedicate yourself to constantly learning new things. With the internet, YouTube, articles, books, etc. there is a wide range of ways to learn and apply new skills. I personally am working on a side hustle (TKD Woodworking) not only to make additional money, but to learn new skills (not just woodworking, but business, marketing, and website design skills). You should always be pushing your self to grow – otherwise you may find yourself spending too much time sitting around in front of the TV or online gaming. You have so much potential, that it’s a shame to waste it.

So what are you learning about lately?

Mr. 39 Months

I don’t need to tell you that taxes suck

Finally was able to get everything together for the taxes in 2019. We use a CPA because of some complications, though its fast closing in on the time when I plan on taking back over doing our own taxes (I did them up till about 2011).

Well, we got the info back, I reviewed them, and the end result was….. we owed about $2,400 to the Fed (and $500 to our state). Plus penalties. Ouch.

I thought we’d prepaid enough to make sure this wasn’t an issue, but apparently not. We’ll have to take some money out of savings to pay for it. This way, we won’t be selling stocks during the current down market. That is why you have spare funds in place.

I can kick myself a bit, but in the end, the next step should be to evaluate your current tax withholdings for 2020 and make sure they are taking enough out. Low and behold, after running the numbers – we were about $2,800 low in withholding, based on what I see coming for the year.

Back to the federal/state W-4 form, where we determine withholdings, make a few adjustments which will reduce our available income a little over $200/month, and we should be set for taxes at the end of 2020. Better to take action at the beginning of the year than to try and find money at the end of the year.

I tend to try and get our taxes to $0, or have us owe a little money. I know some people like to get a nice refund, but I’d rather not give the government and interest free loan. I can use the money better.

Hopefully, your tax situation is better than mine!

Mr. 39 Months

What a difference a week makes….

Well, I am sure many folks are looking at their investments and going “holy *@#$%.” The S&P500 is down over 11.5% from just a week ago, and almost all the other investment folks have (Small Cap, International, etc.) have been similarly pummeled. Instead of late 2018’s gradual drop down, this was a quick slide into the hole. Ouch.

I actually did a quick update of my investments on Feb 21, just to look at them. I had made some significant moves in January, especially to my income account, and I wanted to make sure I had all my tracking in line for my monthly update. As of Feb 21, I was up 3.14% for the year, having recovered from January’s slight pullback. Things were looking good!

Now, for the year, I am down 5.55%, and have lost a total of $68,977. However, it is all “paper losses” that are offset by my huge gains for 2019. If you remember, I had noted previously that, in order for my annual net worth increase to stay on target compared to the last 18 years, I would have to experience a net loss of 9.6% for 2020. Heck, we are already there – and I have nowhere to go but up!

Seriously, this loss is, in my opinion, temporary. The market was overpriced (S&P  500’s P/E ratio was 25.04 as of Feb 1st – way above its 15-16 average. Even now, as of Feb 28, it is estimated to be 22.23, so it is still historically overpriced. The market sell off is, I think, a reaction to the supply chain interruption caused by eh Corona virus. Without raw materials and finished goods from the east, many companies will not hit their earnings for 1st and 2nd quarters, resulting in this drop in price as Wall Street recalculates potential earnings. By the end of the year, I expect we will be back to where we were back on February 21.

Therefore, it is steady as she goes right now. If I had some money on the sidelines, I would be investing in the market right now – but I dollar cost average and invest every month. I did rebalance at the end of 2019, selling stocks and purchasing bonds. My bond funds are up roughly 2% for February, so that helped even out the blow. The S&P may be down 11.5%, but I am not down as much, due to diversification and rebalancing.

I hope that you will stay the course and recover as well!

Mr. 39 Months

Two-Month Checkup on Spending

For some folks in the FIRE community, the opportunity to go through their spending with a fine-tooth comb, to analyze and agonize over every dollar spent, is an act of joy. There is a constant review of spending, and a categorizing of it into appropriate buckets. There is a celebration of dollars saved, and a flagellation when we fail to meet our budget objectives on a daily, weekly or monthly basis. Again, for some folks, this is one of the things they really enjoy, both to do and to write about.

For many others, the author included, we are less exact. For a lot of folks, there is the “set it and forget it” concept, where we determine our initial budget, identify the amounts we can save every month, and then set it up to automatically put this money away. This generally follows the “pay yourself first” philosophy, where you get the money out of your site (into investments) and then live on the remaining money. That is the philosophy that I have lived with for almost 20 years, and while I may not be as quick to hit FI as many others, it has allowed me to reach the point where I am close – while not spending excessive time reviewing my spending.

Still it does make sense, near the start of a new year, to review your base budget and see how you are doing. Better to identify this in the first couple of months, rather than be surprised halfway through the year, when you have less time to react and rectify the situation. This sort of analysis also leads to some surprises. So how have I done for the first 2 months? Here is my earnings, deductions, and expenses for Jan-Feb 2020, as a percentage of total income.

Revenue
Area Category % of total
Earnings Regular Pay 98.6%
Earnings Cell Phone reimbursement from my company 0.7%
Earnings Expense Reimbursement 0.7%
Total Total
Deductions
Area Category % of total
Deductions 401K Roth 5.7%
Deductions Dental 0.6%
Deductions H.S.A. 5.2%
Deductions Long-Term Disability 0.4%
Deductions Medical 4.4%
Deductions Spousal Surcharge 0.9%
Deductions Vision 0.1%
Deductions Wellness Credit -0.7%
Total Total 16.5%
Taxes
Area Category
Taxes Federal Income Tax 11.6%
Taxes Medicare 1.2%
Taxes Social Security 5.3%
Taxes State Income Tax 4.0%
Taxes NJ Family Leave, Disability, Unemployment, etc. 0.8%
Total Total 22.9%
Expenses
Area Category
Area Category
Auto Auto Fuel 1.1%
Auto Auto Repair 0.3%
Auto Auto Registration 0.0%
Auto Auto Tolls 0.4%
Charity Charity 4.3%
Clothes Clothes 0.7%
Entertainment Books 0.0%
Entertainment LA Fitness 0.3%
Entertainment Postal/office supplies 0.0%
Entertainment Hobby 2.2%
Food Groceries 3.4%
Food Dining Out 1.3%
Food Food/Snacks 3.0%
Home Home Repair 2.7%
Insurance Life Insurance 0.4%
Insurance Home/Auto Insurance 1.0%
Investments Investments 25.8%
Investments Savings 0.9%
Medical Medical – H.S.A 0.1%
Other Other 0.2%
Other Haircuts 0.0%
Other Other 1.1%
Taxes Property Taxes 4.5%
Utilities PSE&G 4.2%
Utilities Verizon 2.6%
Utilities Water Bill 0.4%
Total Total 60.5%

Some things, which stuck out after doing this analysis:

  • Taxes still take a big bite (27.4% of gross pay). Since we aren’t paying a mortgage anymore, this is our biggest hitter
  • Investments coming in 32.1% of gross pay (51.4% of net pay after taxes & work deductions). Doing a fairly good job of putting stuff away
  • Medical is coming in at 10.5% of gross – though the H.S.A. is about half of this
  • Food and Utilities each a little over 7%
  • Charity is about 4.3% of gross (we put away a select amount every month for this). Bump this up every year, but still have a ways to go to get to the biblical 10%

The only real surprise for our budget was a $724 utility bill in February. We do an even payment plan, and they relook at it every 6 months, and then charge you or credit you, based on actual usage. We have gotten money back from this as often as we have paid it.

Overall, we appear to be staying close to our budget, and nothing is really too far malfunctioning. Looks like steady as she goes into 2020!

How are you doing with your budget and spending so far in 2020?

Mr. 39 Months

Initial Finance Documents for TKD Woodworking

Therefore, I have done some reading on financial documentation for small businesses and side hustles, and so I have started creating those documents for TKD Woodworking. I will be using accrual based accounting (vs. simpler cash-based) to track my finances.

The three basic finance documents for a business are:

  1. Budget/Profit & Loss Statement: A document, which shows, by month, the amount of money you are bringing in and the money you are spending to create the products/services. This is what many people think of when they do a family budget.
  2. Net Worth Statement:  A listing of the assets the company possesses (real estate, machinery, raw materials, etc.), the cash and accounts receivable (what is owed the company), as well as the debt and accounts payable (bills the company owes). All of this rolls up to the overall value of the company for that “snapshot” in time. 
  3. Cash Flow Statement: With the accrual based accounting system, you often log in expenses and income after a sale. This leads to better tracking and tax accounting, but can lead to a major issue. You may be actually spending cash, but not accounting for it in the P&L statement until months later. You need a third report, cash flow statement, to track the in/out flow of cash in the business – or you may run out of cash while still appearing to be “profitable.”

Each of these reports are linked and effect each other (ex. you can spend money in the cash flow, and increase the net worth statement with inventory, but not affect the P&L statement until you sell the items). The idea behind them is to record the base/start, and track them as the year progresses – in order to look for variances and changes, which need to be addressed. Once the year is up, they are the foundational documents for figuring out taxes.

For my P&L statement/budget, I arrived at a sales plan that assumed I’d start selling halfway through the year, and sell three (3) of each item I’m building. Based on that and current spending (remember, I’m having to purchase raw materials – which impacts my cash flow – but not getting real credit for it re: taxes until I sell something) my P&L looks like this:

Area Annual
Sales Revenue $3,518.94
Cost-of-Goods Sold Expense ($1,148.71)
Gross Margin $2,370.23
Operating Expenses ($1,407.58)
Earnings before interest and Income Tax $962.66
Interest Expense $0.00
Earnings before income tax $962.66
Income Tax Expense ($362.03)
Net Income $600.63

For the Net Worth, I am in a little bit of a pickle. For most companies, the equipment and workspace would be considered part of their assets. However, I am using my shop at home (in my garage) and the machinery (table saw, band saw, etc.) that I already own. The result is that my net worth is actually rather low to start. I am adding in the initial startup case ($3,000 – cost of some checks) and the material costs for the inventory I have built so far.

Assets
2/15/2020
Cash $2,973.65
   
Accounts Receivable $0.00
Inventories $232.42
Prepaid Expenses $0.00
Subtotal of current assets $3,206.07
Property, plant and equipment $0.00
Accumulated Depreciation $0.00
Cost less accumulated depreciation $0
Total Assets $3,206.07
Liabilities and Owner’s Equity
2/15/2020
Advanced payments from Customers $0.00
Accounts Payable $0.00
Accrued Expenses Payable $0.00
Short-term notes payable $0.00
Subtotal of current liabilities $0.00
Long-term notes payable $0.00
Total Liabilities $0.00
Owner’s Equity – invested capital $3,232.42
Owner’s Equity – retained earnings $0.00
Total Liabilities and Owner’s Equity $3,232.42

Another interesting feature of this for the future is that if I purchase tools/machinery in the future for the company and eventually leave/sell out – I will need to separate those items from my personal equipment. More paperwork!

Finally, the cash flow. I have started tracking what I have spent so far, and my expected cash outflows going forward. I put in roughly $639.60 before I started up the company in early February (for inventory, training, some tools, etc.) – so I added that to my initial cash pile.

Cash Flow from Operating Activities Annual
Cash collections from revenue $3,639.60
Cash payments for Expenses ($696.19)
Total $2,943.41
Cash Flow from Investing Activities
Investments in new long-term operating assets $0.00
Cash Flow from Financing Activities
Increase in short-term notes payable $0.00
Increase in long-term notes payable $0.00
Issuance of additional capital stock shares $0.00
Cash distributions from profit to shareowners $0.00
Total $0.00
Net Increase of cash during year $2,943.41
Beginning Cash Balance $0.00
Ending Cash Balance $2,943.41

The last two things I did for the company’s financials is setup a separate business account at a bank (where the $3K was deposited) and to get a business credit card – where I will charge all my future business expenses. As I noted previously, you need to keep your business and personal charges separate if you want to be successful in this (and prevent the possibility of being sued and losing your personal assets).

With the finances in order, it is time to move onto my next steps for the business. Those consist of:

  • Creating a website and building a marketing plan (March)
  • Complete building of samples to determine time/cost for each as well as potential shipping costs (April)
  • Acquire sufficient insurance to protect myself and the business (May)
  • Begin selling on Etsy, Craig’s List and Craft Shows (June)

I will let you know how I am progressing

I hope your own efforts are bearing fruit!

Mr. 39 Months

Opposition Research for TKD Woodworking

So, I’ve done some of the work, built three different items (two types of cutting boards and a photo frame). I’ve got plans for another frame (pretty cool) and some boxes. Now that I’ve built some items, I know the material costs, labor time, and my estimated overhead costs. With that, I can start determining estimated sales cost for each item in order to recoup my time/costs. Time to do some opposition research!

One of the big places to sell arts & crafts online is Etsy.com (I’m sure a lot of you are aware of it). You can purchase a wide range of items, of all shapes and sizes, crafted by people throughout the world. It’s a major “side hustle” location, and lets you create your own Etsy store, where someone can click on and see all the crafts you sell. You can check out your competition there for their prices, quality, and variety of items – and compare to what you are thinking of offering. What did I find out?

I have to improve my game a lot!

Obviously, the items I’m starting with are very easy to make and sell, so there will be a lot of people to compete with. In addition, it’s a worldwide market place, so I will be competing with labor costs that might be well under my estimates (I’m going with $20/hr. for my time). They may also have the ability to setup and make large runs, which can bring down the cost-per-piece of an item. Still, what I’m seeing is impressive:

  1. Costs are all over the board. There are items similar to mine which are selling for 50% – 200% of what I was going to ask
  2. Quality looks pretty good. I definitely can’t try to sell stuff that is not up to par
  3. There are a lot of sellers with 5-star ratings, so when I’m first starting out, I’ll be behind the curve
  4. The options some of the sellers have are tremendous. One person lets you pick the wood your cutting board will be made out of, the pattern, etc. Other ones do personal engraving. All of this for competitive costs to what I was thinking of charging.

I know I’ll need to build a bigger assortment in order to both compete and to see what sells. I’ll also need to look into making items which aren’t as generic as cutting boards.

At least I’ve got an idea of what I’m up against!

Mr. 39 Months