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Crash Test

Isaac Cathey  |  July 24, 2020

AS THE MARKET plunged earlier this year, I recalled the sage advice of billionaire investor Mark Cuban: “When you don’t know what to do, do nothing.” My wife and I are 100% in index funds, so doing nothing was easier for us than for more active investors. Still, we did take some action and, more important, learned some valuable lessons.

Examples? With the bear market apparently behind us, I decided to create a record of the steps we took, so I’d have a written reminder to guide me the next time the market falls out of bed. Here are 10 key lessons that I learned from the 2020 coronavirus crash:

1. A mental shift. It wasn’t fun, especially at first. The initial phase—the first 10% drop—was the most mentally taxing. Shifting from a “how high can we go” mindset to a value mindset was tough, but necessary and profitable. Once we could see the market drop as a discount, doubling down on our investments appealed to our frugal nature.

2. Save on taxes. While losses—realized or not—can be emotionally painful, it helps to know that the taxman is willing to share in your losses. I devised a rotating monthly trading schedule for three broad stock market exchange-traded index funds (ETFs) that provided the necessary separation between buy and sell dates to abide by the wash-sale rule. Although it was psychologically painful to see that much red, sticking to this schedule assured that my losses would be partially offset by generous tax savings.

3. Stick to the plan. As the market plunge got particularly nasty in mid-March, I realized that my wife and I had grown immune to volatility. Swings of 8% to 10% got our attention, but daily swings of 5% or less started to seem relatively minor. After some discussion, we recommitted ourselves to our 80% stock-20% bond asset allocation. We set our limit orders and bought all the way down to within 2% of the bottom. As the orders filled and our cash reserves dwindled, it took an iron stomach to keep going, but I’m proud today that we toughed it out.

4. On second thought, stick to the plan—but don’t be too hasty. One drawback of rebalancing aggressively on the way down is that, once you’re heading back up, the stock side of the portfolio grows. As the stock market bounced back and our asset allocation shifted increasingly toward stocks, we took a deliberately lazy approach to rebalancing, shifting some money back to bonds, but not fully rebalancing our portfolio right away. By doing this, we took advantage of the stock market’s upward momentum.

5. If possible, stay employed. Many were predicting that it would be a long slog out of bear territory, so I was thankful to be employed and able to pay the bills. Perhaps equally important, I was grateful to have my income as a source of new savings, allowing me to invest at depressed stock prices.

6. Stay on budget. In family financial discussions during the crash, it could go two ways. On several occasions, our daily losses were in the tens of thousands. What difference would it make if we blew an unbudgeted $50 on takeout, instead of cooking at home?

Enter the opportunity mindset: Every additional dollar we could squeeze out of our budget and invest had a higher expected return than it would’ve had just a month earlier. Spending $1 on March 23 was $1.51 in Feb. 19 stock market dollars, adjusting for opportunity cost. Put differently, we had a chance to pay only 66 cents for stocks that, just one month prior, investors worldwide agreed were worth $1. Choosing a mindset of opportunity helped us stick to our household budget, even as current events dwarfed its perceived significance.

7. Motivation matters. During the crash, the dollar losses were too huge to stomach. Perhaps the best thing to do was ignore them. But I’m a data-driven guy, so it was useful to find a new metric to motivate me.

For example, with each rebalancing trade on the way down, our cost basis fell. It was cool to see how low I could get my average cost and think, “Wow, these are 2016 prices.” Since the market will certainly set new highs at some point, it was fun to calculate what our portfolio value would rise to whenever that happens. Finally, since no one can control what the market does, it was encouraging to focus on a metric that we all get to control, at least to some degree: how much of our earnings we choose to save and invest. Whatever metric motivates you, find that silver lining and use it.

8. Cash isn’t trash. While it’s true that cash tends to create a drag on a portfolio’s overall return, having that cash to deploy as the crash deepened provided a psychological edge. Our stockpile of cash afforded the opportunity to do something productive—rebalance our portfolio.

9. Know thyself. This one Socratic aphorism sums up what, for me, was the most valuable takeaway from this market episode. In March and April, my YouTube feed filled up with videos of day traders touting their chart-driven strategies, bragging about their gains from shorting the market and declaring they could pinpoint the S&P 500’s bottom at around 1700.

Though I was tempted to engage in margin trading, derivatives, leveraged ETFs and other “advanced” strategies, the market rebound quickly validated my old school, simple, low-cost, broad-based approach. In fact, I’m certain that the deep discounts I enjoyed were courtesy of panicked day traders faced with margin calls, who had no choice but to sell to patient buyers.

10. Attitude matters. Mental resilience is the ultimate contrarian strategy. When the prevailing attitude is pessimism, optimists can benefit. My family’s intuitive confidence—that the world wasn’t ending, that this time wasn’t really different and that the market would surely recover soon enough—kept us on track. I’ve heard many investing champs say that successful investing has far more to do with temperament than knowledge or skill. Having experienced the first huge market drop of my investing lifetime, I can attest to that.

Isaac Cathey is a public sector employee and professional pilot. The bulk of his financial knowledge comes from books by the likes of John Bogle and JL Collins. He spends his free time running, swimming, hiking, camping, biking with his children and doing DIY projects.

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