The Stock Market Hurricane

If you’re not a news junkie, maybe you haven’t heard about this…but there’s a hurricane headed our way. And like most things in life, there’s an investing lesson to be learned here.

There are three conditions that have to be present for a hurricane to form.

1) Warm water

The storm can only develop over water that’s at least 80 degrees. Warmer water means increased evaporation from the ocean’s surface, which creates the necessary moisture in the atmosphere.

But the warm water also has to go deep enough; that 80 degree water needs to run at least 200 feet deep. Hurricanes don’t form in May or June because even though the surface of the water might be warm enough, the warmth doesn’t go deep enough. But throughout the summer months, the water slowly starts to heat up from the surface down, and by the end of summer, the conditions are ripe.

2) Little to no wind shear

Another important factor is the absence of wind shear, which is the difference in wind speed or direction over short distances. If the wind off the coast of Senegal is blowing west but the wind over Cape Verde is blowing south, while the wind off Sierra Leone is also blowing south, but at a different speed, that would indicate strong wind shear. Not ideal conditions for a hurricane to develop.

3) Cooler atmosphere

Finally, the air in the atmosphere has to be significantly cooler than the air at the water’s surface. The rapid cooling of water molecules as they evaporate allows for condensation and quick development of cloud formation in the storm wall.

Unless you have all three components—warm water, little to no wind shear, and cool atmosphere—you won’t find hurricanes forming.

In many ways, the birth of a stock market crash is similar.

Generally speaking, for a stock market crash to occur, we also need three factors to be present…

1) A long period of rising prices and economic optimism

Except for a very slight downturn in 2015, stock prices have done nothing but go up since March of 2009. Some analysts have classified this as the longest bull run in history. Others consider 2015 to have been a slight bear market, so they see it more as a two average-length bull markets with a small bear in the middle. Either way, the last decade has been a long upward trajectory.

As for economic optimism, there’s actually a polling group that created an index to measure this. In August, that index hit a 14-year high, meaning that people feel better about the economy right now than they have since John Edwards was getting $400 haircuts while he ran for Vice President alongside John Kerry.

2) P/E ratios much higher than long term averages

Understood simply, a high P/E ratio usually means that people are really excited about a company (so the stock price is high) even if the profits aren’t there to back up that excitement.

So when P/E ratios are high across the board, that means lots of people are excited about investing in many companies that aren’t necessarily profitable enough to justify that enthusiasm.

The combined P/E ratio of all stocks in the S&P 500 in September is almost exactly 25.

The average P/E ratio of the last 20 years? About 24.6.

3) Extensive use of debt.

According to the federal reserve, the average American household carries the following debt:

Credit card: $16,883
Auto loans: $29,539
Student loans: $50,626
Mortgages: $182,421

Meanwhile, the median household income is about $60,000. So yes, as a country, we’re heavy on the debt right now.

So where does that put us on our Stock Market Hurricane Score Card?

Two of our conditions are definitely present—a long period of rising stock prices and enthusiasm, and extensive use of debt. But we’re not in bad shape on the P/E ratio metric.

Now, the P/E ratio metric is one that can rapidly change, especially if something goes horribly wrong with some of the major players in the market—Apple, Google, Amazon, Facebook, etc.

So based on this analysis, it’s not wise to buy into any doomsday predictors who tell us that the next market crash is imminent. But it’s also wise to note that the right conditions could develop at any moment.

The water is warm and deep, and the atmosphere is cool. Right now, the wind shear is in our favor, but if that changes…look out.

Unhealthy Financial Foods

Depending on who you ask, you might get varying opinions about whether a certain food is good for you.

Are eggs good or bad?

What about butter?


Red meat?

Red wine?

But there are certain foods that anybody with half a brain will agree aren’t good for you. And believe it or not, we can find a lot of those unhealthy foods represented in the financial world…

Empty Calories

Empty calories are the ones that add calories to your diet but no actual nutritional value. Soft drinks, candy, chips, pastries, and frozen desserts would all fit the bill here. They’re problematic because they make you feel full so you don’t have room for foods that actually give you the vitamins and minerals that you need.

Consider these two different meals:

1) McDonald’s Quarter Pounder deluxe, medium fry, and 20 oz Coke.

2) Grilled chicken breast, avocado toast on whole wheat bread, a fruity protein shake, and Pascha dark chocolate for dessert.

Both meals give you somewhere between 1100-1200 calories. The first meal provides you virtually no helpful nutrients, other than a little bit of protein in the Quarter Pounder. But the second meal is high in potassium, phosphorus, zinc, iron, magnesium, copper, protein, fiber, vitamins B and C, omega 3 acids, beta-carotene, and riboflavin—all for the same number of calories!

In the financial world, empty calories come from that 75-page financial “plan” that you get from the big brokerage house.

Most of those pages aren’t customized to you, and they don’t really provide any true advice. Once you sort through all of the pages that are just boiler plate filler and disclosures, you’re left with just a couple of pages that actually give you some analysis that’s actually related to your situation. And most of that analysis isn’t even that accurate.

So you’ve added a lot of “paper calories” to your file cabinet’s diet, without any real tangible benefit. But you feel like you’ve accomplished something because you have this 75-page document, so you don’t really push any further to get a true plan in place for yourself.

It’s no different than eating the McDonald’s meal and feeling full, so you don’t feel the need to eat anything else to give you the nutrients you need.

Added Sugar

Several months ago, a neighbor was cleaning out their pantry in preparation for a move and asked us if we wanted some of the canned goods that they needed to get rid of. Sure, why not—who turns down free food?

As it turned out, most of the cans weren’t things that we’d actually eat, and we ended up purging most of the cans from our own pantry a few weeks later. During the purge, we noticed the ingredients on a can of tomato soup. The first ingredient, to no one’s surprise, was tomato paste. But the second ingredient was high fructose corn syrup.

I’m sorry, tell me again why we’d want sugar in our tomato soup?

Well, we don’t. But most food companies are just trying to fill the can the cheapest way they know how. This often means you get a lot of sugar in foods that don’t seem like they should warrant a high sugar content.

A lot of fruit juices are bad about this too. They even go out of their way to market themselves as a healthy option, but when you really study the ingredients, you find out that most of them have an absurd amount of added sugar.

The problem with most “added sugar” foods is that you think you’re eating smart when you have them. Tomato soup, fruit juice, yogurt…at first blush, all of those sound healthy. Very often, they aren’t.

In the financial world, added sugar comes in the form of hidden fees. You might believe that you own a product with very low fees, or no fees at all. But when we take a closer look at that product (either by exploring the prospectus or by calling the company and asking a few very specific questions), we often find that your fees are much higher than you would have guessed (or in some cases, much higher than you were led to believe).

Trans Fats

Usually when you’re consuming trans fats, you’re aware that you aren’t eating healthy. Cakes, pies, cookies, and doughnuts all fall into this category.

Nobody has ever eaten cookies or doughnuts and tried to convince themselves that they were making healthy choices. You know they aren’t good for you, but they just taste so dang good that you can’t help yourself.

In your portfolio, this is the same as having too much risk exposure. You’re 58 years old and you’ve been watching your 401k grow and grow for the last several years. You know the ride can’t last forever, but it just tastes so good to see that account balance keep growing quarter after quarter. You can’t stop yourself from feasting on the risk.

“I’ll make it more conservative once I get to $500,000,” you say. Or $750,000. Or a million. “Just one more cookie and then I’ll start my diet tomorrow.”

But you never do start the diet, the market crashes, and you’re left with the financial equivalent of a diabetic coma.

The good news about all of this is that it’s actually much easier to eat healthy in your portfolio than it is to eat healthy in real life. So there’s really no need to put it off…

Financial Planning with Mom

Since the dawn of time, all mothers have lived by a certain behavioral code that dictates their thought processes and speech patterns.

Today, in honor of the upcoming Mother’s Day weekend, we’ll be looking at some of those stereotypical statements that moms like to utter, and we’ll apply that wisdom to the financial world…

1) “Because I said so.”

This is one of the more frustrating debate points that your mom could throw at you, because there’s really not an adequate retort to it. You could state your case perfectly, point out all of the illogical aspects of her stance, and finish with a closing argument that would have any jury eating out of your hand.

But then she hits you with “because I said so” and you’re cooked. End of discussion.

Unfortunately, you’ll find some financial advisors who operate with this same “because I said so” mentality. They just want you to go along with what they say because they’re in a position of authority. But unlike Mom, that advisor hasn’t spent your entire life proving that he has your best interest in mind, so that mentality definitely doesn’t fly when it’s coming from him.

I’ve known advisors like this. Their entire business model is based on making clients out of the “low hanging fruit,” which would be the people who don’t ask many questions and just go along with whatever they say. They’re not prepared to truly answer your questions or adequately address any of your concerns. Their mission is to create as many “leads” as possible so that anytime someone poses any sort of intellectual challenge, they can just discard them as a “pain in the butt” and move on to the next person.

An encounter with an advisor like this is ok if you’re someone who does ask a lot of questions. You’ll quickly see that they don’t have the answers you need, and you’ll move on. My concern is for the people who never ask any questions and just go along with the “because I said so” mentality because they assume that they’re working with an authority.

Ask questions. Share concerns. Don’t be intimidated by an authoritative presence.

2) “If you want to act like a child, I’ll start treating you like one.”

Mom usually said this when you were whining about something silly. For instance, maybe you wanted to go on a 4-day road trip with some of your friends, but she wouldn’t let you because you just turned 16 and got your license three weeks ago. But you pitch a fit, so she says, “If you want to act like a child, I’ll start treating you like one and take the car away altogether!”

In the financial world, we see a lot of investors acting like someone of a much younger age. There’s a staggering number of portfolios out there that would be a pretty good fit for an investor in their early 30s. The only problem is that it’s owned by someone in their early 60s—a person who should have a very different risk profile.

The problem here is usually that the portfolio hasn’t been properly adjusted to fit that investor’s stage of life, and it’s often because of a lack of communication between investor and portfolio manager. You assume that your portfolio is being adjusted as you age, and your broker assumes that if you wanted less risk, you’d tell him.

In other words, if you want to act like a child (or a 30-year-old when you’re actually 60), your broker is happy to treat you like one!

3) “If all of your friends jumped off a bridge, would you do it too?”

Literally every mother has said this at some point. I defy you to find one who hasn’t.

Financially speaking, I’m constantly amazed by the number of people who jump off a financial bridge just because all of their friends are doing it.

“Everybody at work says I’m better off to take the bigger pension amount and just invest that extra money instead of taking a smaller amount with a spousal benefit.”

“My brother-in-law says he’s starting his Social Security at 62 because he wants to get his money before the whole system goes belly-up.”

“They say you need a million dollars before you can retire, so I’ll probably be working until I’m 80.”

The “consensus” idea of what’s best may not actually be best for you, so don’t just assume that the herd will lead you in the right direction.

Happy Mother’s Day to all of the moms out there. And remember, “as long as you’re living under her roof, you’ll live by her rules.”


The Financial Double Dribble

Never pick up your dribble without a plan.

In the game of basketball, picking up your dribble at the wrong time can be detrimental. You can’t just start dribbling again because, well, it’s against the rules. It’s called a double dribble. So if you pick up your dribble, you need to have a clear plan of what you’re doing next. You should either be planning to shoot, or you should know who you’re passing it to. Otherwise, you’re just asking for trouble.

A good defender is going to smell blood in the water if you pick up your dribble at the wrong time. He knows that you now have to stay in that same spot until you get rid of the ball, so he’ll take the opportunity to smother you, cut off your passing lanes, and make life difficult for you.

I had to search YouTube for a long time to find a good case study, but here’s an obscure example of somebody picking up his dribble without a plan (with a riveting explanation from the narrator):

And without narration, another example of picking up your dribble without knowing what’s coming next:

So what does all of this have to do with your financial planning? Well, there are several financial equivalents to picking up your dribble without a plan…

1) Social Security

Way too often, people flip the switch and start their Social Security without a plan. In some cases, it’s because they’ve reached the age of 62 and they’re now eligible for Social Security, so they say, “Why not? Let’s do this!” And then a few years down the road it becomes clear that they should have waited to start taking it at a later age. But it’s too late. They already picked up their dribble a few years ago and there’s no undoing it now.

2) Cancelling life insurance

Sometimes your needs for life insurance change. It could be that you now need more life insurance coverage than you previously had. Or maybe you need less, but you do still need some coverage. Or maybe you’ve just determined that your current policy is too expensive or just not the right fit and you need to get a different policy with a different company.

Suppose you have $500,000 in coverage, but this was a life insurance policy that you got when your kids were still living at home. Now the kids are grown and out of the house and you decide that you now only need $200,000 (maybe to pay off the mortgage for your spouse if something happens to you).

In this case, it’s important to get the $200,000 life insurance policy in place before you cancel the $500,000 policy. If you cancel the old policy and then apply for a new one, what happens if your health exam doesn’t go well and they determine that you have some medical condition that’s going to render you unable to get coverage, or maybe the coverage will be more expensive than you care to pay?

Well, you already picked up your dribble when you cancelled the old policy, and now you have nobody to pass the ball to. And now you’re stuck without any coverage at all.

3) Quitting your job

Sometimes you’ve had all you can take at the office and you’re ready to walk away. Take this job and shove it, Mr. Foreman.

Well, hold on just a minute. Let’s not pick up that dribble until you know what happens next.

Sure, there are some people who have quit their job to “bet on themselves” and then gone out and found their next career (or started their own business) within a few days. But those stories aren’t nearly as common as the people who quit their job without a plan, thinking they’ll be back to work somewhere else in a few weeks, only to end up “between jobs” for an extended period of time.

Most people pick up their metaphorical dribble, get swarmed by the defense and dig a financial hole for themselves.

*             *             *

So whatever financial decision you’re about to make, take some time to think things through in advance. Is this a decision that’s equivalent to picking up my dribble? If so, do I know what happens next? Do I have someone to pass the ball to? Do I have a shot to take? If I get in a pinch, do we have any timeouts left?

If you answer those questions before you pick up your dribble, you can save yourself from unnecessarily throwing the ball away.