Should You Be Investing In The Stock Market Right Now (And How Much)? Here’s How To Decide!

At 30-40 Wealth, a question we frequently hear from new (and prospective) clients is “should I be investing in the stock market right now?”. This question is frequently followed by “How Much?”

It’s an important question to ask, and helping individuals/households arrive at an answer is a core part of both the financial and investment planning process. As such, it’s something we address with every client when we start working together, as well as re-review and update each year.

Similar to our approach to other key financial planning questions, we’ve developed a process framework to help us and our clients jointly arrive at an answer that is best for them. Given how frequently we hear this question, and how important we believe it is for a household to answer it for their unique situation, we wrote this blog post to share the core parts of our philosophy and process framework.

Our Cash Management & Investment Philosophy

Before we dive into the process framework, we believe it’s important to first detail a few parts of 30-40 Wealth's philosophy regarding managing cash and investment portfolios:

• (i) Cash needed in the near term (0-12 months) should not take any risk

• (ii) Cash needed in the medium term (1-5 years) can be invested if desired, but the investment portfolio should target a lower risk level (taking no risk with these funds is also perfectly acceptable)

• (iii) Long-term capital (5+ years; frequently 30+) should be invested in accordance with an individuals risk profile (e.g. typically taking on a higher level of risk in exchange for higher target returns)

• (iv) A long-term portfolio is exactly that—invested for the long term—and we don't believe that anyone can time the market. Investing of course has risk (e.g. the worst 1-year return for the S&P500 was -42.4%). But we seek to only allocate capital to stocks when clients plan to hold for many years (likely decades). When you have that long-term horizon, good years tend to more than cancel out the bad, resulting in attractive overall annual returns (e.g. the lowest annual average return for the S&P 500 over a rolling 30-year period was positive ~8.5%).

Step-By-Step Process: How To Determine If You Should Invest In The Stock Market (And How Much)

When we get asked the “should I be investing in stocks, and if so, how much” question, we’ve found that the reason(s) an individual asks this tends to stem from a handful of underlying concerns (i.e. if you are asking yourself this question, our guess is that’s because of one or more of the following reasons):

• Prospective concerns about the amount of cash they are holding, (e.g. are they under-invested)

• Prospective concerns about stock market volatility, and risk of loss

• Large planned (or likely) upcoming asset purchases (e.g. home down payment) or expenses (e.g. taking a sabbatical, or launching a company)

• Questions about how to incorporate their stock options into their holistic investment strategy

The process we use at 30-40 Wealth with our clients to address this question (and their underlying concerns) is to (i) help them mentally allocate their capital into three “buckets” based on if/when they anticipate needing the capital in the future, (ii) ensure that each bucket is invested in accordance with a risk-profile that they are comfortable with, and then (ii) re-assess each year as things change.

Step 1: Estimate Future One-Time Expenses & Savings Rate

We first confirm that you have a positive savings rate*. After that, we estimate the cost impact of all future one-time expenses you have planned (home down-payment, sabbatical, starting a business, planned large investments).

* if you don’t have a positive savings rate, the way we would approach this is different and outside the scope of this blog post).

Step 2: Allocate Future One-Time Expenses Into 3 "Time Buckets"

Once we’ve estimated your future one-time expenses, we bucket each of them into one of three groups based on when we anticipate it will occur.

Step 3: Determine How Much Capital To Invest Long-Term

Next, some simple math determines how much capital we believe is prudent to allocate to, and invest, long-term.

Note: This analysis does not take into account retirement accounts (401ks, IRAs). For mid-career professionals, unless there is significant financial distress (and a potential need to withdraw funds early from these accounts), these accounts are, by their nature, long-term investment accounts.

Step 4: Determine Your Risk Profile

When there is capital to invest long-term, understanding/determining an individuals/households risk profile is key. The details of how we do this is outside the scope of this blog post, but at a high level we:

• Take into consideration both an individuals/households (i) preference to take risk, and (ii) capacity to take risk

• Review risk profile and the target investment portfolio it corresponds to with client (re-confirming estimated long-term average returns and variation risk)

30-40 Wealth primarily works with mid-career tech professionals. These households typically have above-average incomes, a higher tolerance for risk, and occasional large cash windfalls. As such, their risk profiles is typically on the higher end of the spectrum (i.e. Growth or Aggressive Growth).

Step 5: Determine Investment Strategy For Each "Time Bucket"

By definition, each time bucket has a different timeline until the funds are needed. To ensure the funds are available with a reasonably high degree of confidence, we recommend a different level of risk for each of the buckets: no risk for near-term outflows, some or no risk for medium-term outflows, and risk in-line with your risk profile for capital invested long-term.

Re-Assess Annually (And Adjust If/As Necessary)

A lot can change in a year. As such, we re-run this analysis with our clients each year, and adjust when/where necessary. Changes to the above frequently include

• Annual savings increase the amount of capital allocated to the long-term bucket

• One-time expenses get paid, or shift closer — and we need to adjust the capital between the buckets

• Life happens (e.g. job change, relocation, etc.); we update to fit our clients new life

Client Example

A household has the following financial profile and future

• Dual-income household making $300k per year, maxes out their 401k, and after tax saves around $40k per year.

• Both individuals are mid-30s, strong performers in their jobs, and anticipate strong income growth over the next few years (e.g. increasing income via raises and promotions)

• The couple has a total of $350k in retirement accts savings, and an additional $800k in savings

• The couple anticipates a number of life changes and one-time future expenses:

  • A need to pay ~$100k in taxes when they file (~9 months from now) due to some recently recognized long-term capital gains

  • They plan on starting a family in “a couple years”; after paid maternity/paternity leave, one of the individuals anticipates taking 1 year off of work (unpaid)

  • They are currently renters, but anticipate purchasing a home in 3 years (20% down-payment, $1m estimated purchase price)

• Both individuals have pre-IPO stock options; the value of their options is estimated at $600k for one and $1.2m for the other

• The household has a “Growth” risk profile

Step 1: Estimate Future One-Time Expenses; Confirm Positive Savings Rate

• Savings rate is positive. Currently saving ~$40k/yr (after maxing 401ks), and savings per year is anticipated to grow moving forward

• Multiple future one-time expenses

  • $100k in taxes due [~9 months from now]

  • ~1 year unpaid time off of work; estimated capital need is ~$125k [2-3 years from now]

  • $200k home down-payment [3 years from now]

Step 2 & 3: Allocate Future One-Time Expenses Into 3 “Time Buckets”

• Near-term Bucket (0-12 Months): $100k

• Medium-term Bucket (1-5 years): $325k

• Long-term Capital Bucket: $725k total across retirement accounts and savings

Step 4: Determine Risk Profile

• Previously completed/known (Growth risk profile)

Step 5: Determine Appropriate Investment Strategy For Each “Time Bucket”

• Near-term Bucket (0-12 Months): $100k allocated to US Treasuries maturing in ~8 months (i.e. 1 month before client will need to pay the tax)

• Medium-term Bucket (1-5 years): $325k allocated to 30-40 Wealth’s lower-volatility-target portfolio

• Long-term Capital Bucket: $725k allocated to a Growth Portfolio, with select assets strategically allocated to the taxable and/or retirement accounts to optimize for tax (”asset location”)

How Do We Handle The Pre-IPO Stock Options?

• We would have worked with the clients to independently develop a tax and exercise strategy for their stock options separate from this investment analysis

• If a liquidity event occurs, we would

  • (i) re-review + align on a (likely new) strategy for the stock option holdings, and

  • (ii) likely adjust the long-term investment portfolio, as there is now either more cash (acquisition, secondary sale) or a liquid concentrated position (IPO)

• Otherwise, in most cases we would be conservative and assume there would not be a liquidity event (re: the stock options), and thus not include them in the investment portfolio analysis