Ben Carlson has a great post that shows what returns for emerging markets are like after a 20% decline. You can read his full post here.

Actually, his post shouldn’t come as a surprise to anyone who’s sufficiently well-grounded in fundamental investing. Investing is a discipline. You buy when things are cheap and sell/reduce buying when things get expensive.

I wrote about having a plan back in July although I didn’t really go into any details about my plan. Right now, the STI is down roughly 10% and, as of last month’s close, the PE10 is 13.43x — not expensive but nowhere near a level that screams “bargain!”.

What A Plan Looks Like

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Fail to plan and you plan to fail, said some wise person

Broadly, I think anyone’s investment plan needs to cover a few areas:

  1. Objectives
  2. Asset Allocation
  3. Criteria for Rebalancing

1. Objectives

This is probably the most important area as it determines what assets one should be invested in. If one has a longer time horizon (for example, 5 years or more), then one can safely allocate a higher proportion to equities.

Personally, I don’t believe in the traditional financial advisors’ perspective of accumulation and deccumulation. This would basically mean saving and investing lots while you’re young and working and then drawing down on that accumulated sum until the day you die. Of course, they also consider what the amount of bequest in the drawdown.

My personal plan is to accumulate and let this sum snowball to infinity. Of course, at some point, I will start to draw on the sum for my expenses but that amount should be minimal relative to the accumulated sum and the rate of return on that sum. That way, the sum will be able to grow infinitely.

As an example, if my portfolio is $100,000, then my expenses will be no more than 3% of the portfolio. I’m quite confident that the portfolio should grow at a rate more than 3% p.a. which means that I should not have to worry about inflation or ever running out of money.

The main concern with that objective is dealing with a fall in portfolio value. I’m still working this out but off the top of my head, I think basing the 3% withdrawal on a smoothed value of the portfolio and the asset allocation plan should work well enough. For example, if the portfolio value over the last three years has been: $100,000, $110,000 and $80,000, then the withdrawal of 3% will be based on a portfolio value of $96,666. This should allow for excess withdrawals if the portfolio runs up too much and should mitigate drawing too little for expenses when portfolio values crash.

2. Asset Allocation

Which brings me to area 2.

Having too little in stocks will kill returns while having too much will probably cause liquidity problems. For those with long time horizons, I suspect anything more than an 80/20 stock/bond portfolio is too little in stocks.

The stock portion can be further sub-divided into local equities, foreign equities and something like REITs. Remember that correlations tend to move to one when markets crash so don’t worry about trying to own 100 different stocks. It’s futile. As long as you have the major bases covered, like not being all in banking or oil & gas stocks, you’ll be fine.

For the “bond” portion, it can be subdivided among bonds of different maturities and segments (like treasuries or corporate). I would even have a portion of it in cash. This is the buffer when your portfolio tanks due to market crashes.

Whatever you end up with, please make sure that the bulk of your portfolio isn’t made up of non-productive assets like gold or worse still, cryptocurrency. You can have gold coins if you think you’ll ever need to escape your country in a boat and start over anew in some other country but if that’s what most of your wealth is in, then you might as well buy a doomsday shelter.

3. Rebalancing

Area 3 is important because this is where you prevent yourself from buying when things get too expensive and selling when things get cheap. It’s only human to feel like giving up when you see the market crashing and buying when you see everyone else getting outsized returns.

I firmly believe that you need certain rules to prevent yourself from doing harm to yourself. A simple rule could be that you buy into the market only when the market’s dividend yield is above x%. Or you only buy into the market when the current price is below its 200-day moving average. Or, you’ll only buy when the PE10 is below 15x.

Of course, the problem with all these criteria is that they will all be quite arbitrary and not all of it will give you the same signal at the same time. For example, if you were looking to invest in the S&P 500 and your criteria was buying only if the PE10 is below 15x, you would have stayed out of the market for many, many years. You would have avoided the dot-com bubble and the Global Financial Crisis but you would also have missed the run-up in the markets and it’s associated return for many, many years. I don’t think anyone can live with a criteria that doesn’t flash for years and not question the validity of the criteria.

Personally, I would have 3 or 4 criteria and divide the amount of excess “gunpowder” I have into 3 or 4 portions. When it’s time to rebalance your portfolio, each fulfilled criteria would allow me to invest one portion back into the target asset class.

For example, after letting my dividends and savings accumulate in the portfolio, I have $30,000 to invest in stocks. If I have 3 criteria, I would invest $10,000 for each met criteria in stocks according to the proportions decided in my asset allocation.

Parting Thoughts

The CFA Level 3 syllabus has a fantastic and comprehensive section on investment plans which I remember studying for and honestly, this is much, much simpler than what they taught in the CFA syllabus. However, I think what I’ve outlined is much easier to follow and will get you the results  you need.

Feel free to leave your thoughts in the comments below.