COVID Force You Into Retirement? 3 Ways to Make the Most of It

This first appeared on Money & Markets.

Retiring is a little like having children. If you wait for the right time, it will never happen.

I say this as I have two children of my own with a third on the way shortly.

The middle of a pandemic-related recession isn’t an ideal time to be growing a family. It’s also not the best time to retire, but you may not have a choice in the matter. A lot of people have been forced to retire early due to the rough economy we’re in.

So here’s some advice to the recently retired. This is less a specific action plan than a collection of general guidelines. But hopefully this will help you get a little more prepared for your life in retirement than I am for the arrival of my baby girl!

Growth is Important, But Safety is MORE Important in Retirement

You’ve seen the statistics. The stock market “always” returns 8% to 10% per year over time. Or at least that’s been the case for the decades.

But even if we take these numbers at face value, the timing of those returns matter. Over a 30-year horizon, you might enjoy returns in that 8% to 10% range. But you’re going to get some nasty bear markets along the way.

That’s normally not a problem. If you’re taking something like 4% to 5% distributions from your portfolio each year, you have plenty of cushion. But if you hit one of those bear markets right at the beginning of your retirement, it can wreck your plans.

Here’s an example. Let’s say you had the great timing of retiring the day the 1990s tech bubble burst and that you had your entire portfolio in the S&P 500. You took normal 4% withdrawals to fund your retirement.

10 years into your retirement, you would have lost more than two thirds of your nest egg.

So, if you’re recently retired, do not put your entire portfolio into the stock market. I know bond yields are terrible today. I get that. But taking too much risk early in retirement isn’t worth it.

Don’t Chase Yield

I’ve always been a sucker for a high dividend yield. But this is another area where you  need to be careful. Divide the current annual dividend by the stock price to find the dividend yield. The yield can be high for one of two reasons:

  • Either the dividend is exceptionally high.
  • Or the stock price is exceptionally low.

More often than not, the yield is high because the stock price is low… and it’s low for a reason. Some of the highest-yielding stocks are often companies with serious financial problems at risk of cutting their dividends.

This doesn’t mean you have to avoid all high yielders. As I wrote recently, I think REITs, business development companies, pipelines and other high-yield stocks have a place in a portfolio. Just be smart about it, and make sure you’re not overconcentrated. My general rule of thumb is that no single stock should be more than about 5% of a portfolio. And no single sector or strategy should be more than 20%.

Get a Hobby

This last recommendation isn’t financial, but it’s important nonetheless, particularly for men. Various studies have shown that men who retire early tend to die younger. We can theorize as to why this happens, but I think it’s because men lose their sense of purpose without a job.

So find a healthy hobby. I’m nowhere near retirement (I have a new baby to feed…), but I’ve taken up gardening. It helps me clear my mind. And I really enjoy seeing the results. I’m also learning basic carpentry to fix all  the little things around the house my children break.

Maybe your thing is fishing… or playing the drums… or building adult-sized Lego sets. It doesn’t matter. Just be sure you find something that keeps you active and healthy… Also make sure it doesn’t involve watching 24-hour cable news. No matter what your political persuasion, watching the news is bad for your mental health.

Now, if you’ll excuse me, I need to finish assembling a crib.

43% of Your Portfolio in a Single Stock?

I mentioned earlier this week that Warren Buffett was on the hunt for investments again, dropping $10 billion on Dominion Energy’s pipeline assets.

Well, Mr. Buffett was in the news again. MarketWatch reported he had fully 43% in a single stock — Apple (AAPL).

There are a couple of caveats.

To start, we’re talking about Berkshire Hathaway’s portfolio of public stocks. Much of its capital is tied up in private businesses and insurance operations.

So the “real” allocation to Apple is a lot smaller. At today’s prices, Buffett’s Apple investment accounts for about 21% of Berkshire Hathaway.

But 21% is still a big number. And it brings diversification into the spotlight.

Warren Buffett has said that “diversification is protection against ignorance. It makes little sense if you know what you are doing.”

That’s true. As investors, we diversify to protect ourselves from the unknown.

But the “correct” amount to invest in any single position depends on a couple of factors.

Short-Term or Long-Term Diversification

Conventional wisdom says that short-term trading is riskier than long-term investing.

But I disagree. Short-term trading can be a lot less risky.

If you trade in and out of a stock, you’re not likely to ride it all the way to zero. But if you’re a passive buy-and-hold investor — you just might.

For a long-term buy-and-hold position, I put a cap at 5% of the total portfolio. That assures diversification.

If a stock does really well and grows to a larger percentage, I might let it run for a while.

But I’m comfortable investing 3% to 5% of my portfolio in a single stock for a long time.

Here’s how this could play out.

If a 5% position gets cut in half, you’ve lost 2.5% of your total portfolio. In a $100,000 portfolio, you’ve lost $2,500. We can recover from that.

Using a short-term trading strategy with hard and fast rules telling you when to enter and exit means you can put more of your money into a trade.

But be smart. You don’t want to make a massive trade right before the company releases quarterly earnings, and get caught with your pants down.

Investing more than 10% in a single stock is OK if you use good risk management and keep a close eye on the position.

How Big is the Stock?

Apple is one of the largest companies in the world. It has an army of analysts watching its every move.

Taking a large, outsized position in a stock Apple’s size isn’t crazy. Apple makes up about 6% of the S&P 500, for crying out loud.

If you own shares of an S&P 500 index fund, you have a concentrated positon in Apple — whether you wanted it or not.

But think about a small-cap biotech or cannabis stock. Do you really want to invest a large chunk of your net worth in something speculative that could go out of business tomorrow?

Use the example of another successful investor: Ray Dalio of Bridgewater fame.

He popularized the concept of “risk parity.” In a nutshell, it means you should base the size of a position on its risk. The riskier a position, the smaller it should be. The less risky, the larger it should be.

Through this lens, Buffett isn’t crazy to overload his portfolio in Apple.

If you’re going to have an outsized position, it’s better to do it in something large and, relatively speaking, safe.

In the end, even those of us who know what we’re doing would be wise to diversify. It’s protection against ignorance.

And, frankly, as passive investors without a seat on the board of directors, we’re all a little ignorant.

Charles Lewis Sizemore, CFA is the principal of Sizemore Capital Management, an RIA based in Dallas, Texas.

Warren Buffett Is Buying Pipelines. Should You?

Well, it finally happened.

Warren Buffett put some of his massive cash hoard to work. He spent nearly $10 billion buying Dominion Energy’s natural gas pipelines and storage assets.

Berkshire Hathaway, Buffett’s holding company, agreed to a $4 billion purchase of Dominion’s natural gas assets. It took on another $5.7 billion in the company’s debt.

Given the Oracle of Omaha’s reluctance to buy anything these days, this is making headlines. It marks his first significant purchase since the COVID-19 outbreak started. It’s his largest acquisition since his 2016 purchase of aerospace company Precision Castparts.

The financial press pores over every move Buffett makes — and picks each one apart for clues.

So, today, we’re playing Monday morning quarterback (technically Tuesday morning, I suppose).

We can glean insights from Buffett’s latest buy.

It Wasn’t THAT Much Money — to Buffett

Sure, $10 billion sounds like a lot of money.

But Berkshire Hathaway had over $137 billion in cash on its balance sheet as of last quarter.

And Warren Buffett’s big bets dwarf $10 billion.

He spent $37 billion on Precision Castparts and $44 billion to buy railroad Burlington Northern Santa Fe.

Look at his public stock portfolio. His stake in Apple (AAPL) is worth about $62 billion. He has nearly $20 billion each in Bank of America (BAC) and Coca-Cola (KO).

So, taken alone, we shouldn’t draw major conclusions that Buffett is “betting big” on energy infrastructure. But it’s an interesting buy for a couple of reasons.

All About Moats

Warren Buffett has said for years that he likes businesses with “moats” that protect them from competition. For example, it’s hard to compete with Coca-Cola in soft drinks. Building the size, scale and brand recognition are just about impossible.

Natural gas pipelines are anonymous metal tubes. There’s not a lot of branding there. But they do have competitive moats.

Getting permission to build a pipeline is tough these days due to environmental protests and government pushback. That makes the position of existing pipelines stronger.

And pipelines are natural monopolies. Once a pipeline serves a given area, it doesn’t make sense to build more.

Our economy gets greener with every passing day. But the natural gas in these pipelines is part of that greening process. It burns cleaner than coal and petroleum.

Wind and solar energy will make up a bigger slice of the pie. But natural gas will be with us for the foreseeable future.

Be Greedy When Others Are Fearful

Warren Buffett is a natural contrarian. In his own words, the secret of his success is to be greedy when others are fearful and fearful when others are greedy.

Well, most investors are terrified today of pipeline stocks:

  • The sector has been under pressure since 2015.
  • It’s unpopular with younger investors.
  • And it’s under constant attack from political opponents.

This is precisely the kind of setup a value investor lives for.

I don’t have $10 billion to plow into cheap pipelines these days, and I’m betting you don’t either. But the good news is that we don’t have to.

Some of the largest pipeline operators, such as Enterprise Products Partners (EPD), trade today at prices first seen a decade ago.

We’ll watch to see if Mr. Buffett follows his pipeline purchase with bigger investments in public pipeline stocks.

When to Take a Loss

Comedian and newspaper columnist Will Rogers had the stock market figured out a century ago: “If it don’t go up, don’t buy it.”

Alas, not every stock is a winner. Some are going to bomb on you, and knowing when to take a loss on stocks is a critically important part of investing.

Take a look at the chart below. As you can see, gains and losses are not equal. After taking a loss on stocks, you have to gain back more in percentage terms in order to break even.

Portfolio LossGain Required to Break Even
-10%11%
-20%25%
-30%43%
-40%67%
-50%100%
-60%150%
-70%233%
-80%400%
-90%900%
-97%3233%

If you lose 10% to 20% in a trade, it’s not that hard to recover. It only takes 11% to 25% to get back to where you started.

But if you lose 50%, you need 100% returns to get back to break even. Or if you lose 97% — as you easily could in a risky trade gone wrong — you’d need a ridiculous 3,233% on your next trade just to get back to zero.

I like to think I’m a decent investor. But I don’t have a lot of 3,233% trades swirling around in my head.

Knowing When to Take a Loss on Stocks

OK, we’ve established why knowing when to take a loss on stocks is important. You don’t want to dig yourself into a hole you can’t reasonably trade your way out of.

But how, exactly, do you do it? Let’s go over two ways.

Position Sizing

Probably the single most important tool in keeping your losses under control is position sizing. I could write for days about the “correct” way to size a position and never fully cover the topic.

But I can summarize it here in a few words: The riskier the position, the smaller it should be. The safer the position, the larger it should be.

It really is that simple.

Let’s say you put 1% of your net worth into a risky options play. If it blows up in your face, it’s not going to wreck your finances. But if you put half your net worth into it and it blows up… you just permanently reduced your net worth.

So always be smart about position sizing, and never overweight your position on a risky bet.

Stop Loss Orders

A stop loss is a rule to automatically sell if a stock you own drops below a certain point. For example, you could have a stop loss in Apple Inc. (Nasdaq: AAPL) at $350. If the stock price falls below that price, you walk away. You don’t hold out and hope for a recovery.

Brokerage apps like Robinhood let you put a stop loss sell order on all of your stocks. That way you don’t have to watch them closely if you don’t want to, or if you go on vacation or something.

Stop losses are controversial. As a general rule, I’m a fan because they prevent small losses from snowballing into larger ones.

Of course, the downside is that you won’t get to participate in any recovery. Let’s say Apple drops to $350 before immediately turning around and soaring to $400. Well, you just missed all that upside.

The decision to use a stop loss goes hand in hand with position sizing and knowing when to take a loss on stocks. If you keep your position sizes small, a stop loss is far less important. A small position isn’t going to blow up your portfolio if it goes south.

But in a larger position, a stop loss is a great idea. If a stock or fund makes up a large portion of your portfolio, you need to make sure you don’t take losses that you will never recover from.

There is a science to setting the perfect stop loss, and I’ll get into that more in a later piece. But as a general rule, you should set your stops at points that are just below a “normal” trading range for that particular stock.

That’s the essence of knowing when and how best to take a loss on stocks. You should look to sell when something has fundamentally changed and get out before it’s too late.

Charles Lewis Sizemore, CFA is the principal of Sizemore Capital Management, a registered investment adviser based in Dallas, Texas.

What To Do When Your Employer Cuts Your 401k Matching

The following first appeared on Money & Markets.

It’s rough out there. With much of America still closed due to the COVID-19 pandemic, the unemployment rate is the highest it’s been since the Great Depression. But even many Americans that still have jobs are seeing pay and benefit cuts.

401k matching is often one of the first things on the chopping block, and the 401k matching rules are clear. Unless the matching is part of a union contract, companies have the right to slash or eliminate matching, even mid year. This applies to both traditional 01k plans and the safe harbor 401k plans more popular with small businesses.

Reducing or eliminating the employer matching isn’t particularly popular, but it’s a lot less potentially unpopular than mass firings or pay cuts.

What Are the 401k Matching Rules?

If you work for a large company, matching is almost always completely at the discretion of the employer. They have absolutely no obligation to match. They do, however, have a ton of 401k matching rules concerning nondiscrimination. Essentially, they can’t match for the executives but not for the rank and file workers. They can eliminate matching so long as they do it for everyone.

Smaller businesses often offer safe harbor 401k plans, which avoid the nondiscrimination testing but come with their own set of 401k matching rules.  As a general rule, employers have to offer a dollar for dollar 3% match and a 50% match on the next 2%, or they can offer a flat 3% nonelective contribution irrespective of employee deferrals. (In other words, they “match” you even if you don’t contribute.)

But even here, the employer can suspend matching if the company is operating at a loss, provided they give 30-day notice and follow the “top heavy” requirements that prevent too much of the plans benefits from going to the executives.

What Should You Do If You Employer Quits Matching?

If your employer has eliminated matching for the year, you might be tempted to say screw it and quit contributing to your plan.

Well, if you’re in a financial bind due to the pandemic, that might be your best move. If you’re having a hard time paying your mortgage or putting food on the table, the retirement plan clearly isn’t your top priority.

That said, assuming your finances are stable, you should continue to plow every nickel you can into your 401k plan. In 2020, the contribution limit is $19,500 or $26,000 if you’re over 50. That’s your goal, with or without matching.

I’ll spare you the tired old lecture about how the stock market “always” rises over time. “Always” only holds true if your investment time horizon is 30 years or more. My reasoning here has nothing to do with the stock market.

It comes down to taxes. Every dollar you put into your 401k plan is a dollar the IRS can’t get its grubby hands on.

Let’s say you’re in the 32% tax bracket. You effectively earn a 32% “return” on the tax break alone, even if you leave the cash in your plan’s stable value fund essentially earning nothing. And that cash remains available to invest tax free for the rest of your working life. So, if you’re reluctant to chase the market higher here, that’s fine. You can still get the money into the plan, enjoy the tax break, and then just bide your time until there’s a pullback.

All of this would be true whether your employer matched you generously or didn’t match you at all.

So, if you’re employer had to cut back on your plans matching this year, don’t throw out the baby with the bathwater. It still makes sense to save as much as possible in your 401k plan.