Lately we’ve been discussing the slow economy and how the markets look. Behind these posts is my view that nobody really knows what’s going to happen next and we need to continue investing anyway.
But what if, alongside regular investing, we build up extra cash for when the market does finally fall? Today we’ll consider this approach, and I’ll share my thoughts – which may even surprise you.
I’ve come across many people who, like myself, are regular investors. They keep it simple with low-cost diversified funds, and focus on the long term. Many would even consider themselves dividend investors.
But they have another part to their plan. Alongside regular buying, they also build up extra savings slowly over time, which they don’t invest. Instead, the idea is that when the next downturn finally hits, they can use this excess cash to take full advantage of lower share prices.
And that actually makes sense. After all, who wants to buy shares when they’re expensive? Wouldn’t you rather buy the same investments at a 5% dividend yield than a 3% dividend yield? I would!
As far as market-timing strategies go, this one is quite compelling. That’s because it’s not an all-or-nothing bet. It includes good old dollar-cost averaging too. You could say it combines the best of both worlds.
So let’s explore this road a little more, and see how it might play out.
Firstly, if we’re going to time the market, we’ll need a plan. Surely you weren’t just going to wing it? Despite how sexy and seductive it sounds to our brains, we must admit we have no real intuition or insight into future market moves.
Oh, you stay up to date on all the news, politics and even Trump’s twitter account, so you can figure out what’s coming next? That’s great. Because you’re the only one doing that!
Well, apart from the other 64.2 million twitter followers he has, and the 24-hour news networks streaming important info to another couple billion people that is.
Anyway, back to the plan!
Let’s say you’re building up this little pile of cash, in addition to your regular investing. When the downturn hits, then you’ll pounce.
But how do you decide when to put the money into the market? When the market falls 20%? 30%? What about 50%? How do you choose one?
Maybe you decide if the market drops by 40%, you’ll dump those savings in. But then what if it falls only 35%? Pick any percentage and the decision is still the same. Choosing a precise target and using this all-at-once approach would be very difficult.
Maybe you decide you’ll buy at intervals. So when the market falls 10%, you’ll put in a bit. When the market falls 20%, a little more. Then some more after a 30% drop. And finally, when the market’s down 40%, maybe you’ll be all-in.
Okay, we’ll think this through together. Because if we’re going to do this, we’ve gotta plan our actions in advance, or it’s probably not going to work.
Let’s say we’ve got our meaty cash cushion sitting there waiting. You decide to put money in at even increments – after each 10% fall, up to a 40% fall, at which stage you’re all in. This approach is likely to be a bit more effective than the all-at-once approach.
Now let’s say over a period of 6 months, the market falls 12%. Things are looking good, so you tip your first lump into the market. It feels good. You’ve got yourself a bargain! “I knew this was a good idea!”
The market then falls a bit more, it’s now down around 18%. Do you tip more in? Well, your rules say no, you have to wait. But part of you thinks this might be the best chance you get. After all, 50% crashes are actually pretty rare events.
Let’s say you wait. The market falls through your 20% threshold and is now down around 29%. You invest extra at 20%, but now you’re not sure again. A 29% fall is pretty damn close to 30% – is that close enough? Do you break your own rule? What if it was 27%?
Maybe the market starts going back up. You start wondering, is this it? Have you missed your shot?
Now you’re carrying this extra cash and you didn’t even get to invest much. If you invest now, you can still buy cheaper than before the falls. What do you do? Hmm, decisions.
If the market falls 20%, how do you know it won’t fall another 20%? Likewise, if it falls 40%, couldn’t it easily fall further?
On the other hand, maybe the market falls 15%, recovers, and then continues rising for another ten years. All are possibilities and by playing this game, we can’t help but try and figure out which one it is! But there’s no rule for how far the market will or won’t fall.
Instead of this, maybe things get even worse. The market falls further, more than 30%. So of course, you follow your plan and tip more funds in. The headlines and news stories are feeding the negativity more and the market falls heavily, it’s now down almost 40%.
You start getting a little worried as it feels scarier than you imagined. There is talk of large financial institutions going under and political tensions are worsening around the globe. Unemployment rises, people are losing their homes, and some of your friends lose their jobs and are struggling to find work.
This isn’t quite the fun scenario you imagined.
Everything around you convinces you there’s worse times ahead, and your own job may be less certain than you thought. So you decide to keep your cash pile for now. You’ll reassess things in a few months.
You might scoff at this scenario. But these things are worth thinking about. You’ll have to make these decisions in real time. And it won’t be easy. It’ll be scary. It’s likely you’ll want to wait for things to clear a little before putting more money into the market.
Related to the above, maybe you get the downturn you imagine. The sheer amount of negativity around will be overwhelming.
So the natural approach is to wait for just a little bit of positive news, some ‘green shoots’, before tipping the last of your funds into the market. But remember this…
The best time to buy will very likely be the scariest time to buy.
When everything inside you screams don’t do it, and seemingly nobody wants to own shares. When the economy is in the shitter and the market falls further every week.
By the way, the dust never settles. Consider this…
After the GFC, there was non-stop talk of the global economy not recovering, and instead falling into a deeper recession. It was likened to the Great Depression all over again.
Then for years the European debt crisis was going to drag the global economy backwards. After that, every year there have been ongoing fears of the Chinese economy slowing, dragging Australia down with it.
Then it was Brexit (still ongoing). Then Trump as President (still ongoing). Then Aussie housing was going to ‘collapse’ – isn’t it always? Now it’s the trade wars.
Waiting for the dust to settle? Yeah, good luck with that! Quite clearly, this shit never ends!
As I said during the Playing with FIRE chat session, every single year there are recession predictions. And if you listen, you will never invest.
Since the GFC, you would’ve missed out on very solid returns, from basically every asset class – local shares, international shares, property etc.
The part often missed in these thought experiments, is the human element. That is, the feelings and emotions behind the person making the investment decisions.
Sure, it sounds ridiculously easy to invest when the market falls heavily. But in real life, we often get in our own way. We get worried about our portfolio falling further. About potential job loss for ourselves, friends and family.
Maybe efforts to stimulate the economy won’t work. Maybe we’ll be stuck in a stagnant economy for an extended period.
Maybe Aussie companies’ earnings will get hammered and there’ll be a big decline in dividends. Now those big dividend yields on offer don’t look so good, because the dividends themselves may be cut. The uncertainty of all this causes fear and inaction.
By the way, I can’t say I’m immune to this either. I’m young enough to have never lived through a recession and never experienced a sharemarket crash.
As an earlier property investor, I didn’t start investing in shares until 2015. So while I have faith in my ability to stay the course and maintain a long term focus during tough times, that remains to be seen!
As we’ve discovered, the all-at-once approach, and the interval approach could both prove difficult to follow. But building up lots of extra cash has another complication.
The longer we wait, and the more cash we’re holding, the bigger the decision feels. This creates increasing amounts of anxiety to get the timing right.
That can cause us to wait longer for a larger fall, because we’ve got more emotion (and dollars) invested in the outcome. We’ve made the choice and we want to make sure it was worthwhile. We want it to be a success. Because if it’s not, then we’ll be left with the uncomfortable truth that perhaps we were wrong in timing the market.
So in a sick way, we won’t be satisfied with a 20% fall. We want a real shitstorm to occur to justify our approach. Otherwise it just won’t feel worth it.
As humans we love being right. It’s like an intellectual orgasm, and it gives us something to brag about. Can you see how it’s inevitable that our emotions will be wrapped up in the outcome?
Consider the situation where, after a small 15% drop, the market recovers and steadily rises to new highs. As time goes on, our market-timer has a hard time knowing what to do.
He was convinced a big downturn was coming. He could feel it in his bones. And the well-meaning experts confirmed his view. But it doesn’t eventuate.
This is the seduction of market-timing. It feels cautious. It feels prudent. But numbers aside, the difficulty in managing emotions and getting it right is astounding.
In contrast, consider a blissfully ignorant investor, who continues to pour money into the market (seemingly down the drain when the market is falling).
She ignores the portfolio movements, continues receiving larger and larger dividends, while the market-timer’s cash sits stagnant in a crusty old bank account collecting dust, with the rats of tax and inflation gnawing away at its value with every year that passes.
The market-timer grows ever-more resentful of these seemingly idiotic investors, and the emotion of being right festers on itself. But he quietly wonders, maybe this isn’t such a good idea after all?
Believe it or not, I can actually get on board with the market-timing idea that I’ve laid out (well sort of), which I’ll talk about soon. But first, some perspective.
When the sharemarket has had a good run, it’s pretty easy to believe there’ll be a better time to buy, other than right now.
If I catch myself getting too caught up in these thoughts, here’s what I do. I come back to the reason for investing. To grow our wealth and provide an increasing income stream over time. That means over our lifetimes.
So I’m reminded of the purpose of this money, and the many decades it will be invested for. Essentially for the rest of my life. Given I’m 30 now, that’s going to be at least 70 years (yes I’m an optimist).
And with a bit of planning, this money could remain invested for much longer, inside a charitable trust, with the income distributed to charities each year. So it’s a very long time-frame indeed!
Now let’s take a look at what the sharemarket might do over that time.
With our market having a dividend yield of 4%, and a strongly growing population, we could perhaps expect company earnings to grow by around 3-4% per annum over the long term.
So we could also expect share prices, and in turn the index, to grow by the same rate over the long term.
As I write this, the ASX 200 is sitting at a value of 6,650 points. Here’s my rough estimates of what the future value of the Aussie sharemarket could be with a growth rate of 3-4%.
These numbers are pulled from my backside (of course) and rounded for simplicity…
2019: ASX 200 – 6,650. (present day 12/09/2019)
2030: ASX 200 – 10,000. (requires 3.78% growth per annum)
2040: ASX 200 – 15,000. (requires 3.95% growth per annum)
2050: ASX 200 – 20,000. (requires 3.62% growth per annum)
2060: ASX 200 – 30,000. (requires 3.74% growth per annum)
2070: ASX 200 – 50,000. (requires 4.03% growth per annum)
2080: ASX 200 – 70,000. (requires 3.93% growth per annum)
2090: ASX 200 – 100,000. (requires 3.89% growth per annum)
ASX 100,000, baby! I’ll be there for the party! Hell, I’ll be 101 years old, and I might break a hip dancing, but I’ll be there!
Maybe the market even gets there a little early, for my 100th birthday. Come on Australia, you can do it!
But in all seriousness, this is basic compound interest at work here. Nothing all that far-fetched, except maybe me dancing.
Will it happen exactly like this? Of course not. So in this sense, the scenario is laughable. But it’s also very valuable, because it helps put today’s investment decisions in perspective.
These numbers force me to consider the time-frame really involved and realise the utter waste of time and effort it is to focus on timing the market. And of course, this completely ignores the dividends and franking credits earned along the way.
If you’re buying shares at 6,600 before they fall to 5,000…. on their way to 50,000 or 100,000, does it really matter?
My view is no. And you’ll only know in hindsight anyway. By the way, feel free to play this game yourself, using a simple compound growth calculator.
By hoarding cash until the next downturn, the results probably won’t be as good as the ignorant investor who keeps buying as much as she can.
Because then we’d be betting against history. Effectively, we’d be betting against progress.
The market rewards investors over the long term, despite the setbacks from time to time. So our job is to roll with the ups and downs and not to expect a smooth ride. The downs will hurt, but there’ll be far more ups than downs!
The Australian sharemarket has had positive total returns 4 out of every 5 years.
You can see the year-by-year breakdown since 1900 here. In fact, the most common return (by far) for a given year, is between +10% and +20%. That’s tough odds to go up against.
And if that’s not enough, then this blog post runs the numbers: ‘Even God Couldn’t Beat Dollar-Cost Averaging’, by Nick Maggiulli from ‘Of Dollars and Data’. Nick sums it up below…
“Buy the Dip, even with perfect information, typically underperforms DCA. So if you attempt to build up cash and buy at the next bottom, you will likely be worse off than if you had bought every month. Why? Because while you wait for the next dip, the market is likely to keep rising and leave you behind.”
I’m going to throw this out there. We’re all timing the market to a certain degree.
Remember, someone who is blindly investing regularly (dollar-cost averaging) is already timing the market without even knowing it! Here’s why…
You’re saving money and buying shares every month. When the market goes up, your money buys fewer shares. When the market falls, your money stretches further and buys more shares.
So if the market falls over a multi-year period, you’re guaranteed to scoop up larger quantities of shares every single month than you normally would. As you can imagine, this is fantastic for building a portfolio, because you’ll do more of your buying when prices are lower.
All without thinking about it. All without even knowing what’s going on. You’re timing the market wonderfully with zero effort!
You could make it even easier by automating your investing with a broker like Pearler. Set up a direct debit to consistently invest in your chosen funds in the amounts you want and build your portfolio automatically!
So regular investors should celebrate. With dollar-cost averaging you get the benefits of timing the market without the mental pretzel of forecasting what comes next, without listening to fortune-teller shenanigans, and without the anxiety and emotional overload of trying to pick when to dump your money in.
Obviously, I’m not in favour of full-blown market timing, where you’re all-in or all-out. But here’s where I can get on board.
If regular investing, plus having extra cash for market dips is what you feel most comfortable with, then go for it. Seriously. It’s probably not going to make or break your end result. You’ll still become financially independent.
We each have our own unique personality traits, risk tolerance and comfort zones and there’s just no approach that fits everyone.
Having this mental comforter (and ability to buy more shares) might be what helps you stay the course during a scary time in the market. And if it does, then it’ll prove to be totally worth it.
As long as you’re investing in sensible low-cost diversified funds and not buying tiny speculative stocks like lottery tickets, then you’ll still do pretty well.
Just be aware that the extra cash is likely to be a drag on returns over time. And it’ll probably be harder than you expect to put that money in when stocks are falling, as you’ll agonise over whether it’s the right time or not.
But if that’s okay with you, then it’s fine by me. For most of us though, it comes back to the simple things.
Don’t spend a minute of your energy and mental space worrying about things you can’t control. Easier said than done, I know. But a good thing to remind ourselves, nonetheless!
We can’t control the market. But we do have power over plenty of other things. Like our lifestyle. Our savings rate. And what we focus on.
Part of that focus should be extending our time horizon. It doesn’t matter what happens in the next 6 months. What really matters is the next 50+ years. Because you’re buying these investments for their ability to provide an income stream for the rest of your life. Short-term share prices are irrelevant.
I’ll finish with a short summary of our personal approach to investing in shares.
Our goal is to increase our ownership of a large group of productive businesses, via index funds and listed investment companies, which will provide an increasing flow of dividends for the rest of our lives.
By timing the market (or trying to), we’re not progressing. We’re not working in line with our goal of ‘increasing our ownership’.
But as we keep buying shares, our ownership stake increases. And with it, our share of the earnings and dividends from those underlying companies. Every single time we buy, our annual dividend income goes up, in line with our goal.
And the best part is, we can use this growing snowball of dividend income to buy even more shares, when the market does eventually fall.
What are your thoughts on timing the market? Let me know in the comments…
My thoughts on ‘The Great Taking’. An idea that the masses will lose untold amounts of wealth in the next financial crash, due to a deliberate plan by mysterious figures.
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Hey Dave,
Another classic post. Thanks for sharing this. Also, majority of what you said applies to all markets across the world.
Thanks.
Very true, thanks Devendra.
Good analysis mate! Keeping things simple and filtering all the noise around will ultimately result in reaching the desired goal. What are your thoughts on leveraging using a product like NAB Equity Builder?
Absolutely Vishal! It seems okay, not as cheap as using a home loan, but for renters it could work. It really depends on the person whether using debt for shares is a good idea. I probably wouldn’t use it and instead just keep it simple with cash purchases. Are they passing on interest rate cuts?
Yes they have been passing on the rates cuts.
My NAB EB loan has reduced down from an interest rate of 5.15% to 4.55%.
I would expect another rate cut soon in October if the economy doesn’t show any signs of stimulation from the previous rate cuts.
The EB loan has been very good to speed things up and buy a bigger portfolio of shares quicker however having the debt there is like golden handcuffs and reduces the amount of options we have.
My wife and I were thinking of taking the kids to Mexico for a year but obviously we can’t until the loan is gone because we still have to service it.
It will only take another year to get rid of the loan anyway but you see my point. I’ll probably do the same as you Dave and just keep it simple and buy monthly instead. But I will keep the credit open in case there is a major market downturn. Then I’ll load up and borrow as much as I can haha.
Thanks for that Ben. Good to see them passing it on.
Totally see the dilemma there, using debt and especially where loan payments are higher than dividend income makes things a bit trickier. Can work out great (or not), but overall gives less flexibility so needs to be considered. Cheers for sharing mate. And have fun in Mexico when you do go!
Gday Ben, have you found equity builder beneficial from a tax perspective?
Brad
I’ve been investing for about 7 years now. I have no idea what the market is going to do, and any effort I’ve expended trying to know has been wasted. I agree that focusing on savings rate, income, lifestyle is far more valuable and then I just invest when I have adequate savings to do so. If I buy at the top of the market, so be it. If I buy at the bottom of the market, bonus! One of the reasons I like apps like Raiz or Spaceship is that you are just regularly putting in money and not paying much attention to the unit price or underlying ETF prices. The downside of sitting on lump sums is that I get caught in all the thinking traps you describe in the article.
Thanks for sharing Gareth. Haha yep we all play the “I wonder what will happen” game from time to time. Also meant to link this in the post – Saving vs Investing – Where Should You Focus?
Another great read, thank you! It’s worth noting that LICs do hold cash (through dividends received from their investments yet to be deployed or when holding cash to smooth out dividends to shareholders). I think holding cash and investing in LICs can lead to too much cash exposure. Take Berkshire Hathaway’s cash war chest of around US$120 billion as an example. I’m happy for the pros to hold home cash and deploy it when they think it’s best. Obviously, indirect cash exposure can be minimised through purchasing ETFs as the fund has to pay out the distributions it receives.
Thanks Michael, and well pointed out. The LICs do hold some cash, typically less than 5% at all times. This reduces the amount of cash an investor needs to hold in case of dividend cuts, so if desired one can remain more fully invested.
Berkshire is a special case – Buffett is around 20% cash I think. More cash coming in than they can spend on prudent investments. Makes it trickier that it’s not easy to invest such a massive amount of funds in individual stocks, and he also prefers to buy whole businesses, which at that size don’t come around too often with a price and quality he’s happy with.
Hi Dave
I love reading your Thoughts on our Market they all make so much sense as if you had been in the Financial Industry all your Life , I was surprised when you said you have only been doing it for a few short Years , I love your blogs now have my Daughter following you and also my 4 GrandKids , The GrandKids are now in the Market for the long term , Thanks to you
Kind Regards
Merv Britten
Thanks Merv! Yes it’s true, I used to invest solely in property – you can read my story here if you’re not familiar.
I appreciate the feedback, and nice work getting the family on board too!
Gday Dave,,
Thanks for your time.. so I’m just wondering if you have a large sum of money to invest ,, in the current market you wouldn’t wait..?? I’ve been reading that Warren Buffet himself has the biggest amount cash waiting for better opportunities..
Thanks
I researched this back in 2016 when I had a lump sum to throw into the market. The evidence stated that 2/3 of the time you are better off throwing it all in at once — and so I did (April 2016) and it was the correct decision.
Good question Paul – with a large amount I would personally feel more comfortable investing it steadily over time, rather than all at once. Statistically the lump sum is likely to do better, but not guaranteed, so to avoid regret and make it easier psychologically I’d spread it out.
Buffett holding cash is quite different from the rest of us average investors, as I explain in my reply to Michael.
For what it’s worth I had $50k lump sum to invest in September last year. Went all in on VAS at about $80 and it promptly fell to under $70 by Christmas. I was kicking myself for a few weeks, cursing this and that, but before I knew it VAS was around $85. I’ve since DCA-ed in and my average purchase price is down to $77. I no longer care about the ‘mistake’ of the past.
Hey Dave – great post making me rethink all of this. What I do is regularly invest in super (I’m older so makes sense) by maxing out to $25K. This means every month I’m using DCA (about $2,083) like it or not because that’s the way super contributions work through my employer. My super fund is all low cost index funds.
Outside of super, my thing has been to buy more of the index (VAS) or LICs if the price approaches or drops below my cost base. So rather than waiting for a 10% or 20% drop or whatever, I’m aiming to throw a pile of cash in when the price approaches or is lower than cost base. For example, this happened last December when MLT fell to $4.24/ share. Of course the downside to this is that I haven’t added to VAS for 2 years because my cost base is LOW, So I should probably loosen up on that one.
Cheers Scott.
Thanks for sharing your plan – I like it overall, but I think focusing on cost base is not very useful as we’ve discussed before. I’d just focus on building up holdings of funds in the percentages you want, trying not to pay more than NTA in the case of LICs.
As you’ve experienced, by focusing on cost base it skews your decision making by anchoring on previous prices paid, which is irrelevant. What matters is current value and future returns from here – neither of which depend on what price the fund used to trade at. Sorry to harp on that again lol.
Hope that makes sense mate.
Hi Dave — with all these days off over the festive season I’ve had the chance to revisit my approach and crunch some numbers in Sharesight. The 2020 goal is to make a monthly instalment into VAS regardless of the price. It makes sense (as you point out). If there happens to be a crazy dip in a particular month, I might double down.
I note in your most recent portfolio update, you are 20% cash but would like to be about 5% cash. Is the 5% cash the amount required to keep you going for 2 years in line with the Thornhill approach (e.g. high equities allocation with 2 years cash to ride out a downturn)? Thanks
Hey Scott. Sounds like a good plan 🙂
Yeah 5% cash is really just a buffer to cover reduced dividends in a downturn (Thornhill approach). We may even hold less than that if we’re still earning personal income at that stage (once we’re zero property and all shares). Hope that makes sense mate.
The good shares, I follow them for around 3 yrs, buy them when they seem close to the bottom, I’m following around 65 of them, I always find 1 or 2 to buy. 40 of them are LICs,BETA,LITs and ETFs….
Just. Keep. Buying.
Market timing often gets a bad rap because conventional wisdom would have you believe it is overrated. Those who I have come across who use market timing techniques successfully do not focus their attention on what the financial media or experts think is going to happen. They develop their own independent, well-researched and robust plan based on their understanding of market cycles and more importantly, they have the patience and discipline to stick with it. What most people cannot get a handle on is the emotional side of investing. Over the last 5 years, it has been a pretty easy environment to be a share investor of all faiths (i.e. income and capital). At the extremes, my experience tells me that there is very little idle cash to be “invested” – emotion drives people to get into the market for fear of missing out and get out of the market because the pain of regret weighs on them. At such times, without a well constructed plan, it is very difficult to stay on course when all your colleagues, friends and family stampede around you. In such times, how many people can truly say hand on heart that they trust their plan. While I support your comments that the object of the game is accumulating income, income investors are not immune from loss and must face the inevitable stumbling block along the way (i.e. when companies cut their dividend). At times like this, people start to question the logic of their ideas. That is why it is important to understand the market cycle, where we are in that cycle and what it means for your investing. As I was once told, you need to build up your emotional bank account in order to grow the other bank account.
Thanks for your input Steve, much appreciated.
I’m in total agreement that investors of all strategies will be tested if/when things get really hairy. Hence, the importance of following a strategy that you feel truly comfortable with, regardless of what everyone else is doing or what looks to be the ‘best’. It has been a pretty smooth ride in the recent 5-10 yrs, and I suppose only time will show who can tolerate the rollercoaster that is the sharemarket 🙂
I haven’t met anyone who knows how to time the market successfully, nor do I believe it’s even worth considering for the majority of investors. Most of us should simply spend our time doing other things. It’s easy to forget that for the average person, trying to follow the market cycle will mean following the media and trying to figure out what comes next, because that’s the ‘easy’ way to do it. Most people just aren’t that interested in finance/markets to spend all their time/energy learning enough to come up with their own findings, so this can quickly become dangerous.
So my belief is, the overwhelming majority of everyday investors (myself included) are better served putting their head down and continuing to invest surplus cash over the course of their lives.
Another excellent read-thanks Dave. We are soon to buy into a LIC and my partner is asking to wait for another dip so will show him this article. My question is, what is the best approach with dividends? Should they be automatically re-invested or further added to savings to continue buying LICs, thanks in advance
Glad it’s helpful Barb! No best approach really, whichever suits you best. Reinvesting is easier/less effort, but taking the cash dividend lets you decide where to invest. For what it’s worth I take the cash and then choose what to buy.
From a CGT perspective, assuming the portfolio is relatively small (< $5K dividends), might it be best to take the dividends and then invest? That way, for example, instead of 5 different holdings using DRP to buy 5 x $1K, all attracting CGT events anyway, you buy $5K of one holding. Once a holding pays $5K dividends then DRP your heart out!
However DRP regardless has behavioural benefits through automation and we're not meant to sell afterall. Whatever works for you I guess but I think I'll switch DRP on for larger dividends I think.
Or have I got that wrong?
I’m not sure what you mean. Capital gains tax is only payable when you sell an asset. This is not related to re-investing dividends. If you take the dividend and reinvest into the same fund manually, your cost base and income tax will be exactly the same as if you use DRP.
Oh sorry. Badly worded. I mean, wouldn’t it be better to have one $5K cost base of one holding (by manually allocating the dividends) than five $1K (DRP) cost bases? That way, if you had to sell, it’s easier to track the larger parcel of shares to sell. I’m probably over-thinking it.
Oh I see. Yeah it’s definitely easier to have less holdings and then also less purchases to keep track of. But for a long term investor, it shouldn’t make much difference because ideally you’re not selling, and can also be made easier with free tools like Sharesight.
Great discussion. I have always wondered about building a stockpile to use in a market drop- I think you’ve highlighted some good behavioural points why it might not be a good idea. I’m think I’m going to stick to dollar-cost averaging!
Cheers Rohan. The stockpile approach is great in theory, but would be very difficult in practice. I think for most of us keeping it simple is definitely the better way to go 🙂
Hi Dave, Thanks for all the great read’s. Regarding shares! whats your view on the asx ? seems like most of your shares are within Australia, any thoughts on buying shares from international market?
Thanks, Brad
My view on the ASX? Positive over the long term, for reasons outlined here.
We have our super invested in 100% international shares (index), which gives us some overall diversification. But for our personal portfolio, we stick with Australian shares given we’re focused on living off dividend income. But we’ll likely add international shares to our personal portfolio later too. I go into it in a bit more detail in this post. Hope that helps.
Hi Dave,
You would be better off buying ASX inside Super and International outside super. ASX has a higher payout ratio and franking credit. So bring inside Super (in a 15% tax bracket) gives better return due to fracking credit and lower tax on dividends.
I know you are after income and hence why you are buying ASX outside Super. But ultimately it’s a single portfolio. You can look at total return. If retiring before 60 then just sell 1-2% of your international shares to make up the difference in yield.
Personally I am doing this. All high income /yields assets inside super and rest outside super. Also I’ll FI at age 42 but don’t plan on RE for a long time. Perhaps age 55.
Thanks for the comment Manu. Fantastic work on your FI progress!
I’m aware of that approach, and this stuff is always up to individual preference, but I don’t quite see it that way. I wrote a post about Super and why I approach it this way which may provide more info (the assumed tax savings due to lower yield international are a mirage in many cases).
I don’t think there’s ‘right’ answer on how to structure so I fully support your choice – all the best!
Hi Dave,
I’m old school and experienced my first crash in 1987.
What I’ve learned from all of the crashes up to the GFC is that even the Blue chip shares are not immune to failure and ultimately bankrupcy.
If you care to look up Babcock and Brown ,$9 Billion market cap to $0,
ABC Learning $3 Billion to $0 etc,etc,.All market darlings of the time.
My point is by sticking with the LIC’s and now ETF’s which hold a broad exposure to the top ASX Bluechip companies,they can tolerate failures, rather than you personally owning individual shares and having your portfolio decimated when one of your stocks goes under.
So I am totally in favour with your suggestion of regular investing and ignoring the market “noise”
You could have bought AFI before the GFC for $6.10,during the GFC for $3.60 and now for $6.30. They are still around and the dividends never stopped!
Good lessons there Old School, thanks! Sticking with diversified funds might not be as exciting, but it’s a hell of a lot safer than relying on just a handful of individual shares 🙂
Forget the exact source (Fidelity, maybe?), but they essentially conducted a study that revealed the best investment returns were achieved by people who had already died. This return was equalled only by people who forgot they had money invested in the first place.
It’s not market timing that messes with people’s investment returns — it’s human nature. I’ve always thought I’d take the lump sum I have in my mortgage offset account and invest a quarter of it when VAS hit: $64, $48, $32 and $16. This is probably silly though, because if it ever hit $32 (it’s $85 now) let alone $16 (!), the remaining half of my lump sum will most likely be worth more to me in my hand than invested in something that might take X years to recover. Human nature would no doubt prevent me from successfully executing my plan. And I don’t mean my own… my wife would probably put a hit on me if I tried to tip our life savings into something that had tanked that much!
Haha! Great example Chris.
We get in our own way most of the time, and when creating these imaginary scenarios for ourselves, we tend to forget what a large market crash would likely represent… absolute panic. We’ll just have to wait and see what the next scary time brings and keep reinforcing the basics of investing to stay the course. I actually think some in the FI community are in for a rude awakening as they’ve come to expect nothing but bulletproof double-digit returns from stocks and especially the US market.
Agreed re: rude awakening… me included! Rest assured I’ll be scouring the comments of this infinitely wise blog to see what the hardened pros are doing.
Hi dude,
Peter often recommends holding cash.
I’ve been investing in government bonds which probably sits Inbetween cash and equities.
I intend to hold about 15percent.
Cheers
Peter Thornhill I assume?
He recommends a cash buffer when living off a portfolio to top-up income when dividends fall during a recession, NOT for the purpose of timing the market.
Two very different things. Peter buys regularly but always has spare cash because of this buffer approach.
I asked him about this in our interview, regarding ‘waiting for opportunities’.
Nothing at all wrong with holding a decent amount of cash/bonds if that’s what someone is comfortable with, and it’s very handy when living off a portfolio. I didn’t mean to hold zero cash at all times – I just meant that I don’t think trying to time the market is a good idea.
I can’t remember where I heard it, but there was an interview with Peter Thornhill where he talks about how he has a line of credit secured by his home, and he intends to use it in the event of a big market correction. Was it your interview with him?
I’ve seen Peter state that the line of credit is already invested in the market, to allow him to remain 100% stocks. He keeps cash as a buffer, and then has the home equity invested which cancels out the cash = 100% invested. Peter likely buys more aggressively if he can in a crash, but his advice in our interview is:
Do you prefer to be fully invested the majority of the time or wait for opportunities? Does waiting make any sense?
Peter Thornhill: Waiting for what?
Are you saying don’t bother, just keep investing?
Peter Thornhill: Yes. This is the start of analysis paralysis. Wasting time every day watching prices.
To gauge “the level of fear”, I use VIX and set an alert and buys index when it spikes everytime, ie VIX>20, BUY! If you want to buy a few times less a year, set it higher. just a rule of thumb.
Ming, any thoughts on the disparity between the VIX and the MOVE Index?
Hi .
An excellent idea and original if l am not mistaken .
A method of buying in market weakness within a strategy of ” continual ” buying no matter what . l like it !
Cheers , Ramon .
Nice thread Snowball, I’ve been following Nick Maggiulli for a while now, some great insights there
Cheers Redwing! Yep, he’s pretty good – Ritholtz have quite a team of advisors/bloggers over there!
I recently had a large sum to invest and, given the frothiness of the market, was a tad wary. About whether to DCA, or even invest at all.
But at the end of the day I feel you have to go with research, well summarised here:
https://awealthofcommonsense.com/2018/05/the-lump-sum-vs-dollar-cost-averaging-decision/
So I’ve gone all in. Mostly in dividend producing OZ shares for our living expenses, but also diversifying with a chunk in global shares and bonds.
So far so good.
Having said that, whilst I wouldn’t sell if the market flops, I have significant CGT coming up and am prepared to move underperforming assets around.
Thanks for sharing Steve. Good on you for following the data and making a decision that way 🙂
Great article! What are your thoughts about lump sum vs DCA when you already have a large lump sum of savings? Jim Collins’ blog would suggest it’s better to put the lump sump in immediately and then continue to DCA your income stream into investments going forwards, as more time in the market means more returns in the long term. Personally I am inclined to agree with him; the difficulty is when you add in the human element and the fear of short term loss, that makes people decide to DCA the lump sum and more often than not end up buying at a higher cost overall!
Thanks NF! Can’t argue with the likelihood of lump sum winning, but most people myself included won’t feel very comfortable with that, especially if it represents a large % of net worth. Psychologically DCA wins hands down though. Personally, I’ve taken the approach of doing both before, lump sum half immediately and drip feed the rest in over time.
It sits somewhere in between in terms of risk, behaviour, outcome and avoiding regret. Having to choose itself can be a mental struggle, so doing both makes it easier. No one right answer for everyone is my overall view.
I call this the golden thread. Pure gold!!! Dave, your thinking, your page…..I don’t know what to say. Very hard to find gems on the internet, but this is hell of a big one! Priceless.
Thanks Michael, really appreciate the kind words!
I very much like this thread.
Interestingly some discussion against buy and hold:
In summary, the key points we covered in this episode are:
– Stocks don’t always go up!
– The problem with buy and hold: it doesn’t work all the time
– The problem with ‘average’ returns
– This is why the geometric return is the key to maximizing your long-term wealth
– Why you must buy low and sell high to optimise your actual wealth
https://podcasts.apple.com/au/podcast/episode-2-this-is-why-buy-and-hold-doesnt-always-work/id1508878997
Thanks Aaron. I’ve been a fan of Pete’s for a long time. Here’s my take on it:
Their arguments are not defiantly against buy and hold as a strategy. It’s really against buying at any price – they’re simply saying valuations matter to future returns. And I don’t think anyone would argue with that.
The main issue is deciding when valuations are ‘too high’ and having an action plan around that – which obviously they have inside their coaching program etc. And their approach is to buy specific emerging markets when they see developed like Oz and US as expensive. Most people won’t want long term investments in say Pakistan or Turkey for example, so you then need to become somewhat of a trader making bets based on valuations, rather than a long term investor in chosen markets.
I’m sure it can work well for people who have the interest/intelligence/stomach/plan for it, but I think most people are better suited to a strategy more simple and approachable, where less decisions are required and they are happy with exactly where their money is invested for the next few decades.
Having said that, I would definitely look at other options if I thought the market was seriously overvalued.