It should be no surprise to those who have been following me for quite some time that I absolutely hate the fact of someone else managing my money. I believe that no one else other than myself has my best interest at heart 100% of the time. With that said some things in life are just out of our control and the only thing we can do is manage them as best we can.
My 401k plan prohibits me from investing in individual stocks. The only choices I have are between a handful of Life Cycle Funds and 5 different index funds. I only pay attention to 2 of the index funds and here is why. One of the index funds acts as a money market account (MM index fund) earning less than 1% return annually, the other index fund is aimed at mimicking the return of the S&P 500 (SP500 index fund). Let me be clear, NEITHER of these funds are exactly what I want. If I had my way I would let my money sit in cash instead of a money market account or purchase shares in the actual S&P 500. But as I said previous sometimes you have to deal with what you have.
1. How I Manage My Contributions
Because I do not trust anyone else to manage my money I only contribute the maximum amount that my company is willing to match. For example, if my company is only willing to match 5% of my salary and that comes out to $3000/year then I only contribute $3000/year for a combined total of $6,000/year. A 100% return on my money instantly! You can’t beat it and if you are not doing the same you’d better have a good reason!
When allocating money in my 401k I use 2 indicators to base my decisions:
- S&P 500 Monthly Exponential Moving Average (EMA) of 20
- Shiller PE10 Ratio
2. How I use the S&P 500 20 Monthly EMA:
Let be crystal clear, there is nothing magical about the 20 month EMA. I use it simply to establish and follow a trend. When you are young you have time working for you and it is in your best interest to follow long term trends. The system is simple, so simple in fact a 3rd grader can understand and implement it. This is no scam or gimmick and I will prove it to you in a moment. At the end of every month I log into my account to check the price of the S&P 500, if the price is ABOVE the 20 Month EMA I leave my money vested in the SP 500 index fund. If the price of the S&P 500 is BELOW the 20 Month EMA I cash out of the SP 500 index fund and move my money into the MM index fund.
Take a look at how this strategy has worked over the past 20 years!
As I said it is so simple a 3rd grader can understand it. Here is a general summary (quick glance) break down of how you would have performed:
- 1993 – 2001: 225% Return
- Mid 2003 – 2008: 40% Return
- Late 2009 – Present: 33% Return (Not accounting for the whipsaws that occurred)
I apologize that I did not have time to sit down and back test this system for you and provide an example. Please don’t let that blind you from seeing the bigger picture. Also, keep in mind that these returns DID NOT include dividends issued. The main take away for you is to FOLLOW THE TREND!!
3. How I use the Shiller PE10 Ratio
I pound my fist on the table repeatedly when explaining to family members that stocks are businesses and not just pieces of paper. The bottom line when it comes to investing is you want to own GREAT BUSINESSES and buy those businesses at DISCOUNT PRICES. Plain and simple!
The S&P 500 consists of the “top” 500 publicly traded companies in the United States as determined by Standard & Poor. With that being said by purchasing shares in the S&P 500 you are purchasing 500 different companies. Since I am a long term investor it is wise for me ONLY to allocate NEW money when the the S&P 500 is trading at fair value or a discount.
What is a fair value for the S&P 500? I use the Shiller PE10 ratio to determine this, a Shiller PE Ratio of 15 is fair value!
- If the Shiller PE Ratio is under 15 then I allocate my monthly deposits from my paycheck into the S&P 500 index fund.
- If the Shiller PE Ratio is over 15 then I allocate my monthly deposits from my paycheck into the MM index fund.
It’s that simple!
Let’s take a look at how this system would have done over the past 20 years.
Unfortunately there was only one buying opportunity within the last 20 years when the S&P 500 was trading under fair value. This is typical rarely do good businesses trade at a great value.
4. How To Put It All Together
But wait a minute Marvin… you said you put money in your SP 500 index fund when it trades above the 20 Month EMA but then turn around and say you only allocate new money to the SP 500 index fund when the S&P 500 is trading under fair value. I’M CONFUSED!!!
I apologize for the confusion, but I had to explain both steps separately in order for you to understand their purpose. Now that we have both concepts down I am going to give you the rules one by one.
- Rule #1: If the Shiller PE Ratio is below 15 I allocate ALL capital into the SP 500 index fund.
- Rule #2: Rule #1 trumps everything else!
- Rule #3: Utilize the S&P 500 20 Month EMA method when the Shiller PE Ratio is ABOVE 15.
I know this requires an active approach for your 401k and far exceeds making a one time decision when you first join a company then forgetting about it. I will tell you however that it is WELL WORTH the 10 minutes a month. I’ve even made it easy on myself. In my google calendar I set up an alert that hits my inbox at the end of every month and have links to the closing price of the S&P 500 for the month as well as the link to the Shiller PE10 Ratio.
If you want to make it easy on yourself, you can subscribe to my monthly newsletter where I monitor these indicators and give you the results.
As always ANY QUESTIONS you have please do not hesitate. If you’re feeling shy and don’t want the whole world to see your question email me: email@example.com
Here’s to Our Wealth!