EngFI2022

22 Jan, 2025

Posts

Small-Cap Stocks In The News

The longer I pay attention the market news the more I realize they just need something to talk about. Since large cap stocks did so well in 2023 and 2024, the media needs to make up the next big thing to sound relevant. I decided to take a quick look at some data.

Lately I’ve been reading how small and mid-cap stocks are poised to do well in 2025. Conventional wisdom says small cap stocks do better over the long run. The logic is they have more room to grow compared to large cap stocks at the cost of volatility.

Ten Year Growth by the Numbers (2015-2024)

I took a look at the S&P 500, Dow, Total market (VTSAX), Mid-cap (S&P 400) and Small-cap (Russel 2000) over the last 10 years.

The S&P wins out with a total return of 197%

VTSAX total market fund returned 183%

The Dow large stock index returned 150%

S&P 400 mid-cap results were 125%

Russel 2000 small-cap returned 94%

But that is not the full story. During Covid the top 3 dropped ~27% while mid and small-caps dropped ~36%. To be fair the small and mid-cap stocks returned to pre-Covid levels a few months quicker. To capitalize on that quicker rebound, one would have to time the market. Most everyone knows that’s a fool’s game. Long term investors would have done best just to sit back and watch with an S&P or total market index fund.

Market Cycles

Has the S&P been on a market cycle high? Could market cycles favor Small and Mid-cap stocks over longer periods than 10 years? This makes me think about Paul Merriman’s “quilt” charts. https://irp.cdn-website.com/6b78c197/dms3rep/multi/%28K%29+Quilt+Charts+%281928-2023%29_Page_02.jpg There have been numerous periods where Small Cap Value has out performed the S&P for 5 years in a row! (40’s, 60’s, 70’s, 2000’s). Looking at the quilt chart one could suggest that small-cap stocks are due for a comeback.

I wish Paul’s chart included a total market fund like VTSAX of FSKAX. The closest we get is his 4-fund portfolio which is 25% each S&P 500, Large-cap value, Small-cap value and Small-cap blend. If you study the quilt chart you will notice the S&P and Small-Cap classes take turns being at the top and bottom of the performance ranking. Further investigation shows Paul’s 4-fund portfolio (A substitute for a Total Market fund?) is always in the middle. Never the best or never the worst.

Conclusion

Considering this data, it appears market cycles exist and the S&P may not stay on top for the next decade. But no one knows! Having both large and small stocks in your portfolio seem to level the ride a bit. It seems that a broad fund like a total market fund just might cover all your bases. In my opinion this is another vote for Total Market funds.

1EngineerOnFire.com

EngFI2022

21 Jan, 2025

Posts

New Year Checkup

The holidays have past and the dust settled. It’s a perfect time to review your financial life and see if everything is in order.

New Year Budget

The foundation of any solid financial plan is a good budget. Take this time to review expenses from last year. Update based on last year’s expenses and any expected increases. Take the opportunity to dial in a bit more accuracy. See more on budgets here: https://www.1engineeronfire.com/wp-admin/post.php?post=306&action=edit

Taxes

Take the time to put your tax documents together. Most documents should be available by the end of January. Consider making any last year IRA contributions if you haven’t met your max. Make the appointment with you tax professional and get forms filed. Early filing may reduce your chances a scam artist will file in your name.

Roth conversions needed to be complete in the year of the conversion. Making a conversion now gives your money time to grow to help offset the tax paid on the conversion. Consider your tax strategy for the new year and be sure your withholdings are in line with your obligations.

Portfolio

This is a great time to confirm your strategy meets your needs. Does your allocation still meet your needs? Consider simplifying by combining accounts, perhaps a new advisor or change in brokerage firm. If you manage your own accounts, is it time to rebalance? Time to automate contributions or if retired withdrawals? Take this opportunity to make the changes you considered throughout the year but didn’t find time to do.

Insurance

For most people insurance is a major line item in their budget. Take this time to review your coverages. Does your home policy have “replacement cost” or “actual cash value” coverage. You want replacement cost if you have a loss. If you haven’t reviewed this policy in some time be sure the coverage amounts are in line with current market prices.

Auto insurance coverage is very competitive and costly. Make sure your liability coverages are in line with your assets. Work with an independent agent to get the best prices. Call your favorite body shop and ask which providers they prefer to work with. These guys know which companies help get you back on the road vs. fight tooth and nail for every penny.

Trust and Estate Planning

If you have minor children, you absolutely need a trust. Don’t risk the state determining the fate of your children. Make this a priority if you have yet to complete a trust.

If you have a trust when was the last time you reviewed it? If you have experienced a change in your life you may need to update. Examples include but not limited to (A new child or grandchild in the family, death or incapacity of a loved one, desire to add or change a charity, etc.). Review and update as necessary.

If you have living parents, do they have a trust? If not have the tough discussions and help them get their affairs in order. Discuss their wishes for medical and financial plans. The effort put in now will save 10-fold the effort if these items are not in place during stressful times.

Charity

We’ve worked hard to secure our financial futures but also need to understand we need to be good stewards and help our fellow man. Planned giving during our time here and leaving a legacy should be a priority. A new year is a great time to review your giving plan. If you have not set up a legacy giving plan in your Trust consider setting it up now. If you are blessed enough to secure your financial future you have the skills to help others.

Simplify

Life is short and the only think we cannot buy is time. Look at ways to simplify your life. If you are working automate investment contributions. If you are retired, automate your withdrawals. Automate you bill paying. Search out other ways to simplify your life. Use this newly found time to spend with friends and family and create memories and experiences!

1EngineerOnFire

EngFI2022

14 Dec, 2024

Posts

Quick Reference Links (Dec 2024)

1EngineerOnFIRE site LINKS to get you started or back on track:

Books on Investing https://www.1engineeronfire.com/?p=232

Web Sights – TBD

Start Investing https://www.1engineeronfire.com/?p=302

You Need a Budget https://www.1engineeronfire.com/?p=306

Talking About Money https://www.1engineeronfire.com/?p=314

Teaching Children About Money https://www.1engineeronfire.com/?p=173

Retirement Withdrawal Strategies https://www.1engineeronfire.com/?p=73

The 4% Rule Summarized https://www.1engineeronfire.com/?p=57

Financial Strategies for Different Life Stages https://www.1engineeronfire.com/?p=312

Finding Your Enough https://www.1engineeronfire.com/?p=384

EngFI2022

28 Nov, 2024

Posts

The year 2024 has proven interesting if nothing else. A return to higher interest rates and better returns in the “income” side of the market. I have always been an equity investor favoring stocks and mutual funds. Now being retired I do have cash reserves in various instruments. Let’s discuss where to store cash.

Cash is relativily easy. You can put it in a safe, your local bank, an online savings, CD or money market account. These options give you liquidity and varing degrees of access. Even with higher rates your local bank is not likely giving up much in interest and still often below 1%.

The highest yeild Online banks are hovering between 4.2% and 4.9% currently (November 2024). These rates will fluxuate with the interest market but the balance is likely FDIC insured. You do give up some access with online banks if you read the fine print it may take 7 days to access your funds.

Money Market funds are currently in line with the online bank returns but you typically need to transfer to cash prior to accessing funds. In a money market fund a fund manager is buying a number of different income type investments trying to get a better yeild. There is no guarantee but since they invest in safe assets there is little risk. The funds are accessible with a sell order and some brokers may let you write checks on the account.

CD’s or Certificate of Deposit. A CD offers a guaranteed rate of return over a specific amount of time with FDIC insurance like a bank account. Rates vary based on the market rate but are locked in at purcahse. The current rate environment has CD’s competing with money market and high yield online bank accounts. CD’s are one of the safest investments and you can build a CD ladder if you need access to cash over time.

A CD ladder is a strategy of buying a number of CD’s with varying maturatity dates. Imagine you wanted to provide a steady cash flow every 6 months. You would buy a 6 month CD, a 12 month, a 18 month etc. That way every 6 months a CD matures and you have access to the cash and interest.

Let’s discuss Bonds. I’ve never been a fan but have been studying. A bond is just a loan to a company or municipality. You get a rate of return (cupon) often paid semi-annually and your principal back at maturity. There is risk, if the company or municipality goes bankrupt, you won’t be paid and that’s where the ratings come in. Credit rating agencys rate bonds for worthyness and therefore risk level.

Bonds can also be sold on the secondary market. If you chose to sell prior to maturity a broker will offer on the market. If newer bond rates have dropped yours is now more valuable and will be worth more. If rates increased no one will want your bond unless it is discounted. The safest bonds are US Treasury bonds. Just buy them and hold to maturity.

As I said in the beginning I’m not a fan of bonds. I never bought a bond until just prior to retirement. I was trying to protect a pool of funds to bridge between my early retirement and age 59 1/2. Well I got caught in one of the rare times both stocks and bonds dropped! Granted the bonds dropped significantly less than my equitys but you never want to loose “safe” money.

So where does all this leave me? My wife and I are both over 59 1/2 so we have penality free access to all accounts https://www.1engineeronfire.com/wp-admin/post.php?post=366&action=edit . If I treat pension money like “income” I’m a 50/50 investor. But just looking at invested capital I still stay 90% stock and 10% cash. This way I can get the high return of the market but have a 3-6 year cash buffer if the market goes South.

This approach takes disipline and perhaps a variable withdrawal strategy https://www.1engineeronfire.com/wp-admin/edit.php?tag=retirement if things get rough in the market. I’ve watched a few black Fridays, a few recessions and the COVID-19 event over my 30+ years of investing. I’m confident I’ll stay the course!

1EngineerOnFIRE

EngFI2022

14 Jun, 2024

Posts

I’ve been retired 4 years now and have enjoyed every minute. My wife and I spend more time doing the things we enjoy. I don’t fret over the stock market but I still enjoy keeping tract.

I have done some more research on withdrawal strategies and it seems options are endless. Two and Three bucket strategies, dividend strategies, annuities, auto withdrawals and endless combinations of anything imaginable!

Ideally one would have enough assets to live off the dividends while the stock continues to grow. This would allow you to leave a legacy and never worry about finances. Unfortunately, this strategy requires a nest-egg value unachievable for many Americans.

I like the idea of drawing down stocks when they are up and cash when stocks are down. But I hate having too much cash on the sidelines. My Fidelity advisor suggested I just set my preferred allocation and draw down my assets proportionally. That seems a bit over simplified for my taste.

My Merrill Lynch advisor takes a more cerebral approach to withdrawals. When I ask for funds, he looks at all my holdings, he then only sells stocks that have had a good run and may be overpriced. He recommends only a year or two worth of cash equivalents for downturns.

Key factors to consider include:

Retirement age, pension payments, social security planning, portfolio amount and risk tolerance.

To avoid overcomplicating the issue you need to know your annual income need. Project that over your upcoming life phases (Go go, slow go, no go years). Subtract the guaranteed income from the total need to find the “gap”. Plan your portfolio withdrawals based on the gap amount for each life phase.

Many people will find their withdrawal rate a bit high (>5%) during early retirement and the go-go years. Dropping the withdrawal rate to something more reasonable (3-4%) during the slow go years and finally a drop to a very sustainable rate later in retirement. I’m ultra conservative on my withdrawals and keep them in the 3% range.

Understanding your likely income need is critical for this planning. Apply a comfortable inflation rate, reasonable rate of return and add consider your risk tolerance then you can feel comfortable with your withdrawals.

If your plan is sound, it really won’t matter the exact withdrawal strategy. You should be confident in your planning to know you will not outlive your money.

1EngineerOnFIRE

EngFI2022

8 Nov, 2023

Posts

HOW MUCH IS ENOUGH?

Do you even know what Your Enough is?

PROBLEM

Here in the US we are driven to succeed often defined by how much stuff or money we have. How big is your house, what type and how many cars, vacations, toys, etc. I propose we may need to redefine success to allow more people to reach it.

I was never one to keep up with the Joneses as I had my own written goals I was trying to meet. I modified those goals over the years and met them all. But now that I’m retired, all that stuff I worked so hard for seems less important. Could it be my goals were misdirected?

I know people who are so focused on money that every decision they make assures they make more. They unknowingly put relationships at risk by prioritizing making or saving a buck! Sure it’s good to be conscious of your spending but you need to be aware of the total cost.

I’ve seen people who live in very nice homes and have very nice things only to become disappointed and ask “What am I doing wrong that I don’t have that?” when they see a bigger home or fancier car, boat, etc. They clearly don’t know their enough!

FINDING YOUR ENOUGH

What I’ve learned is that having goals is a good thing and keeps one motivated. But make sure your goals are in line what makes YOU happy. You need to find your enough early in your planning or you will find yourself forever looking for more.

I’m finding that time with family and friends, new experiences and meeting new people is way more enjoyable than buying another sports car, boat, motorcycle, etc. I just want to get back to the next adventure. Don’t get me wrong I still enjoy my toys but it’s the experience with friends that makes the difference, not who has the newest and best toy. Keeping up with the Joneses is a fools game.

So how do you find Your Enough? It will be different for everyone but look back over the last year or two. List the 2,3,5… things that made you smile the most or things you can’t wait to do again. Those things are what matter most to you. Build your goals around doing those things. Look carefully at what made them special. If it was a camping trip, I bet time around the grill or campfire was more important than what kind of tent or RV you had.

Perhaps we should redefine success with happiness and things that make us smile. Having a secure lifestyle that brings you joy should be the goal.

CONCLUSION

With this concept in mind you can develop a plan to find your enough and be well on your way to achieving Financial Independence.

1EngineerOnFIRE 1engineeronfire.com

EngFI2022

6 Dec, 2022

Posts

INVESTING IN A DOWN MARKET (November 2022)

The year 2022 has been a tough one for the markets. As I write this article the DOW is -6.65% and the S&P is -15.4% YTD. Not catastrophic numbers but not the double-digit positive returns we all hope for. So, what do you do when the market is down. It depends on your stage as an investor. In its simplest form investing can be thought of as having just two stages, accumulation and distribution. Your actions depend on your investment stage.

ACCUMULATION STAGE

Investors in the accumulation stage are working to reach their retirement goal buy regular investing. They will invest 10-15%, or more, in their 401-k, IRAs or brokerage accounts. The most successful investors automate this process with monthly investments in these plans. (See “Picking the Right Investments” here https://www.1engineeronfire.com/?p=363.) The investor can then focus on their careers, family and friends knowing they have a plan to reach their goals.

In a poor market the investor in the accumulation stage is smart to stay fully invested knowing they are buying shares at low prices and the market will eventually return. The confidence of having a long-term plan and automated investing makes it easy to ignore market downturns. The worst thing the investor can do is pull their funds out of the market and wait for things to improve. History shows they will most certainly sell low and buy high. This locks in their losses and they miss the growth opportunity when the market returns. The saying “It’s not timing the market but time in the market” that really counts.

DISTRIBUTION STAGE

Investors in the distribution stage have more to worry about in a declining market. They have reached their goal of retirement and are regularly withdrawing money from their portfolio to provide income. Different withdrawal strategies have advantages in different markets. See my post on common withdrawal strategies here https://www.1engineeronfire.com/?p=73.

If you are fortunate enough to have a portfolio that far exceeds your income needs great! You are probably invested conservatively living off dividends and interest and will never run out of money. In that case a down market is of little concern.

If your portfolio is significant (>25 x annual need) but you would like to preserve your capital you may need to be flexible in down markets by adjusting your withdrawals accordingly. Small changes to your lifestyle, short term, will increase your success rate significantly.

Some financial advisors will use elaborate calculations to design a drawdown strategy that has you running out of money shortly after you die. This is a great sales tool because you set the parameters and assume all the risk. The advisor tells you that you are doing great, just keep investing with them😊. The mathematics behind these calculations are valid but do any of us really know when we will die??? If you retired based on one of these calculations you need to be very, very concerned in a down market. Consider changes to your lifestyle and check in with that advisor to recalculate your withdrawal rate so you don’t run out of money.

The chart below is an example of an advisor run simulation. Each line represents a different study of stock returns based on different possibilities. In this case all of the red lines represent return predictions where the investor is running out of money before predicted death in the year 2045.

CONCLUSION

In a down market the investor in the accumulation stage should just keep on investing. The rewards of buying low are just around the corner.

For the investors in the distribution stage now is the time to pay close attention. Stay informed of your portfolio balance and your withdrawal rate. Make changes to your lifestyle (reduce your withdrawals) if necessary to assure long term success. It’s better to leave a legacy than look for a handout!

What do you think? 1EngineerOnFIRE.com

EngFI2022

21 Sep, 2022

Posts

If you’re paying attention, you know the market goes up and down. And if you’ve been investing a few decades, you know there will be some pretty scary down periods. The good news is most bear markets are followed by some pretty aggressive bull markets.

2022 has been one of those bad market years. Most people have watched all of their 2021 gains disappear and it is only September! What is going on? My time in the market (~35 years) has taught me to look away in bad markets and stay the course. J.L. Collins made an analogy between stocks and beer. My interpretation was, we buy the beer (company) but it comes with some foam (market hype). The foam goes up and down but we really only care about the beer. Don’t get too worried about the foam!

I’m 2+ years in retirement and looking at roughly a 22% drop so far this year (that’s a lot of foam). I retired with a portfolio of mostly stocks (90/10) and had never owned bonds until 6 months before retirement. Then the bond market did something unusual, it dropped with stocks. Something I never observed before. Looking at my portfolio recently I noticed something interesting. My dividend stocks seemed to dip only ~12% when my other holdings fell ~25% while my “safe” bonds dropped 10%. Could it be dividend paying stocks may be a hedge to reduce losses in down markets? Perhaps this is not news to some but as a new retiree I’ve been looking more into income investing and need to learn more.

What else is going on? The Fed is trying to slow inflation with unprecedented rate hikes. And don’t forget it’s mid-term election year. The politicians in power will do everything in their power to make things look good and take credit. Those not in power will blame all things bad on the opponent. Not to worry it’s all in the foam. They are not really hurting the value of the beer!

What am I doing

Since your bonds are traditionally used to stabilize your portfolio in a down market and provide funds for buying during lows, I’ve moved 1/2 of that position back to a low-cost S&P 500 fund. My bond position will now be less than 5%. When prices recover, I’ll consider moving some of my more volatile stock to dividend stock. I currently hold ~28% conservative stock and ~28% aggressive stock with an advisor. The balance is in low-cost stock index funds with a dash of bonds.

I’m still looking for that perfect retirement mix. I still believe the advisor is worth the fee if I make the effort on my side. Besides I’m only paying the advisor fee on a portion of my portfolio and they have faired well against other investments. Once I find my perfect mix and automate my retirement withdrawals, I may go it alone.

What do I recommend?

Accumulation phase – Just keep buying VTSAX or FSROX in an IRA (Roth if you can) after getting the full match in your employer plan. If you have more to invest, do the same in a taxable brokerage account. At least 15% of your gross should be invested without fail. Pay yourself first!

If you are thinking about retirement (5 years or less) take full advantage of your employer match and keep pouring savings into a Roth, standard IRA or brokerage account. Start calculating your “retirement” number and consider adding a buffer for a market downturn in early retirement. Read Wes Moss’s book “You Can Retire Sooner Than You Think” and start preparing to be a happy retiree now!

Retired – It’s important to balance your withdrawals with your budget and use the principals of the 4% rule to fit your circumstance. As an early retiree and if your withdrawals approach 4% consider reducing your lifestyle until market conditions improve. If you did a great job planning and withdrawals are below 4% enjoy retirement as planned, you deserve it!

Conclusion

Considering this year’s events what should we be thinking? Markets go up and down and it’s mostly just the foam on top of the beer. If you are in the accumulation phase, just keep buying when stocks prices are down. If you are thinking about retiring be aware that markets can fall and having a buffer above your needs can help protect your retirement from market decline. If anything, 2022 has taught us that even bonds can be unpredictable. Strong dividend providing companies may offer some protection from market drops. Always remember it’s not timing the market but time in the market that counts.

1EngineerOnFIRE 21Sep2022

EngFI2022

2 Aug, 2022

Posts

So far 2022 has been a rough year for the markets. I can now say determining “my retirement number” and adding 40% was a good bet!

The last 2 quarters have seen market drops. My strategy has always been to look away when the market is down and stay the course. My current withdrawal rate has inched up into the 3% range. If I had retired at “my number” I would be looking at withdrawals of over 4% or making cuts to my living expenses.

The added 40% has allowed me to confidently continue our lifestyle after this latest market downturn.

If the market drops another 20% I will simply stop withdrawals for discretionary spending. Things like travel, cars, home projects and my slush fund to keep it invested while the market is down. This is my plan if my withdrawal rate approaches a 4% withdrawal rate.

One thing I noted is that the dividend stocks have held up well in the downturn compared to the other classes. I may consider this as a variation of the all in on index fund recommendation.

1EngineerOnFIRE.com

EngFI2022

15 Jun, 2022

Posts

How do you take advantage of tax-free investment growth if you don’t have an employer plan? Look to the Individual Retirement Account (IRA).

Many people have heard of or have an IRA account but the differences between Roth and standard accounts are sometimes misunderstood. I’ll try to clarify the basic differences and discuss the advantages and disadvantages of each account.

Tax Free Growth

The greatest advantage of both accounts is tax free growth. All funds placed in the accounts are allowed to grow tax free. Any growth of principle is not subject to taxation. This is a huge advantage for long-term investing as 100% of growth is added to the principle further compounding your investment dollars.

Example: $10,000 invested in a taxable account (standard brokerage account) would grow to $17,164 in 10 years (7% growth and 22% tax rate). Where in an IRA that same $10,000 would grow to $19,180. That $2,816 doesn’t seem huge but when your $10,000 becomes $1 Million that $281,000 difference gets your attention.

Standard IRA Tax Free Contributions

When you invest in a standard IRA your contribution is pre-tax. Your income in the eyes of the IRS is reduced by the amount of the contribution. This is a benefit for high earners planning to stay in a lower tax bracket. Your contribution and earnings grow tax free. The downside is you have to pay tax on the contribution and growth when you withdrawal in retirement. By age 70 (72 for younger savers) the IRS will ask you to make minimum withdrawals per a Required Minimum Distribution (RMD) schedule.

Additionally, there is a 10% penalty for withdrawals prior to age 59 ½ with a few, often misunderstood exceptions. Other than a few special circumstances you can make (SEPP) withdrawals without penalties prior to age 59 1/2. Contribution limits for 2022 apply of $6,000 ($7,000 if over 50) and are subject to employer plan availability and income rules. Non-deductible contributions are allowed for people who don’t qualify due to employer plans and high income. See the latest Tax code for details.

Roth IRA

When you invest in a Roth IRA your contribution is post-tax. Your contribution and earnings grow tax free. After 5 years your contributions are available for withdrawals penalty free but that should be reserved only for emergencies. Since you paid tax on the contributions there is no tax on withdrawals. There is a 10% penalty on withdrawals of any growth prior to age 59 ½. There is no RMD requirement since the IRS taxed your contributions.

Current 2022 tax law allows for a Roth conversion from a standard IRA but taxes are due in the year of the conversion. Contribution limits for 2022 apply of $6,000 ($7,000 if over 50) and are subject to income limits on a phased-out basis. Again, see the IRS code for up-to-date details.

What Should You Do?

Successful investors with an employer plan should first contribute at least enough to receive full employer matching funds. If the employer fund has good investment choices, like low fee index funds (S&P or similar), I recommend maxing out the employer plan. If choices are not the best due to poor fund selection or high fees then max out your Roth IRA. After meeting those criteria contribute to your traditional IRA. Any further investing can be done in a standard investment brokerage account.

I don’t recommend picking individual stocks but if you must, only do so with no more than 10% of your portfolio. See my post on picking investments https://www.1engineeronfire.com/?p=363

Conclusion

You don’t need an employer plan to take advantage of an IRA account
Tax free growth is a key advantage of both standard and Roth IRA accounts
Penalty free withdrawals on funds after 59 ½
Some withdrawal flexibility exists but you must follow the rules to avoid penalty

1EngineerOnFIRE

Was this helpful? Please leave a comment.