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We’ve gotten a handful of calls recently about what to do with “money earning nothing at the bank”. In this week’s episode, the guys, joined by Casey, discuss the role of savings in a financial plan, as well as what to do when markets are moving sideways, and how “average returns” are usually anything but in the short term.
Show Notes
Why Demand for Fed’s Reverse Repo Facility Are Surging Again
Check out our thoughts on potentially misleading financial news headlines here!
Disclaimer: Tom Mullooly is an investment advisor representative with Mullooly Asset Management. All opinions expressed by Tom and his podcast guests are solely their own opinions and do not necessarily reflect the opinions of Mullooly Asset Management. This podcast is for informational purposes only, and should not be relied upon as a basis for investment decisions. Clients of Mullooly Asset Management may maintain positions in securities discussed in this podcast.
The Price You Pay For Safety – Transcript
Casey Mullooly: Welcome to the Mullooly Asset podcast. This is episode 357, 357. This is Casey Mullooly filling in for Tim this week. Tim is in crunch time studying for the CFP exam. So I will be with you for the next couple of weeks. I’m also here with Tom Mullooly.
Tom Mullooly: Good morning.
Casey Mullooly: And Brendan Mullooly, the usual suspects.
Brendan M: Yeah. Happy to have you, Case.
Casey Mullooly: Happy to be here. Hope I can fill in swimmingly for Tim. All right, let’s get right into it.
Tom Mullooly: Before you had walked out yesterday, you had a little hesitation talking about reverse repo.
Casey Mullooly: I’ve got nothing valuable to add to that topic. What’s a higher level thing that we could pull out of that?
Tom Mullooly: I think there’s things-
Brendan M: Don’t let somebody use that as the boogeyman, just because you don’t understand it. It’s not a reason to change your investments. I don’t know. I’ve read it and I comprehend it, but I don’t know what an individual investor is supposed to do with their portfolio if they’re concerned about that or if they’re bullish because of that. I mean, I’m not sure that that should really be factoring into what anybody is doing, but people tend to lord topics like that over folks and scare them with it. And it sounds scary because it sounds sophisticated and it’s like, wow, this person really knows what they’re talking about. I better listen to them. And I just, I don’t like that.
Casey Mullooly: Yeah. That’s exactly why I was hesitant to talk about it because I was like, it’s really digging into the weeds of what the Fed does and what the whole financial system. And it’s like, all right, well what’s the takeaway for our clients, our listeners? And I was struggling to find one because I don’t think there is one.
Tom Mullooly: Yeah, I think that there’s a lot of reasons why banks are now banking with the Fed after not doing anything for months and months. And all of a sudden this volume has totally exploded in the last couple of weeks. I read three separate articles last night in preparation for this that had three separate reasons why and three totally different outcomes. So I think, as we’ve all discovered, that market participants, whether they’re individual investors or people talking on TV, are going to latch on to some story as the reason for their future agenda. Like, this is what’s going to happen to the market because this is setting up for doomsday or this is going to clear the path for something really good to happen. Who knows?
Brendan Mullooly: This just seems like the kind of narrative that an end the Fed gold bug person would latch onto to say this whole thing’s a scam. See, it’s coming down. The Fed’s just propping up the banks. And it’s not even banks that are doing this. It looked like it was money market mutual funds, which of course are attached to the banking system, but this isn’t … I’m not sure it’s as dire as definitely some zero hedge types would make it out to be.
Tom Mullooly: Sure. There’s a lot of plumbing that goes on behind the scenes that most market participants aren’t even aware of. I mean, for goodness sakes, how many calls did we get this year about wash sale rules?
Casey Mullooly: Really? I mean, that’s pretty basic.
Tom Mullooly: But there’s a lot of people that want to use this narrative to say, “Hey, did you know that there was a rule set in 2018 that the Fed can only keep 135 billion in cash and they’ve got like 3.8 trillion, and so now they’re just buying T-Bills and paying people in cash instead of rolling them over.” That was just one of the narratives that I had read in preparation for this.
Casey Mullooly: I guess one of the takeaways that I had was, and I know that we’ve gotten this call a couple of times now with regular savings accounts not earning any interest for folks. And they call us and be like, “Oh, well what can we do? I have 50 grand sitting in the bank earning nothing. What should I do about that?”
Tom Mullooly: One of the things that I’ve gotten used to saying lately is that’s the price you pay for safety. I don’t discount that. I mean, you have to have some portion of your asset base in ready cash. That’s just the way it is.
Brendan Mullooly: I don’t think the amount of cash that you hold should be dictated by the interest rate that you’re earning on it. That’s a bonus, or in this case a penalty, but everybody has cash that they need to hold. So that needs to be there regardless of whether it’s earning 0% or two and a quarter percent, like it was for a six months stretch in 2018 or 2019. Sure, that was great when it was happening, but at the end of the day, it’s two separate things. And I think that cash needs to be there regardless of what’s being paid out on it.
Casey Mullooly: Right. I think what people don’t maybe realize is that they’re putting it at risk, and that’s-
Tom Mullooly: Probably not what they had in mind.
Brendan M: Right, exactly.
Brendan M: Sometimes I think the question is, the way that it’s phrased makes it seem like the person’s really upset about the cash being at the bank. But I think sometimes it gets brought up because they expect us to be like, “Oh my God, you’re not maximizing that money? You’re a fool. Let me tell you what you should be doing instead.” And in reality, it’s just affirmation that they’re doing the right thing. And if there is a mistake, it’s just that the amount there is maybe not right-sized. So we, again, just discuss things like, what is this money for? Why is it there in the first place? What are the alternatives? Are any of these palatable? And in a lot of cases, the answer is no, and it’s like, all right, well then the money is going to stay at the bank, and you can rest assured that we’re stamping our approval on that saying that that’s the right thing for you to do in this situation, even in spite of the interest rate you’re earning.
Tom Mullooly: I can just share this anecdote. It was about a year ago, sitting down with leadership of an organization who does business with us. I had suggested that they take a certain portion of money, in this case, it was $300,000, and put it into short-term T-Bills, and they’re going to earn relatively nothing on this money. And the question came back, well, why wouldn’t we invest it? Why wouldn’t we put it into the market? And I only had to dial back about 60 days to show them that, hey, if we needed this money in a pinch, and we almost did in February and March of 2020, it would have been 30 or 35% less than what’s there now. And so I say it, and it sounds harsh that this is the price you pay for safety, but it’s the cost of keeping that money safe because when you need it, you really need it. You can’t wait for the market to come back.
Tom Mullooly: You can’t be patient if you have a cash need immediately, and you’re going to wind up doing something that you’re probably going to regret, selling some investments at terrible prices, just to have a little bit of safety. Have the safety now.
Casey Mullooly: Right. Stocks don’t only go up. That’s not how this works at all.
Tom Mullooly: Wait, wait, wait. Is that true?
Casey Mullooly: Yeah. Sorry to break the news to you guys, but stocks go down almost as much as they go up. Let’s get grounded here and deal with reality.
Tom Mullooly: I also think, and maybe you guys will agree, that there are long stretches of time in normal markets where markets do nothing.
Casey Mullooly: Yeah. We’ve kind of seen a period here since the beginning of April where we’re just been trading in a band. So what has your guys’ experience been in a market like this where we’re not really heading in either direction?
Brendan M: Sometimes it’s tough to tell that you’re in one of those periods of time. So maybe not fully realizing we’re there yet, but I know we had a period of time from the beginning of 2015 through the summer of 2016, almost a year and a half where the S&P 500 was flat. We were up during that stretch. We had multiple 10 plus percent corrections, and that was just in the large cap names. We had small cap stocks down 20, 30% during that stretch of time.
Tom Mullooly: Just for the listeners, Brendan is just letting that roll off his back, but you know what, that was painful. 25, 30% drops in some of these small cap names. I mean, some of these positions were getting destroyed.
Brendan M: Right. The energy sector was down more than 75% during that period of time, and that affected high yield bonds. The spreads on those got totally blown out. So you had people, that was when that Third Ave Credit Fund got absolutely blown to bits. So you had these weird things going on in the market and you looked at the headline indices and you were like, “All right. Why is my portfolio doing so much worse?” And it’s like, well the large cap stocks are only down a little bit during this period of time, but other things are getting wrecked.
Tom Mullooly: That particular time, Brendan, was a chain reaction in the sense that we saw oil go, Casey, you were charting this, it went from 100 down to about 25 or 30 bucks.
Brendan M: I was going to say 19.
Tom Mullooly: Yeah. The impact that that had on all those frackers and the drillers were that these small cap stocks, where you’ll find a lot of energy names started really getting hammered. And then what also happened was they couldn’t come through on their loan payments. So all of these regional banks and local banks started taking it on the chin because they were going to have all these loan defaults, and things just really started snowballing. So we saw oil go down, small caps go down, banks go down. And it was just a big snowball taking more and more different parts of the market with it. Now, I don’t think people sometimes connect the dots when they’re looking at, okay, what happens when oil is going up or going down, or what happens when interest rates are going up and going down? What is that going to mean to my investment? Why did technology start taking it on the chin earlier this year when interest rates were going up? They don’t even seem like they’re connected.
Brendan M: They may not be. It may just be this period of time that makes them seem like they’re connected. So, I’m not sure that they are. I don’t agree with that sentiment. So you have these periods of time where the market goes sideways, but depending on your vantage point, in terms of where you were at along that year and a half, you could have been up, you could have been down pretty significantly, but you reached June of 2016, and if you looked back, it was no progress for 18 months, more or less. And I think that’s just something that you have to be prepared to deal with as an investor. If we had connected the dots and said, “All right, energy is going to start going down,” and connected all those dots that eventually ended up happening. It’s not as if there was something to do to your portfolio as somebody who is investing on a basis longer than like the next couple of months.
Tom Mullooly: Oh my goodness, [crosstalk 00:11:56].
Brendan M: It was like, just hang tight and make sure you’re taking the appropriate amount of risk, and understand that you’re not promised anything over a year, a year and a half, two years. I mean over longer periods of time, we put money to work because we expect to be rewarded for that and to have more money to do things in the future, that will cost more in the future. But over short timeframes, I mean, you’re going to have to be okay with the fact that sometimes you’re going to look back months or a year or two, and there may be no progress. That’s par for the course.
Tom Mullooly: And I think that looking back, I’m going to botch these numbers, but we came out of a period where I’m not even going to get into 2008 or ’09, but in 2011, the market kind of went sideways, 2012, the market good. 2013, fantastic. I mean, probably one of-
Brendan M: As good as 2017.
Tom Mullooly: Right. So we had an excellent year in the market. Then we had, 2014 was basically on its way to a double digit return, 10, 11%. Then we had this Ebola business and the Fed stopped doing QE in 2014, and the market gave it all back. So we went through this period, as Brendan noted, 2015 and ’16, where we were really digesting what’s going on. And what happened in 2017?
Brendan M: Another good year like 2013.
Tom Mullooly: Yeah.
Brendan M: That we then digested in 2018 when the market went down for the year.
Tom Mullooly: Yeah. A lot of people-
Brendan M: You forgot about that one because it was sandwiched in between-
Tom Mullooly: … they forget about it.
Brendan M: … ’17 and ’19, which were good years to be in stocks. But in 2018, we had a 20% draw down in the fourth quarter alone that took us to negative territory for the year, the first down year and the S&P 500 since 2008.
Tom Mullooly: Right. Yeah. So it all happened in a 90 day window.
Brendan M: We’re all fine, and even if you looked back over a couple year period after that, your annualized rate of return was probably fantastic. It’s just that it didn’t come in a straight line. You earned all of it in a year, and then you gave back some, or went flat lined for a couple years after that.
Tom Mullooly: I’m smiling because I had, and you’re probably referring to this, but I had a conversation with a client who was unhappy with the returns. And I said to him, at one point when the market was going down, I said, “Hey look, what if I told you three years ago that you were going to make 10% a year for three years?” He said, “That would be blankety blank great.” And I said, “Okay, here’s the terms. In the first year, you’re going to make 30%. In year two and year three, you will make nothing, and you’re going to wind up with a 10% per year average. Still want to sign up for this?” And he was like, “Okay, okay. I get it.” I’m like, “This is what the market’s giving us.” So, we’re going to have some years where we’re feasting at the table and other years where we just got to wait in line.
Brendan M: I think that there’s periods of time too, it kind of lends itself to that Charlie Ellis idea of not making unforced errors. So you have this period of time where the market’s not doing anything, and that’s probably when you get itchy and you’re like, we should be doing something different. This is clearly not working. We’re not making any money. This is not what I signed up for with stocks. When in reality, it’s a test, because I think during those periods of time, the Charlie Ellis story that I’m alluding to is how amateur tennis is more about not making mistakes and allowing your opponent to hit the ball out of bounds or do something foolish, whereas professional tennis, you need to make the good shot to beat the pro because you’re both excellent.
Brendan M: I think for most investors, you should try to think of investing as amateur tennis in the sense that don’t do something stupid. You don’t need to.
Casey Mullooly: Yeah. And it’s interesting because, I mean, you guys just talked about a handful of stories that were blaring on the news and on MarketWatch and CNBC in these time periods, but the moral of the story, or at least the takeaway that I’ve got from listening to you guys, was stick to the plan. You would be playing the loser’s game if you were reacting and trying to allocate your money based off of all these headlines that were happening too in that time period.
Brendan M: Oil’s going down. We need to be short the regional banks for the next month.
Casey Mullooly: Okay, good luck with that.
Tom Mullooly: Stop it, stop it.
Casey Mullooly: What you said about the 30% average over three years too, I think that that’s an interesting thing that I wanted to get your take on, Bren. That just speaks to how hard it is and how misleading it can be to use things like average returns in a financial plan.
Brendan M: Yeah. I mean, over periods of time, your annualized rate of return is going to look different depending on what lens you’re using to look at it. So over the lifetime of a retirement income plan, I think that your average return will probably look something like historical rates of return over time. But when we’re talking to folks who are on the precipice of retirement, we need to take into account not only what they might average over 30 years of retirement, but especially what are things going to look like over the next five or 10 years, where sequence of return risk is really factoring in, meaning if we’re on our way to annualizing at 10% a year or something in a portfolio for somebody, that’s all great, but if we get a couple of bad ones in the beginning, that’s normal and anticipated, you could get to 10% annualized returns in a million different ways in terms of what you get in year one, two, three, four, and so on, out to year 30.
Casey Mullooly: Right. So I just want to dive into that sequence of return risk is the risk that in years one through five of retirement, you’re going to take a big hit. And then the plan pretty much just gets blown up.
Brendan M: Yeah, you would need to make significant adjustments.
Casey Mullooly: So if you’re taking money from your retirement account in those years, and then you’re also losing 10, 15, 20%, that changes things entirely.
Tom Mullooly: Two bad years in a row will wreck your plan.
Brendan M: It may not wreck the plan. It may just mean you’ve got to change your course, but it’s definitely going to make people sweat. I mean, if you think about a million dollar retirement portfolio, if we have back-to-back years where you’re losing 10% of your money and you’re also withdrawing let’s say 5% in each of those years, I mean, that’s not as it would actually happen in real time, but that’s a third of your portfolio gone. And then you’re looking at that value like, this pile has to last for the next 28 years. That’s frightening. I thought I was in good shape just two years ago. So, you’ve got to be cognizant of how reality is going to play out as opposed to saying, “Well, the markets average this over the long-term. So let’s just anticipate making that every year.”
Tom Mullooly: Right great if it did that.
Casey Mullooly: It’s not a straight line, six, seven, 8% every year. It’s like you said, it’s going to be 30% year one, 0% years two and three, and then who knows. It’s hard enough to predict what the market’s going to do tomorrow. You think we’re going to know what the market’s going to do in 25 years? Again, that’s reality.
Tom Mullooly: Yeah, we want to use these conservative numbers, especially when we’re talking about the future, but as Brendan has shown to a couple of clients recently, if you have trouble in the first year, two or three, it really doesn’t matter what the numbers look like in years 15, 20, 25, if you can’t get there.
Tom Mullooly: Okay. That’s going to wrap up episode Magnum, 357 Magnum. Thanks for tuning in. And we will catch up with you on the next podcast.
Disclaimer: Tom Mullooly is an investment advisor representative with Mullooly Asset Management. All opinions expressed by Tom and his podcast guests are solely their own opinions and do not necessarily reflect the opinions of Mullooly Asset Management. This podcast is for informational purposes only, and should not be relied upon as a basis for investment decisions. Clients of Mullooly Asset Management may maintain positions in securities discussed in this podcast.