March 2020 – The Log House

In the last few weeks the world has changed quite a lot. With no sight to an end to the corona-virus spread, cities after cities are going into lock down and people are forced to stay at home.

This will impact the economy in a very bad way and many businesses like entertainment, travel and food will be severely affected or shut down. In these unprecedented times, the current situation of the stock market and its decline is understandable.

Since this blog is concerned with personal finances, let us look at the impact this black swan event can have and how to get over this crisis.

We will examine 5 adverse scenarios and how my previous posts (in good times) suggested recession proof way of managing personal finance.

Social distancing

This has been enforced in many cities and people are not allowed to be meet each other face to face.

- This will impact people and their livelihood when it depends on teams and network. For example, direct real estate investing like house flipping, buying houses, wholesale deals and likes.
- Financial, insurance advisors and their clients who depended on face to face interactive sessions. While this can still be done over video conferencing and online communication, the personal coaching sessions may be less personal after all now.
- Investments which depended on a broker or branch are impacted since offices are shut down or low on staff.

The key to solving these issues is to setup systems that enables you to transact virtually from anywhere in the world, including your home. If you have automated your financial systems using FinTech, those systems are not affected by the current situation.

FinTech – can you be immune to it?

Losing jobs or income

- As various industries are expected to be hit hard by this event, many people may lose their jobs or get a reduced income for an unknown period in the future.
- This will cause difficulty in managing household cash flows, paying bills, mortgage and tiding over emergency situations.
- Emergency medical conditions, for example, someone in the household may contract the virus and need to be hospitalized. Even with insurance, it may cause a hefty out of pocket expenditure.

The key to solving such emergency situations is to have enough cash cushion in terms of Emergency Fund and to cover Short Term Obligations.

One essential comfort zone

Investments are tumbling and losing their value

- Your stomach will have a strange feeling when you look at your stock, ETF or mutual fund portfolios under 401k and Taxable accounts.
- Almost all portfolios are beaten down 25-30% and may go further down to 50% or more.
- With the risk of financial institutions and other companies going out of business, even fixed income portfolio is not safe. There may be large scale defaults in the bond market, as companies struggle to meet their short term debt obligations.

The key to solving such challenges is to remain invested and not panic sell out of it at this time.

Afraid of investing? Not so simple either

Fear is gripping us

- While there had been virus spread earlier, the scale of the COVID-19 is unprecedented and growing.
- This type of lock down has never happened before, and after what happened in Italy and China, we are gripped in a fear of the fatality rate caused by the virus.
- This has stopped us from behaving rationally and with our investments, people may be reacting with the same fear. I have read many discussions on Quora where people are predicting a long recession and advising others to pull out investments or completely stop investing more.
- Fear is the worst enemy and negativity is biggest killer of future prospects.

The key is to remain calm and take necessary precautions (staying at home, frequently washing your hands etc.). Similarly for finances, do not take up unnecessary debt at this point but just remain invested and keep your monthly investments ongoing.

The biggest enemy of your investments

Not building new assets

- While there may be a recession ahead, this may be the starting of a good time to buy assets.
- Our net worth is beaten down due to the stock market crash, and this is not the time to rue over the loss.

Instead we should focus on increasing the underlying asset values and look to the future for those assets to throw in cash flow and appreciate.

The Net worth vs. Cash flow debate

Conclusion

At the end, we all have to realize that the world will tide over this crisis.

For our finances, we just have to carry on doing what matters and take a long term view.

If you adopt the SAFE plan as in below post, nothing should really change.

The SAFE plan – Simple, Automated, Flexible and Efficient

With the forced shutdown, learn a new skill indoors and do not worry about your investments.

acoustic adult close up fun — Photo by Porapak Apichodilok on Pexels.com

One of the questions all investors consider is how to spread their investments. This is super essential in a volatile economic environment that we are now being forced by coronavirus.

Coronavirus is already sending stock markets across the world in a downward spiral, companies may find it difficult to service debt and hence affect bonds, and interest rates going downwards put cash and money market funds into useless investments.

How do we then allocate our funds and make sure we are not into an all-or-none, boom-or-bust kind of situation?

There are essentially 4 kinds of investments that a simple investor like us will hold over time.

Cash and cash equivalents – CDs, money market, timed deposits etc.
Debt – Fixed duration and fixed income products like bonds bought and held till maturity.
Market Linked – Index Funds, Mutual Funds, ETF, direct stocks, REITs.
Real Estate – Properties (homes and rentals), Private REITs.

The 4 Quadrant approach

The below table shows how these investments fit each quadrant of a time horizon vs. liquidity.

Financial Planning	Liquid	Not Liquid
Short Term	Q1 – Cash and Cash Equivalents	Q2 – Debt (Bonds till maturity, other lending investments)
Long Term	Q3 – Market linked (funds and stocks)	Q4 – Real Estate

For example, cash and debt instruments are typically short term reserves. While cash in savings account is highly liquid, bonds typically have a fixed maturity duration unless they can be traded in the secondary market.

On the contrary, stocks and funds may be liquid but typically yield best results only over the long term, due to short term market volatility. Real Estate is both long term and highly illiquid since it may take months and years before a property investment can yield profit or get sold.

If we allocate our resources with the 4-Quadrant principles in mind, then the short term market volatility or conditions will not bother us much. Each of the Quadrants will have enough invested/saved to go through the current phase.

For example, if I need immediate cash or want to maintain an emergency fund, Q1 is the place. There is no need to panic sell Q2, Q3 or Q4 investments.

Similarly for a medium term (2-4 years), the required funds can be maintained in fixed duration bond products (Q2) matching the maturity to a goal horizon.

At last, stocks and real estate are for the long term (> 10 years) and should be left to grow on their own. We can keep adding to them in a well defined proportion. But we do not need to panic sell them if the Q1 and Q2 are in place.

Simplest Asset Allocation

Another advantage of this approach is automatic asset allocation. Sometimes without realizing we may be overweight in one Quadrant. For example, some people may be just lazy to invest and keep their money lying in savings accounts, hence Q1 heavy.

While others may be so overweight in Stocks and Real Estate that in case of an emergency or reaction to market movements, they may sell or trade unnecessarily and hastily. Worst is premature withdrawal from retirement funds and paying penalty and taxes.

A balanced allocation to each Quadrant based on goals is the right approach.

For example, lets say I have $200,000 net worth. I can allocate the following after estimating my monthly expenses ($3000) and near term goals (Education, buying a house etc.).

Q1 – 6 $3000 = $18,000 in money market fund*	Q2 – $40,000 for a new house in 2 years – Treasury Bond Fund
Q3 – $42,000 in 401-k and Roth IRA	Q4 – $100,000 in present home equity

Lets analyze few scenarios here.

I suddenly lose my job – Assuming it will take 4-6 months to get a new job, I can withdraw from Q1 my monthly expenses and tide over this crisis.
I need to save for a new house in 2 years – I keep saving every month in Q2 and buy investments maturing in about 2 years.
Whether the above events happen or not, the Q3 keeps growing as the funds remain invested in the market. In fact, as long as there is no crisis, I can keep making dollar cost averaged investments every single month into 401-k and Roth IRA accounts.
Q4 is even longer term and can be one’s own personal residence and additional rental properties. If Q1 and Q2 are in place, there should not be any hurry or knee-jerk reaction to sell or lose these valuable assets.

The actual amounts or assets can vary depending on a person’s goals and needs.

Overall this framework will also avoid a person to go into debt unnecessarily. Similarly paying off debt or mortgage can be considered money invested in Q2 and Q4 respectively.

Conclusion

The 4-Q is thus a simple financial planning framework. Sticking to this 4-Q framework and directing one’s monthly investments to the relevant quarter helps build wealth in the long run, as well as take care of short term obligations.

Month: March 2020

Locked down – 5 hurdles to overcome

Social distancing

Losing jobs or income

Investments are tumbling and losing their value

Fear is gripping us

Not building new assets

Conclusion

The 4-Q way of protecting your finances from coronavirus driven volatility

The 4 Quadrant approach

Simplest Asset Allocation

Conclusion