Why Cash Rhymes with Crash

Aaaaand we’re back. As I write this, the ASX 200 is at 5550.

It first crossed that mark back in November of 2006. That’s almost eight years without price gains. For every step forward, there’s a stumble back. Of course, some investors aren’t doing anywhere near as badly. Reinvested dividends sent the ASX 200 Accumulation Index (in red) to new highs back in 2013:

ASX 200 Performance versus the ASX 200 Accumulation index

asx 200

Source: Traderdealer.com.au

More on dividends in a moment. But first, imagine what a boring old term deposit or savings account could’ve done for you over eight years. At say 4% a year, you’d be sitting on a 36% gain (compounding). Without the emotional trauma in the meantime.

Of course, if you decided to sit in cash before the crash, you might’ve invested it once stocks tumbled. You’d be sitting on a pretty decent gain. Not a very big one, mind you. Of the 75% on offer if you timed things perfectly, you might’ve collected half. Which leaves you back at 36%.

So there’s a reason cash rhymes with crash. They go together like love and marriage. It ain’t easy to sit on the sidelines and in one asset class. But it can be a good idea sometimes.

That’s award winning financial advisor Vern Gowdie’s message in his newsletter. Making a case for 100% cash is rather difficult. But he does it well. The risk of a crash in the stock market is high. Vern also adds on other advice from his years as a traditional financial advisor, as well as from his own personal experience trying to teach his daughters about wealth management.

The thing is, staying in cash is an expensive option this time around. Interest rates are very low compared to 2007. Your cash won’t give you that same 36% gain. After inflation, it will give you diddlysquat. And it’s not like you know what will happen to the stock market. If you do, please let me know.

So what if you could get both? A decent return on your savings and an exposure to the stock market? Well, you can. Dividend stocks go up in a bull market. And they pay dividends in a bear market. Many of them even let you reinvest your dividends, which is a good idea in both bull and bear markets. You’re picking up shares that increase in value or picking up shares while they’re cheap.

Last week our new ‘Portfolio Tracker’ system went live…internally. I’m not sure if I’m supposed to tell you about it, but here’s why I bring it up: The positions in The Money for Life Letter Portfolio surged. Of course, they didn’t surge on the market. Everything is selling off at the moment. But the Portfolio Tracker adds in the dividends, which I didn’t keep track of in the old portfolio.

The jump in profits highlighted for me just how powerful dividends are. It’s so easy to forget and be sucked in by the lure of capital gains again. Having dividends automatically added suddenly shows just how powerful they are over time.

But when a crash does come, the pain for investors of all stripes is still there. Sure, you’re collecting dividends. But seeing your shares plummet and potentially hit their stop losses is messy. Emotionally and financially messy.

So what can you do? Vern reckons waiting it out in cash is the best option. That’s fine if you’re willing to forgo the return on dividends and hybrids. But I prefer the Security Ladder solution. It allows you to weather a crash like 2008 until shares have recovered.

So if a crash happens, you just live off your Security Ladder payouts and wait for shares to recover. If there is no crash, you just reinvest the payout. If you maintain a constant staggered set of payouts like this, you will be ready for a crash when it happens.

All investments with a fixed payout on a fixed day are suitable for a Security Ladder strategy.

But what are the chances of this crash happening? Well, a number of crash alarms have started wailing. From politics to economics to financial analysis, it’s difficult to ignore that a lot could go wrong. Not to mention this time of year is historically a bad one for the stock market.

But while it’s OK to set aside some of your capital to try to game events like crashes, I don’t think it is a good overall strategy. Betting on rare events is difficult, even for those who make a living out of it.

A good overall strategy is one that has you protected at any time. And that’s the whole point of the Security Ladder. If you haven’t already, I urge you to build one soon. Doing nothing to protect your stock market wealth is implicitly claiming you know when a crash will happen and will sell out in time.

How to Spend Money

Researchers have known for a while that spending money on experiences as opposed to ‘things’ will make you happier. A go-kart race with your grandchildren beats a painting. A fishing trip beats a new kitchen. A round of golf…well…let’s not get carried away.

But it turns out that some materialistic purchases are less bad than others.

For example, a new fishing rod, tennis racket, wetsuit or musical instrument are a great idea, compared to items you just own for the sake of it. According to psychologists Darwin A. Guevarra and Ryan T. Howell in the Journal of Consumer Psychology, ‘experiential goods’ are an important part of the key to happiness. They allow or enhance the kind of experiences that do make you happy.

Of course, there are few experiential goods better than a financial newsletter. But if you’re weighing up a few purchases in your life, why not consider whether they are ‘experientially’ or materialistically motivated. You might decide to go for a cheaper car and buy a snazzy new snow jacket instead.


Nick Hubble
For Markets and Money

Join Markets and Money on Google+

Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

Leave a Reply

Your email address will not be published. Required fields are marked *

Markets & Money